For companies that are financially distressed, audit partners who rate higher on professional skepticism are more likely to publicly issue audit reports that question the viability of those companies, according to a study forthcoming in AUDITING: A Journal of Practice & Theory.
The going concern assumption is a financial accounting principle that assumes a company will continue to operate for the foreseeable future without the need to liquidate its assets. Financial statement auditors add an additional paragraph to their audit opinions when conditions at a company raise substantial doubt about the company’s ability to continue as a going concern. When determining whether a company’s financial viability is in doubt, auditors assess the extent of the company’s financial distress and the quality of management’s mitigation plans; areas where the audit partner’s professional skepticism should play a role.
In a study titled “Audit Partner Trait Skepticism and Going-Concern Reporting Decisions” researchers obtained trait professional skepticism ratings for 136 Belgian audit partners via a survey and linked them to their financially distressed audit clients (e.g., companies with operational losses, negative working capital). The often used Hurtt Professional Skepticism Scale was employed to measure the partners’ trait skepticism. The researchers then determined if the partners’ professional skepticism was positively linked to their issuing a financial statement audit report that also raised doubts about the company’s ability to continue as a going concern.
The research team examined the audit reports of 19,200 financially distressed companies in Belgium between 2008 and 2017. The vast majority of the companies examined were private companies, as is the case with most Belgian companies. The study is authored by Kris Hardies from the University of Antwerp, Sanne Janssen of the Court of Audit, Ann Vanstraelen of Maastricht University, and Karla M. Zehms from the University of Wisconsin–Madison.
“Our goal was really to look at whether audit partners’ trait skepticism explains variation in real audit outcomes, focusing specifically on their going concern reporting decisions. Going concern reporting is an area where skepticism really should be quite important. It’s also a very judgmental issue, so likely an area where there could be room for partners’ individual characteristics to matter,” says Hardies.
The study finds that audit partners are not homogeneous. Some partners are inherently more skeptical than others, and, for distressed audit clients, their level of trait skepticism was positively associated with the issuance of a going concern report. Twenty-six percent of the audits examined in the study resulted in a going concern report being issued for the distressed company.
Hardies concludes, “This may be relevant for audit firms when considering which partners to assign to their riskiest clients, but also for audit committee members when thinking about auditor appointments, especially in cases where they really want the audit partner to be able to challenge management.”