Going Concern Audit Opinions: Why So Few Warning Flares?

Photo From the Eyes Wide Open Exhibit, Chicago, November 2006.

Lehman Brothers. Bear Stearns. Washington Mutual. AIG. Countrywide. New Century. American Home Mortgage. Citigroup. Merrill Lynch. GE Capital. Fannie Mae. Freddie Mac. Fortis. Royal Bank of Scotland. Lloyds TSB. HBOS. Northern Rock.

When each of the notorious “financial crisis” institutions collapsed, were bailed out/nationalized by their governments or were acquired/rescued by “healthier” institutions, they were all carrying in their wallets non-qualified, clean opinions on their financial statements from their auditors. In none of the cases had the auditors warned shareholders and the markets that there was “ a substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited.”

From a speech to the AICPA Conference in December 2008 by former PCOAB Chief Auditor and Director of Professional Standards Tom Ray:

“…The auditor’s evaluation (under AU 341) is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Conditions or events that may indicate there is substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time include, for example –

Negative trends – for example, recurring operating losses, working capital deficiencies, negative cash flows from operating activities, and adverse key financial ratios

Other indications of possible financial difficulties – for example, default on loan or similar agreements, denial of usual trade credit from suppliers, noncompliance with statutory capital requirements, and the need to seek new sources or methods of financing or to dispose of substantial assets

Internal matters – for example, work stoppages or other labor difficulties, uneconomic long-term commitments, and the need to significantly revise operations

If you have been reading the financial press over the past several months, I imagine these types of things sound familiar to you. I think it is reasonable to assume that more companies than in the past will exhibit one or more indicators of substantial doubt. If such indicators are present, I encourage you to engage in a dialog with your client’s management and audit committee about these matters as soon as possible.”

So I asked Don Whalen, Director of Research at Audit Analytics, to update their March of 2009 study that looked at trends in “going concern” opinions issued by auditors.  In April 2009 Compliance Week quoted Mr. Whalen as saying that:

“If filing patterns for 2008 year-end financial statements hold steady, an increasing number of accelerated filers listed on major stock exchanges will get audit opinions expressing doubts about their ability to continue as going concerns.

According to analysis of going concern opinions filed by auditors for previous years and for early 2008 results, Audit Analytics says 23 percent of all 2008 audit opinions for publicly listed entities will say there’s a question about whether the entity will still be in business a year later. To boot, a larger-than-usual number of those audit opinions will be handed out to major entities listed on major exchanges.”

Well, Mr. Whalen made a pretty damn good prediction. According to updated figures, obtained exclusively this week by re: The Auditors, the percentage of audit opinions with “going concern” opinions went up to 21.4% in 2008 versus 20.88 % in 2007 and less than 20% in all prior years going back to 2000.

Because the total number of Audit Opinions dropped by 7.2% in 2008 (15773 opinions in 2007 compared to 14641 in 2008), the absolute total number of going concerns went down in 2008 even though the percentage went up. There is also a noticeable spike in the number of “going concern” opinions for large accelerated filers.

Another interesting comment Mr. Whalen made to me explained what happened to those 2007 “going concern” opinion companies.

“I was a little surprised that only 14,161 auditor opinions were filed with the SEC in 2008.  This number is much lower than the prior year’s amount of 15773. Of the 3293 Going Concerns in 2007, here’s the overview of the status of some of those companies today:

·         826 are now a Shell, Blank Check, or Non-Operational Establishment;

·         In addition, 184 different companies filed a termination with the SEC;

·         An additional 13 uncounted companies filed a notice with the SEC of a Chapter 7 bankruptcy; and

·         This does not include an addition 49 companies that went dark (have not filed with the SEC in 18 months).

The total of the categories above equals 1072 companies. Therefore, over 1000 companies that had a “going concern” opinion in 2007 seemed to have stopped operating as a substantial entity. (Note from fm: I would say that was a pretty good early warning system! )

I also noticed that outside the group of companies listed above, an additional 64 would be characterized as emerging companies (companies that filed an S-1 or equivalent but has yet to file a periodic report such as a 10-KSB).”

So what does this tell us about the value of the “going concern” opinion to warn shareholders and the markets of companies that are fragile, in a precarious state, engaging in risky business or trying to operate with an inadequate business model in risky markets? Tells me it’s pretty damn valuable and should be encouraged even more. And when it’s not provided and should have been, the auditors should be held responsible.

And to do that, someone like Judge Jed Rakoff needs to go “all activist on their auditor tails” versus being “pragmatic” like Judge Richard Posner.

Attitudes such as those previously expressed by Judge Posner regarding the auditors’ role in the capital markets system serve us as poorly as those of the judges who used to sign off on SEC settlement with no questions before Judge Rakoff came along. Judges like Posner are letting the watchdogs for the capitalist system and the shareholders – regulators and auditors – off the hook.

Judge Richard Posner during oral arguments in Fehribach v. Ernst & Young LLP, 2007 WL 2033734 (7th Cir. 7/17/07) (pdf),

Posner: The auditor’s responsibility … so far as the company is concerned … is to make sure the [numbers] are accurate….  You don’t need an auditor to tell you your market is collapsing….  The auditors are not supposed to have business insight.  They’re counters.  They’re not supposed to make predictions about how your markets are doing.  They’re supposed to reconcile your books and indicate you’re not a going concern because your debt is too high and so on….

Do you think the auditor is supposed to know about market power?…  An auditor is not an economic consultant who goes out and figures out what the market trends in an industry are!…Your trends? That’s what the company knows. [Plantiff’s Attorney: You’re right. Here’s what the auditor’s responsibility under SAS 59…]

Posner: That is too vague for me…”

In describing the essence of the case, Judge Posner states:

“The argument has to be that had Ernst & Young included the going-concern qualification in its audit report of October 1995, Bank One would have acted sooner, precipitating an earlier liquidation.”

Unfortunately, in this case, the plaintiff’s attorney failed to convincingly explain the function of an audit report and the proper audience for it, in particular for a small private company heavily dependent on a bank credit line. This was unfortunately necessary for Judge Posner.

At the same time, Judge Posner’s renowned “pragmatism” gave him cover for his supercilious expressions of frustration and boredom with the exposition of the actual standards by which he should be judging the auditor’s performance of their duties.

Judge Posner found no connection between the auditor’s lack of performance of a proper SAS 59 analysis, which would have likely resulted in a going concern opinion, and the delay in an inevitable involuntary bankruptcy. A “going concern” opinion would have triggered a breach of loan covenants immediately, given that the company had a contractual obligation to provide the bank an audit report with an unqualified audit opinion to maintain their line of credit.

(I am assuming the minimally profitable small family owned company that was the subject of this suit would have no other reason to pay big bucks to have an audit by EY nor to delay submission of it to their bank than because a clean audit was required to maintain their bank line of credit.)

What Judge Posner found “too vague” was the description of the auditor’s responsibilities under SAS 59:

“…The auditor’s evaluation includes considering whether the results obtained in planning, performing, and completing the audit identify conditions and events that, when considered in the aggregate, indicate there could be a substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time. It may be necessary to obtain additional information about such conditions and events, as well as the appropriate evidential matter to support information that mitigates the auditor’s doubt.”

Even though the standard details the kinds of internal and external factors that the auditor must consider, Judge Posner writes in his opinion:

“Elsewhere the standards emphasize that the auditor must have ‘an appropriate understanding of the entity and its environment.’ Yet nowhere is the auditor required to investigate external matters, as distinct from “discovering them during the engagement.” An accounting firm that conducts an annual audit of a multitude of unrelated firms in a multitude of different industries cannot be expected to be expert in the firms’ business environments…”

Why am I revisiting a decision from July of 2007 that the auditor won?

Well, this case was about more than just a discussion of a “going concern” opinion or the lack thereof. It is also a case where Judge Posner’s pragmatism and wish to be pithy and memorable gives us additional case law on the controversial theory of liability called “deepening insolvency.” The opinion provides a short discourse on the theory, in particular for assessing damages when an auditor fails to stop the clock with a “going concern” opinion and opens themselves up to claims of damages for “deepening insolvency.

In another more recent case that skirted around the “deepening insolvency” theory, the auditors, PricewaterhouseCoopers, lost big.

“On September 9, 2008, the United States Court of Appeals for the Third Circuit in Philadelphia affirmed a $119.9 million jury verdict and $182.9 million judgment entered in 2005 by a New Jersey federal trial court against the accounting firm PricewaterhouseCoopers, LLP (“PwC”) on behalf of Jones Day client Vermont Insurance Commissioner.

That verdict, characterized at the time by The Wall Street Journal as one of the largest ever handed down against one of the “Big Eight” accounting firms for audit failure, was in favor of the Vermont Insurance Commissioner as receiver for the insolvent Ambassador Insurance Company…PwC, was found negligent for failing to properly audit the company’s financial statements, and particularly its loss reserves, which negligence allowed the company to remain in business beyond the point of solvency…The judgment against PwC came after a nine week jury trial. The appeal raised, among others, issues concerning the scope of an auditor’s liability when there are allegations of management misconduct, as well as questions concerning the availability and appropriate measure of damages available in auditing malpractice suits brought by insolvent corporations or their receivers.

In one of the most important and extensive discussions of auditor liability by a federal appellate court in years, the Third Circuit sided with the receiver of Ambassador on both issues. The Court held that, under New Jersey law, misconduct of management cannot be asserted as a defense against the company by an auditor who participated in the misconduct. In addition, the Court clarified recent decisions concerning “deepening insolvency” damages by holding that an increase in the liabilities of a company, even if insolvent, is damage to the company and may be recovered from wrongdoers if negligence is proven.”

I’m not sure if Steven Thomas, the attorney representing the New Century Trustee intends to explore this issue when arguing their suit against KPMG US and KPMG International. I can’t think of a better case, though, to give it a shot. There’s smoking gun evidence against KPMG of potential malpractice and complicity in the fraud for the sake of their fees, which prevented them from issuing a “going concern” opinion or otherwise warning shareholders, regulators and the markets that something really, really bad was going to happen.

“To account for the risks it was taking, and to provide comfort to creditors and investors to whom it disclosed these risks, New Century hired a professional, independent well-known certified public accounting firm to audit its financial statements. The auditor was KPMG LLP. KPMG LLP was retained when the company was formed in 1995, and served as New Century’s outside auditor until April 27, 2007, when it resigned, having issued twelve unqualified audit opinions on New Century’s financial statements. These opinions certified each of New Century’s consolidated balance sheets and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows.

…Beginning in at least 2005, these loan repurchase provisions began to have an increasingly material, and ultimately overwhelming negative impact on New Century’s financial statements… the trend of increasing repurchases indicated that the most significant piece of New Century’s business – its loan portfolio – was severely weakened.

KPMG LLP was fully aware of this trend. Its own workpapers note that the repurchases had more than doubled from 2004 to 2005, going from $135.4 million to $332.1 million. Even with this increase in the rate of repurchases — a clear indicator of weakness in the loan portfolio — KPMG LLP failed to expand its procedures or testing of New Century’s reserves. Indeed, although KPMG LLP expressly acknowledged in its workpapers that the risk associated with the portfolio had gone from low to high, KPMG LLP did not expand its audit work in response to this increased risk.”

The question for all of those who can advocate on behalf of shareholders – regulators, Attorneys General, and the plaintiff’s bar – is:

Why aren’t there more “going concern opinions” issued earlier and more emphatically, and why weren’t there any for the most notorious of the “financial crisis” firms?

40 replies
  1. Oversight for the Better
    Oversight for the Better says:

    “Elsewhere the standards emphasize that the auditor must have ‘an appropriate understanding of the entity and its environment.’ Yet nowhere is the auditor required to investigate external matters, as distinct from “discovering them during the engagement.” An accounting firm that conducts an annual audit of a multitude of unrelated firms in a multitude of different industries cannot be expected to be expert in the firms’ business environments…”

    Oh yeah? How then, can an auditor accept the audit engagement without the required understanding of the entity and its environment? I recall this standard from Accounting 101. How can a human being with a Law degree make such an obviously inane statement? I would like to order a brain scan to see what’s going on.

    Okay, so our bigger conglomerates, technology, financial products, etc. have become much more unwieldy than our Accounting Standards and financial legislation were originally written for (ref. SallyAnne Harper, head of GAO, 9/14/09 IIA meeting in Houston). But still ! ! It’s no excuse for the large Accounting Firms. If anything, they should be additionally fined for not revealing their weaknesses and taking the initiative to develop the means to strengthen knowledge of our brave new economy.

  2. What ever happened to Capitalism?
    What ever happened to Capitalism? says:

    Posner is the most respected appellate judge in the US. His academic publications and legal thoughts carry more gravitas than those of some SCOTUS justices. Anytime he speaks, his words and reasons should be thoroughly and critically considered.

    Facts of this case:
    (1) EY performed an audit of FY’95 financials, did not perform audits of subsequent years
    (2) Save for the disputed GC opinion, the audit was agreed upon as performed correctly
    (2) Taurus declared Ch7 nearly two years after the EY report, during which time its CFO was convicted of fraud
    (3) Mgmt fraud did not begin until after EY left

    Who was (not) suing who:
    (1) Taurus owners (also mgmt, family-run), for reasons that included had they been given an GC opinion, they would have immediately liquidated the company, and saved $3MM
    (2) Under Indiana law, EY had no duty to Taurus’s creditors, so they could not be party against EY

    Posner’s RFD:
    The failure of Taurus was primarily caused by Supply/Demand changes and fraud. Nowhere in the auditing standards is an audit firm required to make judgments or predictions about market direction. The standards only require GC disclosure if the firm is aware of major customs losses, impending legislation, default/convenant violations, or the like. The auditor does not have to issue a GC just because he feels the meat futures market’s backwardation will cause sale to tragically decline. That sort of judgment is the sole responsibility and risk of the investor or stakeholder.

    Posner’s “Inanity” @Oversight for the Better?
    “Appropriate understanding of the entity an its environment” must not be construed as the same level of expertise in said environments expected of those who make strategy (Mgmt). The understanding of the environment need only be “appropriate” for the purposes of saying, for instance, this customer will likely pay this A/R, basically enough understanding to attest to F/S. The real inane statement is to say that its reasonable to allow investors to sit back and have audit firms do market analysis for them, and them sue them when their opinions are wrong.

    We have strayed to far from caveat emptor; we have become a society of victims. You don’t have to invest, though when you do, all you can really expect is that when a company says they have X cash, they have X cash, or when they say they owe X much, they owe X much. After that, its all up to you. What ever happened to Capitalism?

  3. Independent Accountant
    Independent Accountant says:

    Why so few going concern opinions on Citigroup and such? It’s the “deal”. Uncle Sam will protect the Big 87654 from litigation and cement their position as capital market “gatekeepers” in return for the Big 87654 ignoring the obvious when it would interfere with the Treasury’s and Fed’s efforts to keep big banks afloat. What’s not to understand?

  4. H3
    H3 says:

    I get tired of this whine about capitalism. If you want it, you must preserve it and an adequate audit that has the investor in mind is a necessary condition.

    The whole point of the 1933, 1934 laws was to provide enough information that a knowledgeable investor could “caveat emptor”. Without adequate (and that means properly enforced) oversight, markets do not exist – they eventually devolve into personal exchages between armed deceptive “war lords” or little taverns where decisions are made based on who you know not, what is known.

  5. Tony Rezko
    Tony Rezko says:

    2- Yes, and he shoots the English with bolts of lightning from his arse – I like Posner too but don’t be such a sycophant. Cass Sunstein (just to give an example) is pretty sharp, too, but I bet they disagree on a lot of stuff so we won’t make any progress with “my intellectual vs. your intellectual.” And this isn’t in his “wheelhouse,” by the way, and you probably know that.

    Posner on auditors: “They’re not supposed to make predictions about how your markets are doing.” Straw man.

    “The auditors are not supposed to have business insight.” That’s absurd. Then they are incapable of doing the job they advertise to clients. If it’s true, auditors are paid too damn much.

    What does Posner think those rubes who couldn’t pass the bar ought to do? “They’re supposed to reconcile your books and indicate you’re not a going concern because your debt is too high and so on…” Yes, with their adding machines and whatnot. Well, that GC part was sorta FM’s point, wasn’t it?

  6. Oversight for the Better
    Oversight for the Better says:

    Okay, @ 2, you obviously know more about the situation in this example than I do. But, I still have some questions and this goes to @5 as well. These are:
    1) When would you consider it to be a responsibility of the auditing firm to report a GC? In other words, do you have an example? Or, do you think that kind of judgment should not be the duty of CPA’s at all?

    2) I agree that it is not the duty of auditors to predict the market. However, shouldn’t auditors be evaluating the auditee’s ability to withstand a market crash given the actual cash and actual debt? The risk is ALWAYS there.

    Yes, I am an investor and I am responsible for where I choose to put my money. I am also a Homo Sapien and have observed the degree to which Homo Sapiens will exploit Homo Sapiens. Also, in Capitalist markets, management may feel it necessary to engage in risky practices, just because everyone else is doing it and they have to do so to compete. As such, I want some protection. Maybe traditional audits aren’t designed to go as far as we need in our current world. Any suggestions?

  7. Posner obviously never took an audit class
    Posner obviously never took an audit class says:

    “Elsewhere the standards emphasize that the auditor must have ‘an appropriate understanding of the entity and its environment.’ Yet nowhere is the auditor required to investigate external matters, as distinct from “discovering them during the engagement….”

    Without investigating external matters, how on this earth does an auditor fully determine whether a client can continue as a going concern. I mean, that’s one indicator of going concern status, is it not? Maybe Posner does need Audit 101…badly!

    @What happened to capitalism says:

    ““Appropriate understanding of the entity an its environment” must not be construed as the same level of expertise in said environments expected of those who make strategy (Mgmt). The understanding of the environment need only be “appropriate” for the purposes of saying, for instance, this customer will likely pay this A/R, basically enough understanding to attest to F/S.”

    Don’t you get it?? That’s the problem – some auditors are not obtaining enough understanding of the client’s business to even say whether it’s able to repay its debt or obtain a line of credit. Or, it could be that they know what’s going on but may be incentivized to keep their mouth shut (as @Independent Accountant justifiably referred to). In any case, red flags aren’t being addressed in a timely manner. By the way, nowhere does SAS 59 or anyone else say that auditors are required to be industry experts before they start fieldwork or that they should forecast growth of the client over a 10-year horizon. Just obtain enough info to determine whether a company doesn’t need life support for the next FY, and if they do, open your mouth and report it!!

    “We have strayed to far from caveat emptor; we have become a society of victims”

    Easy to say this when your trust hasn’t been shattered like glass by a person or organization that has misrepresented information or hid the truth from you. Perhaps the reason were are a “society of victims” is because were also a society of offenders. We don’t need to travel across the world to see what has happened over the last 12-18 months with irresponsible lending (and yes, borrowing), Madoff, Stanford, etc. When we actually keep bad apples from spoling the rest of the bunch, then maybe we’ll have less “victims”.

  8. @ Whatever happened to Capitalism?
    @ Whatever happened to Capitalism? says:

    Capitalism hasn’t been around for a long time. Look around you, we live in a plutocracy.

  9. Tenacious Truman
    Tenacious Truman says:

    @9 — Your are mistaken. Pluto was demoted in 2006, and is no longer recognized as an official planet. Did you mean to say that we live in a dwarfplanetcracy?

    On a more serious note–and this is a point I’ve made several times on this site–when auditors and accountants go into a court of law, the judges don’t give GAAP and auditing standards the same deference they would give to, say, statutes and regulations. Even a respected jurist such as Posner doesn’t want to get into the “vague” details of what an auditor’s duty is under GAAP, preferring instead to use their own perceptions of what that duty should be. Thus, attempts to use GAAP and “Audit 101” as litigation shields are risky.

    I was somewhat amused by the discussion about how much auditors are supposed to know about the industry they’re auditing. In my experience, such knowledge is uneven at best: some auditors have gained considerable industry expertise (and then complain that they’re being siloed and losing promotion opportunities) while others have little or no clue about the industry in which their auditee is operating. But that situation doesn’t really bother me as much as the number of corporate controllers and CFOs I’ve encountered, who have no clue at all about the industry in which they’re operating. RevRec might be wildly different, A/R aging might have different expectations, stuff like that. Typically these individuals have been recruited from other companies (in completely different industries) for their accounting knowledge (or because they know somebody) … but then flounder around for a few years trying to figure out the differences between their previous companies and their new company. Some never figure it out, and either become ex-controllers/CFOs or get promoted.

    — Tenacious T.

  10. Anonymous
    Anonymous says:

    I remember being in the audit room when the partner in charge of the engagement was on the phone with the regional management discussing what constitutes “substantial” doubt. This partner was trying as hard as hell to keep from giving a “going concern” comment on the audit report.

    Maybe because I have limited experience in public accounting, but I thought this to be a huge violation of some sort of ethical code if not professional standards. I do believe the partner was trying to save the company from its creditors, but not because he felt what the company was doing is important. Rather, I think he was worried about his audit fees, and the firms’ recent reputation for “realigning” headcount.

    Am I too naive? Isn’t this putting the fox in charge of the hen house?

  11. Ex Deloitte and PwC Consulting
    Ex Deloitte and PwC Consulting says:

    @12 — that’s a pretty sweeping and significant opinion. How much should we reduce the public auditor’s fees by if we no longer require this function from them? 20%? 40%?

    Don’t investors deserve assurance that their money is invested in something that, regardless of short/medium term performance, will actually still be around next year? If they do, where else would they turn for that? Private analysts don’t seem like a safer bet to me, it seems to me that this is something that public audit is fundamentally for. But that’s maybe just me.

  12. JB's got to be kidding
    JB's got to be kidding says:

    @12 – Are you writing the SASs?? Do you serve in a regulatory role within the AICPA that determines guidance regarding going concern reports? If it’s not the auditor’s responsibility to report whether a company is going concern or not, who’s is it, then? Management’s? — Nope, b/c management can misrepresent the health of their own entity to investors when in actuality they could be suffering. Audit committee or Board of Directors? Nope, they have more of a governance role. Then who’s responsible @12, who? How are investors supposed to find out how healthy a company really is?…Or maybe you’re suggesting they should be the auditors in that space???

    If anyone else shares the same bold opinion as @12, ask yourself this. What use is the auditor to the public if they can’t perform the necessary procedures to determine whether an entity can go on as a GC? Do you think the audit function should even exist?

  13. Philip J. Fry
    Philip J. Fry says:

    When it comes to financial services firms (or any entity that relies on short-term lending) you run the risk of a going concern qualification becoming a self fulfilling prophecy. If a troubled but otherwise solvent bank gets dinged with a going concern comment from their auditors then you could end up scaring away lenders/depositors/commercial paper holders and create a liquidity problem that ends up bringing down an institution that would otherwise have survived. So the auditor must either: (A) risk killing your client in an effort to cover your own assets; or (B) delay waving the going concern flag until the client is on the verge of collapse, in which case it’s too late for investors to act on that information anyway.

    I don’t agree that auditors have no responsibility when it comes to a going concern issue but I hear where JB is coming from.

  14. Bitter Auditor
    Bitter Auditor says:

    I have seen so many blind eyes turned to “going concern” concerns by the partners and managers that I’ve worked for that I can’t even count them all.

    What’s the difference between endorsing entries that falsely inflate EBITDA so that convenants are met/creditors are happy versus glossing over “going concern” concerns until the lights are shut off, and then and only then admitting that there might be a “going concern” concern. Either way the financial statements become glorified puppets for what the company is really doing.

    It’s the age-old question: Seriously, what are fairly stated financial statements? Did they ever really exist? I don’t think so — there are only varying degrees of financial statement falsehood.

  15. Tenacious Truman
    Tenacious Truman says:

    “It’s the age-old question: Seriously, what are fairly stated financial statements? Did they ever really exist? I don’t think so — there are only varying degrees of financial statement falsehood.”

    Classic line!

    The thing is, our enterprise-wide big name accounting system processed (so I’m told) 323,000,000 individual transactions last year. I’m not sanguine that they were all processed correctly. I’m even less sure that our Big 4 auditors reviewed a statistically significant number of those transactions.

    Does that mean our auditors were negligent, or that we were trying to commit some type of fraud? Or — more likely — that the breadth and complexity of the needed audit proceedures exceed that which can reasonably be afforded, and thus both parties (auditor and auditee) have tacitly agreed to settle for half-a-loaf in lieu of nothing?

    Which is a bit off point from the GC discussion, but still worthy of pondering, it seems to me….

    — Tenacious T.

  16. fm
    fm says:


    “…the breadth and complexity of the needed audit proceedures exceed that which can reasonably be afforded, and thus both parties (auditor and auditee) have tacitly agreed to settle for half-a-loaf in lieu of nothing?”

    The problem is: Did the shareholders get a vote? Are the auditors being managed by the audit committee to focus on the needs of the shareholders for fairly stated financial statements” or are they being directed to meet management’s (and possibly the directors’) desire for short-term, half a loaf, self-serving services?

    The current system no longer serves the shareholders and other significant stakeholders of the modern public corporation on a just and equitable basis.

  17. Tenacious Truman
    Tenacious Truman says:

    fm @ 18 —

    Your points are noted and we are not really in disagreement. You focus on whether the company (either through management or the audit committee) is pushing the auditors to do what’s right. I focus on the auditors pushing the company to fairly compensate them for doing what’s right, so that there is no budgetary excuse for not performing all necessary procedures.

    (Who should be held accountable for determining whether audit procedures are sufficient, the auditor or auditee? “Both” you might say, and I wouldn’t argue too much. But the auditors are supposed to be the “experts” and should be held accountable for the audit procedures, in my view.)

    Anyway I need to go now because we have to plan for next week’s meetings with our Big 4 auditors. They are flying their audit team across the country (coast to coast) for a week of “quarterly reviews” — for which we are no doubt paying. You would think, since I work in a major metropolitan area, that the firm would use its local auditors to conduct the local reviews, sparing its staff travel fatigue and reducing our audit fees, but no. I guess the auditor partner understands the need to keep his own people busy and billable, and we get to pay for it.

    — Tenacious T.

  18. ClownCollege
    ClownCollege says:


    Your company’s fault for agreeing to have your Big 4 firm staff the engagement remotely, and also for not capping reimburseable travel expenses. Remember, an RFP is a beautiful thing!

  19. Tenacious Truman
    Tenacious Truman says:


    Not disagreeing with you. But a couple of follow-up questions, please. regarding our “agreement” to let our auditors staff the engagement remotely.

    1. My company employs more than 50,000 people. How many of those would you think actually know who the audit team is and where it is coming from? (Bonus question: is there a single person anywhere in the company who would be able to create a calendar of external audit activity by location and date, for our global operations?)

    2. Do you think our CFO, CAO, or controller know which individuals conduct the audit? (Bonus question: can anyone at the C-level other than the CFO and CAO both name the audit partner and recognize him/her on sight?)

    3. Among management employees (i.e., those not on the audit committee), how many would feel comfortable recommending a competition? (Bonus question: would a new auditor be less expensive, or more because of 1st year testing?)

    Having been part of the Big 4 for a decade, I know how the game is played. A big part of the financial success of the auditors is the lack of transparency of the audit process and the resulting ignorance of the client. And from the perspective of the client, there isn’t much reason to dig into the audit process because the auditors are completely fungible. Completely. Our focus is on managing the business, not managing the auditors. Yes, that means they get away with crap like sending the audit team 2,000 miles to conduct a routine quarterly review, at our expense. ** Shrug **

    Finally, I have pointed out this situation to my management as a cost avoidance opportunity. Nobody cares. Not a raised eyebrow in the house. That doesn’t mean I don’t know what’s going on, or that I like it.

    — Tenacious T.

  20. huh?
    huh? says:

    I think there are benefits for the corporate audit team to fly around the world to visit the sites. Often times when you have the local team doing the work they go off the reservation and audit everythign, even things the corporate team doesn’t need them to. Once in a while, having the local audit partner and the team visit locations is essential and worth the cost and hassle in the long run.

    Also, I think industry expertise is a little overrated. It helps on revenue recognition, but not much on stock comp, pensions, impairments, derivatives, etc.

  21. Dallas CPA
    Dallas CPA says:

    Your post about ” Going Concern Audit Opinions: Why So Few Warning Flares? ” is very well written.

    I hear so much about how we should regulate Walstreet, but not much of talking of the ” roles of big accounting firms” in this financial crisis. By this time, I would also hope big ” business schools” are teaching some sort of ” business ethics” or ” How not to be a crook ” etc..

  22. Vic -Businessaccent
    Vic -Businessaccent says:

    A comprehensive and well written article on today’s issue in auditing and accouning.
    The question is certainly significant. Going concern audit opinions have been issued even on big companies during the recession, where a lot of doubts on going concern issues have been pointed out to those corporations. I hope tomorrows audit standards and applications would do better that time.

  23. Ken Biddick
    Ken Biddick says:

    Really late to this party and would have missed it but-for Sara McIntosh. An auditor’s basic charge is to do no harm. The principle of “due care” instructs the auditor to consider the best interests of existing shareholders and other parties in interest as well as those to come after. Not an easy task when deciding on a GC opinion. Not to discount the thoughts that audit partners would try to protect their fee base, however, that would be a very short sighted endeavor if a client was truely destined for bankruptcy. A GC opinion is actually not the only option if conditions indicate that an entity may have difficulty meeting obligations as they come due over the next twelve months. An auditor has the option to include a disclosure discussing current conditions that raised such doubts and what management’s plan are that have caused the auditor to believe that the entity can meet their obligations even given the conditions that may have others draw a different conclusion. This disclosure serves as a shot across-the-bow without hitting the panic button. When it comes to protecting the audit fee, this disclosure is the most vulnerable. Shame is it is also the most useful to the constituents contemplated by the Principles of Professional Conduct.

    Btw, audit standards have generally been drafted to allow for lots of professional judgement. Hence any court without the guidance of an expert witness to assist in educating the trier of fact to what a reasonable CPA would do given the circumstances has no means to interpret them. That would render the standard ambiguous to the uninformed.

    Recently, standards have tightened-up on their ambiguity possibly to avoid the threat of goverment regulatory action.

  24. Tenacious Truman
    Tenacious Truman says:

    Ken Biddick @ 30,

    Have your read the Supreme Court’s decision in Arthur Young?

    — Tenacious T.

Trackbacks & Pingbacks

  1. […] is this really news? Judge Richard Posner during oral arguments in Fehribach v. Ernst & Young LLP, 2007 WL […]

  2. […] auditors admitted they did not issue “going concern” warnings for any of the large banks that were eventually nationalized because they were assured during […]

  3. […] Lord’s Committee was more interested in questioning the auditors about the issue of “going concern” opinions and, in particular, why there were none for the banks that failed, were bailed out, or were […]

  4. […] Rep. Frank thinks some version of the Specter bill repealing Stoneridge will make it back into the legislation. I don’t think the Kaufman team agrees. I told them I was in favor of such a repeal since, under PSLRA, judges are letting negligent and corrupt auditors off the hook far too often. It’s easy to bring a suit against the auditors but very hard for plaintiffs to survive a a motion to dismiss, especially when fraud is alleged.  Almost every suit for auditor malpractice or professional negligence settles.  Notable exceptions are BDO Seidman’s loss in the Bankest verdict and PwC’s loss in the Ambassador Insurance case. […]

  5. […] action against auditors neutered by the PSLRA and by the Stoneridge decision, and the tendency of some judges to see the auditors as mere bookkeepers there to serve management will somehow act as a deterrent […]

  6. […] treatise that in pari delicto was ushered into modern bankruptcy jurisprudence as a part of the deepening insolvency discussion. I’ve written about deepening insolvency many times as it relates to the auditors […]

  7. […] their clients did not tell us about the extent of the losses until it was too late. There were no “going concern” warnings for any of the financial institutions that went bankrupt, were taken over, or were […]

  8. […] their clients did not tell us about the extent of the losses until it was too late. There were no “going concern” warnings for any of the financial institutions that went bankrupt, were taken over, or were […]

  9. […] their clients did not tell us about the extent of the losses until it was too late.  There were no “going concern” warnings for any of the financial institutions that went bankrupt, were taken over, or were […]

  10. […] In fact KPMG and Deloitte’s “coordinating entities” (head office) are Swiss and PwC and E&Y’s are U.K. based.  According to Wikipedia, these head office coordinating entities “do not themselves practice accountancy (the malpractice risk area of their collective businesses), and do not own or control the member firms. See no one’s in charge—Francine McKenna, at her blog reTheAuditors had a great post on just this subject entitled “Going Concern Audit Opinions – Why So Few Warning Flares?” […]

  11. […] to the various fraud and Madoff related suits. It may or may not have been better for them to have warned us with “going concern” opinions earlier.  We’ll let the judges and juries decide, if any of the cases are actually tried.  Most […]

  12. […] with.  I’m quite surprised actually, now that I focus on judges and their opinions so much, how often many of them express what I consider to be very biased opinions in private – if you can call a speech in […]

  13. […] 3:50-5:00 p.m. E-mail.  Francine McKenna, write a whopping good article at re:  The Auditor, “Going Concern Audit Opinions:  Why So Few Warning Flares?” […]

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