Magazine article Journal of Commercial Lending

Companies in Trouble: What Are the Auditor's Responsibilities?

Magazine article Journal of Commercial Lending

Companies in Trouble: What Are the Auditor's Responsibilities?

Article excerpt

Auditors have access to company information that is unavailable to outsiders. Because of this, it is generally perceived that auditors are in the best position to recognize potential business failures. Consequently, many believe that auditors should provide timely warnings to investors, creditors, and other third parties. Some professionals within the accounting profession consider this expectation to be unrealistic and beyond the scope of an audit. Furthermore, accounting professionals are quick to point out that an audit is intended to provide assurances about the fairness of a company's financial statements and not about its financial condition.

The debate about auditors' responsibilities intensified after a rash of high-profile business failures in the mid-1980s. The bankruptcies frequently were preceded by "clean" audit reports. The cry "Where were the auditors?" was increasingly voiced by reporters, lawmakers, and lawyers, and business failures began to be viewed as audit failures.

The erosion of public confidence in the auditing profession led one major accounting firm to suggest that auditors address the public's concerns head-on by accepting the responsibility of assessing a company's financial condition. After lengthy debate, the accounting profession attempted to address the growing gap between the public's expectations and the profession's own view of its responsibilities with a set of nine new auditing standards commonly referred to as the expectation-gap audit standards. Among the new standards was Statement on Auditing Standards (SAS) No. 59, "The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern" which increased the auditor's responsibility to assess and report on a company's ability to continue as a going concern.

Responsibilities under SAS No. 59

Under SAS No. 59, an auditor's evaluation of a company's going concern status can be a two-step process.

Evaluate the Evidence

In the first step, which is required for every audit, the auditor must evaluate the evidence obtained during the audit to determine whether conditions or events exist that raise substantial doubts about the company's ability to continue as a going concern. The auditor is not required to perform any procedures specifically aimed at assessing the company's financial condition. Instead, the standard states that the evidence obtained from other procedures should be sufficient for this purpose. SAS No. 59 includes the following examples, which are not intended to be exhaustive, of conditions and events that could raise substantial doubts regarding the company's condition:

1. Negative trends

* Recurring operating losses.

* Negative cash flow from operations.

* Deficiencies in working capital.

* Adverse financial ratios.

2. Internal events

* Labor difficulties.

* Uneconomic long-term commitments.

* Dependence on the success of a particular project.

3. External events

* Loss of a principal customer or supplier.

* Expiration of key patents or licenses.

* Uninsured catastrophic losses.

* Legal proceedings.

4. Other indications of financial difficulties

* Technical default on loan agreements.

* Absence of normal credit arrangements with suppliers.

* Nonpayment of dividends.

* Debt restructuring.

While an auditor does not perform procedures specifically designed to assess a company's financial health, it seems unlikely that an auditor would fail to uncover these types of conditions and events after a detailed examination of a company's financial records. It also seems unlikely that the auditor would fail to recognize that such factors may indicate financial distress.

If, based on the available evidence, the auditor does not have substantial doubts about the company's ability to continue as a going concern, no further procedures are required under SAS No. …

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