Magazine article Journal of Commercial Lending

How Auditors' Reporting Choices Influence Loan Officers' Decisions

Magazine article Journal of Commercial Lending

How Auditors' Reporting Choices Influence Loan Officers' Decisions

Article excerpt

How influential is an auditor's report on whether loan officers grant a loan? A special study of RMA Associates considered four case studies. This article present the results, which explore the way loan officers distinguish between potential borrowers with audited statements containing unqualified modified reports and disclaimers when material financial statement uncertainties are present.

Currently, the American Institute of Certified Public Accountants' Auditing Standards Board (ASB) provides auditors with a "free choice" of report in the presence of material financial statement uncertainties. With those uncertainties, including going-concern uncertainties, the auditor can issue a report that is technically unqualified but contains an explanatory paragraph describing the nature of the uncertainty (an unqualified modified report). The auditor also has the option of issuing an opinion stating that the nature of the uncertainties prevents him or her from expressing an opinion (a disclaimer).

At present, no guidance is provided by the ASB on when to issue either an unqualified modified report or a disclaimer. This lack of direction may stem from a perception by the ASB that financial statement users consider both forms of report to be equivalent. It may also result from the ASB's inability to determine when each reporting alternative should be issued.

Study Background

This article describes the results of a study that examined whether senior bank loan officers consider both forms of reporting to be equivalent. One of four questionnaires was mailed to 2,000 senior loan officers selected by Robert Morris Associates (see Table 1). A case study in each questionnaire contained background information regarding the main products and activities of a company, financial statements (balance sheet, income statement, cash flow statements, and notes to the financial statements), the auditor's report, and a series of questions. The loan officers were asked whether they would grant a requested line of credit. Questions also were asked that measured loan officers' perceptions of risk.

Table 1. Experimental Materials

Nature of Uncertainty       Unqualified Modified   Disclaimer
                            Report

General uncertainty         Case study 1          Case study 2
                            Farm Equipment Inc.   Farm Equipment
                                                  Inc.

Going-concern uncertainty   Case study 3          Case study 4
                            Medical Guide Inc.    Medical Guide Inc.

Four Case Studies

Two case studies involved Farm Equipment Inc., a manufacturer of agricultural equipment, that faced litigation from a customer alleging inadequate performance on a contract. The lawsuit, if successful, would not have affected the company's solvency. Five hundred loan officers received the case accompanied by an auditor's unqualified modified report; another 500 loan officers received the case with a disclaimer of opinion by the auditor. (The only difference between the case studies mailed to the two groups was the auditor's report.) Any differences in reaction (decision to grant or not grant the requested line of credit) or perception of risk between the two groups would be attributable to the type of auditor's report.

Two other case studies involved Medical Guide Inc., a company that sold software to the medical profession. This company faced going-concern uncertainties owing to a programming error that tarnished its image in the market. Again, 500 loan officers received the Medical Guide case with an unqualified modified report while another 500 received an identical case study with a disclaimer report.

The number of loan officers who responded to each case study and their loan decisions are shown in Table 2. (A total of 489 loan officers provided usable responses representing a response rate of 24. …

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