Auditing The Going Concern Assertion - Coursework Example

The of Greenwich Business School Audit and Assurance (ACCO 1125) work  Insert your at this point (UoG-UK/ABRS/TMC/SEGI) AUDITING THE GOING CONCERN ASSERTION  Insert your name and ID number at this point  Insert your programme at this point Course Leader: Julian Spencer-Wood  Insert the date at this point Contents Page 1. Introduction 2. The Data (or findings) and Analysis 2.1 Going Concern Assumption: The Management’s Role 2.2 Going Concern Assumption: The External Auditor’s Role 2.3 The Financial Crisis and the Going Concern Opinion 2.4 Criticisms on Auditor’s Role on the Going Concern Assumption 2.5 Potential Changes in Auditing Going Concern Assertions 3. Conclusion 4. Recommendations 5. References 6. Appendix 1 7. Appendix 2 8. Appendix 3 Required: You are to consider how the auditor approach the directors’ going concern assertion; how and why has it changed over time; most importantly, what current criticism and proposals have been initiated since the ‘credit crunch’ (related to the auditor and auditing)? You may take a broad approach or focus in depth on certain aspects related to the topic in the main body of you report. Remember it is about AUDIT not ACCOUNTING aspects; it is not just descriptive (‘how’), but ‘investigative’ - What is happening? Why? Do people agree or disagree? Are changes called for? ’….. ‘What can I draw from my data?’ 1. Introduction For any business, there is always the assumption that the business will continue for a long time. In accounting, this assumption is referred to as going concern. According to the Framework for the Preparation and Presentation issued by the International Accounting Standards Board (IASB), the going concern is one of the two fundamental assertions used when preparing the financial statements (Deloitte, Framework, 2010). It ‘provides perspective on the future of the entity’ (Gibson, 2009) as it presumes the long – term continued existence of the company. The primary responsibility for assessing the going concern lies with the company’s directors. On the other hand, the company’s external auditor has the responsibility of verifying whether such an assertion is valid and ‘has been adequately disclosed in the financial statements’ (Gray and Manson, 2008). The International Standards on Auditing (ISA) 570 discussed the extent of the auditor’s responsibility when it comes to auditing the management’s going concern assertion (IFAC, 2009). The credit crunch and the bankruptcy of several big companies in 2008 and 2009 have spotlighted the growing apprehension on the going concern assumption. According to Ed Nussbaum, Chief Executive Officer of Grant Thornton, the public ‘will see an unprecendented number of going – concern footnote disclosures and clarification from the auditors’ (as quoted by Johnson, March 2009). This rise in going concern opinions (GCOs) had put more pressure on the auditors. It had also caused auditors and their clients ‘to get testy with each other about the company’s ability to survive’ as management sometimes sees GCOs as something that will contribute to the demise of the company (Johnson, April 2009). This paper will analyze how the going concern assertion developed and its importance in a business entity. It examines the external auditor’s role in providing assurance in the validity of this assertion and how this role has changed over time. It also analyses how the financial crisis has affected the external auditors and their audit work and how the financial crisis has affected the audit of the going concern assumption. 2. Main Body 2.1 Going Concern Assumption: The Management’s Role Based on International Accounting Standards (IAS) 1, Presentation of Financial Statements, management is the one responsible for assessing whether or not the entity has the ability to carry on as a going concern (IFAC, 2009). This is reiterated in the draft Statement of Financial Accounting Standard (FAS) that was issued by the U. S. Financial Accounting Standards Board (FASB) in 2008. The FAS (2008) clearly stated that the responsibility for assessing that the entity is a going concern is with management. These two standards would show that both the IASB and the FASB hold the same view as to who is really responsibility for assessing whether or not the entity is a going concern. This view is based on the facts that, first, the entity’s management has the ability to identify those conditions or situations that may indicate that the entity may not be able to continue its operations in the future. Second, management is also the one who can make and implement plans in the future that may mitigate these conditions. 2.2 Going Concern Assumption: The External Auditor’s Role The external auditor is also a major party ‘in the assessment of a company as a going concern’ (Williamson, 2001). The standards on auditing do not exactly require auditors to go through every nook and cranny of the financial statements and look for evidence that the company is not a going concern. However, this is one of the major areas of concerns of the auditing profession. Paragraph six of ISA 570 requires auditors to gather enough ‘appropriate audit evidence’ (IFAC, 2009) to verify if the management’s going concern assertion is proper under the circumstances. However, Paragraph 7 of the same ISA noted that due to limitations that are inherent in an auditor’s work, the auditor does not have the ability to predict the future. This shows that the IFAC is still cautioning the readers not to totally rely on the auditor’s going concern opinion or the lack thereof. 2.2 The Financial Crisis and the Going Concern Opinion It is undeniable that the auditing profession has its shares of criticisms and concerns. With the current financial crisis, criticisms and concerns about the GCOs have been growing. However, prior to discussing these criticisms, a discussion on how the financial crisis has affected the GCOs issued by the auditors is in order. Experts believed that ‘the going concern qualification in the audited financial statements is going to be a big issue’ in 2009 (Kalavacherla, as quoted by Reuters, 2009). As a matter of fact, the number of GCOs was seen to peak in 2009, with high profile companies such as General Motors heading the list of those companies that received a GCO (Chasan, 2009). The United States Securities and Exchange Commission even projected an almost twenty – three per cent (23%) increase in the number of companies with GCOs in 2009, as compared to 2008 (Nelson, 2009). The general feeling that the GCOs will have a negative impact on the companies caused several authoritative bodies to issue clarifications and to launch awareness programs on GCOs. In a practice alert issued by the International Auditing and Assurance Standards Board (IAASB; 2009), the IAASB clarified that the ‘existence of the credit crisis…does not of itself create the need for an emphasis’ or a GCO. Such a clarification was echoed by the Institute of Chartered Accountants in England and Wales (ICAEW). In its 2009 publication, the ICAEW sought to increase the awareness of the company’s directors and the public. The publication stated quite clearly that GCOs ‘do not necessarily mean the end’ (ICAEW, 2009) of the company and provided guidelines on how the company’s directors should handle such a situation. 2.3 Criticisms on Auditor’s Role on the Going Concern Assumption With the public seeing more and more companies going bankrupt in 2008 and 2009, criticisms on the auditor’s role in these bankruptcies, in general, and the going concern assumption, in particular, were rising. One such criticism is the failure of the auditors to raise going concern warnings or issue GCOs on companies (i.e., Lehman Brothers) that went bankrupt in 2008 and 2009 (Sikka, 2009). Several companies that actually declared bankruptcies during this two – year period received unqualified opinions from their external auditors shortly before their declaration. This puts doubt on the validity of the actual opinion issued by the external auditor. Appendix 2 shows the table published in P. Sikka’s (2009) article that showed distressed financial institutions from various countries that received unqualified opinions from their auditors. As the author conceded, this table is not complete; however, it is sobering to note just how far off the opinions issued by the external auditors were to the actual situation of these companies. The second criticism is that the GCO may actually become a ‘self – fulfilling prophecy’ (Johnson, March 2009), as there is fear that the GCO may accelerate the company’s bankruptcy as the various stakeholders and the public shy away from the company once they see the GCO. A study conducted in Portugal showed that companies that receive GCOs ‘are more likely to default in comparison with’ companies that receive clean opinions (Bhimani, Gulamhussen and Lopes, 2006). However, another study, conducted in 2001, noted that there was no ‘evidence of the self – fulfilling prophecy argument’ (Citron and Taffler, 2001). Despite this, the perception has persisted throughout the years. It is no wonder then that the auditors and their client’s management and directors spend long hours discussing (and even debating) whether or not a GCO is appropriate for the entity. The third criticism is broader in nature as it deals with auditor independence and ethics as these ultimately affect the auditor’s decision whether or not to issue a GCO. Critics have cited that external auditors are reluctant to issue GCOs or to even give going concern warnings due to independence issues and conflicts of interest (Rodgers, Guiral and Gonzalo, 2008). This criticism has been present for a long period of time and will not likely go away even if the financial crisis comes to an end. 2.4 Potential Changes in Auditing Going Concern Assertions With the criticisms against GCOs, it is highly probable that there will be changes in the way external auditors audit the going concern assertions. FASB’s issuance of a FAS for going concern was not only meant to coincide with the related rules of IAS 1 but also to require the entities’ management to assess the ability of the entity to continue as a going concern within (at least) a twelve – month period after the balance sheet date (FASB, 2008). The publication of a FAS devoted to going concern reflects what FASB perceived as the need to ‘define going concern’ (Grant Thornton, 2009) as well as clarify certain concerns or issues about going concern. The time period is also a potential change for auditing going concern assertions. Under auditing standards, the rule is for auditors to ‘keep their assessments to under the year from when they review a company’s financial statements’ (Johnson, March 2009). However, the above FAS set a minimum time frame of twelve months. Thus, management’s assessment may actually be longer than what the auditors are required to review. Although such a change has been criticized because it increases the uncertainty involved in this assertion, the jury is still out whether this will actually be implemented or not. Another change, which is already happening but may actually take – off post – credit crunch period, is the increasing instances when GCOs are issued. After the bankruptcy of Enron in 2001 ‘there is evidence that auditors have been issuing more going concern modified audit reports post – 2001’ (Carey, Kortum and Moroney, 2008). A similar study was conducted by Linda Myers, Jaime Schmidt and Mike Wilkins (2009) where the conclusion was that going concern reporting post – 2001 has improved and became more conservative. Appendix 3 shows the three major tables included in this study. 3. Conclusion The going concern assumption is one of the cornerstones behind the preparation of the company’s financial statements. It is a critical part that both management and the external auditors are required to take an active part in. The credit crunch had brought to the forefront the increasing awareness on the external auditor’s responsibility to issue these GCOs. The crunch had also caused the number of GCOs to rise, with the public becoming more and more concerned about such cases. Criticisms against the auditing profession and the GCOs have also been on the rise during this time. Some of these criticisms include the inability of the external auditor to issue a GCO when the situation actually warrants it. Another is the fear that the GCOs are actually ‘self – fulfilling’ (Citron and Taffler, 2001) and that the companies may not be able to recover fully if they are issued GCOs. Still another is the over-all criticisms about auditor independence and ethics, as they connect to the GCO. With the above criticisms and the effects felt during the financial crisis, it is quite possible that the audit of this assertion will see some changes in the future. One is the issuance of FASB’s FAS on going concern. Another is the potential change in the time frame for assessing the going concern. Still another (which is in fact ongoing) is the increasing number of instances that GCOs are issued. These changes are all for improving the profession, in general, and the quality of audit opinions issued, in particular, and it is interesting to see how they will unfold in the future and whether or not the aftermath of the financial crisis will bring in lasting changes as far as the auditing of the going concern assertion is concerned. 4. Recommendations There are many points for recommendation related to the above discussions. One recommendation is for the auditors to always ensure that they remain independent, vigilant and ethically guided. This means that they should not be afraid to issue a GCO warning or an actual GCO when they feel the situation warrants such an opinion. Moreover, auditors also need to make sure that they fully consider the going concern assessment and only refer to going concern in their audit reports when appropriate. The companies’ directors should properly consider the going concern assumption when preparing their companies’ financial statements. Proper documentation, analysis and consideration of the situation should be done to ensure that every angle is considered. The directors should not be afraid of losing the public’s trust when they announce the results of the going concern assessment as they need to be as honest as possible to avoid letting down their investors and the public who depend on them. Lastly, public awareness on the nature of the GCOs and what they really mean should be raised. Most of the criticisms and concerns came from fears that GCOs will spell the ultimate demise of the company. However, this is not always the case and this should be emphasized. In fact, the GCO can be used by the directors and the investors to pursue strategies that will revive the company and ensure its survival in the long term. 5. References Bhimani, A., Gulamhussen, M. and Lopes, S. (2006). The Effectiveness of the Auditor’s Going Concern Evaluation as an External Governance Mechanism: Evidence from Loan Defaults. Available from: http://www.business.illinois.edu/accountancy/research/vkzcenter/%20conferences/hawaii/papers/Bhimani%20Gulamhussen%20Lopes.pdf [Accessed 12th February 2010]. Carey, P., Kortum, S. and Moroney, R. (2008). Auditor’s Going Concern Modified Opinions Post 2001: Increased Conservatism or Improved Accuracy. Available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1309943 [Accessed 13th February 2010]. Chasan, E. (2009). Auditor “Going Concern” Warnings Seen Peaking in ’09, Reuters.com, Available from: http://www.reuters.com/article/idUSTRE51Q0F620090227 [Accessed 14th February 2010]. Citron, D. and Taffler, R. (2001). ‘Ethical Behaviour in the U. K. Audit Profession: the Case of the Self – Fulfilling Prophecy Under Going – Concern Uncertainties’, Journal of Business Ethics, Volume 29, Number 4 ,pp 353-363. Deloitte (2010). Summaries of International Financial Reporting Standards: Framework for the Preparation and Presentation of Financial Statements. Available at: http://www.iasplus.com/standard/framewk.htm [Accessed 11th February 2010]. FASB (2008). Proposed Statement of Financial Accounting Standards: Going Concern: Available at: http://www.fasb.org/ed_going_concern.pdf [Accessed 12th February 2010]. Gibson, C. (2009): Financial Reporting and Analysis, 11th ed, Ohio: South – Western Cengage Learning 2010]. Grant Thornton (2009), On the Horizon. Available from: http://www.gt.com/staticfiles/GTCom/files/services/Audit%20and%20assurance%20services/Assurancepublications/OntheHorizon/Jan_March_2009_On_The_Horizon/OTH_02-23_09Tax.pdf [Accessed 14th February 2010]. Gray, I. and Manson, S. (2009): The Audit Process. 4th ed. London: Thomson Learning.]. Holmes, D. (ed., 2009). “Going Concern” Dilemma Puts Audit in Spotlight. Reuters.com. Available from: http://www.reuters.com/article/idUSTRE50Q28N20090127 [Accessed 13th February 2010]. ICAEW (2009), Don’t Panic. Available from: http://www.icaew.com/index.cfm/%20route/162847/icaew_ga/Home/About_us/Institute_in_Accountancy/Going_Concern_Article_January_2008/pdf [Accessed 12th February 2010]. ICAEW (2010). Benefits of Joining the ICAEW. Available at: http://www.icaew.com/index.cfm/route/125716/icaew_ga/en/Home/Join_us/Why_join_the_ICAEW/Benefits_of_joining_the_ICAEW [Accessed 14th February 2010]. Johnson, S. (April 2009). Regulators Eye “Going Concern” Concerns. CFO.com. Available at: http://www.cfo.com/article.cfm/13436183/1/c_2984378 [Accessed 12th February 2010]. Johnson, S. (March 2009). ‘The Growing Concern Over “Going Concern’. CFO.com. Available at: http://www.cfo.com/article.cfm/13252004/1/c_2984378 [Accessed 11th February 2010]. IAASB (2009). Audit Considerations in Respect of Going Concern in the Current Economic Environment. Available from : http://web.ifac.org/download/IAASB_Staff_Audit_Practice_ Alerts_2009_01.pdf [Accessed 12th February 2010]. IFAC (2009). International Standard on Auditing 570: Going Concern. Available at: http://web.ifac.org/download/2009_Auditing_Handbook_A031_ISA_570.pdf [Accessed 12th February 2010]. Myers, L., Schmidt, J. and Wilkins, M. (2009). ‘An Investigation of Recent Changes in Going Concern Reporting Decisions Among Big N and Non-Big N Auditors’. Available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1411316 [Accessed 13th February 2010]. Nelson, M. (2009). Going Concern or Not a Going Concern? That is the Question. Available at: http://www.cbh.com/news/newsletter_details.asp?id=287 [Accessed 14th February 2010]. Rodgers, W., Guiral, A. and Gonzalo, J. (2008). ‘Different Pathways that Suggest Whether Auditors’ Going Concern Opinions are Ethically Based’, Journal of Business Ethics, Volume 86, No 3, pp 347-361. Sikka, P. (2009). ‘Financial Crisis and the Silence of the Auditors’, Accounting, Organizations and Society, Volume 34, Issues 6-7, Pages 868-873. Williamson, D. The Going Concern Principle: When and How to Assess the Value of a Company and/or Its Assets. Available at: http://business.fortunecity.com/discount/ 29/goingconc.htm [Accessed 11th February 2010]. 6. Appendix 1 Word count: 2,197 6. Appendix 2 7. Appendix 3 Read More