Question

(c) Auditors should accept some of the blame when a company on which they have expressed an unmodified audit opinion subsequently fails, and they should also do more to highlight going concern problems being faced by a company. Required Discuss this statement.

Answer 1

Part - 1

Amid to unexpected closure of big companies recently, a discussion arises that whether the audit firm should have spotted the going concern problems, and warned stakeholders of the issues.

Here, the first part of the statement asks whether auditors should accept some of the blame when their client firm fails. This suggests that the auditor is in some way at fault, and has helped to contribute in some way to the failure of a business. It is the responsibility of management to ensure proper risk assessment and risk management is conducted in a business.

Hence, Unless there is any gross negligence by the auditor, audit firm is not required to accept any such responsibility.

Although in some jurisdictions the auditor performs an assessment of risk management procedures, this is not the fault of the auditor if such procedures are inadequate and contribute to the collapse of a company.

However, it is fair to say that auditors have a responsibility to gain an in-depth understanding of their client’s business, including the environment in which it is operating. This means that the auditor should at the very least be aware of going concern problems, and are in a position to alert management to problems that they may have overlooked. But it remains the responsibility of management to deal with such problems.

The auditor, when assessing going concern status, does not have a crystal ball, and cannot be expected to foresee situations in the future which may impact the survival of their client’s business. Especially in a speedy economic downturn it is unfair to criticise the auditor’s view of going concern status at a year end.

The issue may be one of misunderstanding – the so-called expectation gap. The general public perceive the role of the auditor to be much wider than just providing an opinion on the financial statements.

The expectation is that auditors provide advice on business strategy, and so should take some of the responsibility when the business fails. This indicates that the public do not understand the importance of the independent status of the auditor, and that the auditor must not take on the role of management.

There may of course be situations in which an audit firm has not acted appropriately, for example, in not challenging the management on matters having a significant impact on the financial statements, or failing to detect frauds which have a material impact on the financial statements. In such cases the auditor may indeed be partly to blame if the company subsequently collapses.

Part – 2

The second part of the statement asks whether the auditor should do more to warn stakeholders about going concern issues. It could be argued that it is the responsibility of management to make such warnings, and in fact, financial reporting standards require a lot of disclosure about concentrations of risk.

In particular IFRS 7 Financial Instruments: Disclosures requires detailed notes to the accounts describing and providing details on concentrations of certain risks. So, a lack of disclosure may not be the critical issue.

The problem is more likely to be that readers of financial statements do not have the financial awareness to understand these disclosures. The auditors cannot be blamed if users of financial statements are not sufficiently financially literate to be able to understand such disclosures.

Auditors highlight significant going concern problems using an emphasis of matter paragraph within the audit report. This means that problems should be clearly highlighted for users of the accounts. Perhaps more could be done to make any such disclosures as transparent as possible, which would aid users’ understanding of going concern problems.

In addition, shareholders’ meetings could be used more often as a vehicle for the auditor to raise concerns with shareholders. Auditors, however, may be reluctant to voice concerns in such a forum, and may be put under pressure from management not to speak out.

To conclude, it would seem unfair to make auditors take some of the blame for the failure of a company, when it is explicitly the role of management to safeguard the company and manage its risk exposure.

However, auditors could be more proactive in highlighting going concern problems through the various channels available to them, i.e. through highlighting matters within the audit report, and through contact with shareholders at general meetings of the company.