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Emerald Article: Assessing going concern: The practical value of corporate
failure models and auditors' perceptions
Nirosh Kuruppu, Fawzi Laswad, Peter Oyelere

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To cite this document: Nirosh Kuruppu, Fawzi Laswad, Peter Oyelere, (2012),"Assessing going concern: The practical value of
corporate failure models and auditors' perceptions", Pacific Accounting Review, Vol. 24 Iss: 1 pp. 33 - 50
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Assessing going concern

Assessing
going concern

The practical value of corporate failure models

and auditors perceptions
Nirosh Kuruppu

33

Sultan Qaboos University, Muscat, Sultanate of Oman

Fawzi Laswad
Massey University, Palmerston North, New Zealand, and

Peter Oyelere
United Arab Emirates University, Al Ain, United Arab Emirates
Abstract
Purpose The purpose of this paper is to ascertain the practical efficacy of statistical corporate
failure models in improving auditors going concern assessment. It also aims to examine auditors
perceptions of corporate failure models as an analytical procedure in this context.
Design/methodology/approach The paper utilises a survey questionnaire with a case study
component to evaluate the practical value of corporate failure models for assessing going concern, and
to examine auditors perceptions of such models as an analytical procedure for assessing going
concern.
Findings The results indicate that corporate failure models facilitate the formation of more
appropriate going concern opinions and increase judgment consensus. Auditors perceive such models
as useful in obtaining relevant evidential matter and in mitigating some of the subjectivity involved in
assessing going concern. However, the results also indicate that corporate failure models are perceived
to be more effective in the planning stages than at the final stages of the audit. Furthermore, auditors
are seeking more explicit guidance in auditing standards on the use of corporate failure models for
assessing going concern.
Originality/value The study extends previous research by examining the practical efficacy of
corporate failure models for assisting auditors to assess going concern in light of human information
processing limitations. Further, it examines auditors perceptions of corporate failure models as an
analytical procedure, and the guidance that auditors seek on the use of such models in auditing
standards.
Keywords Going concern opinions, Corporate failure models, Business failures, Auditors, Perception,
Audit judgement, New Zealand
Paper type Research paper

1. Introduction
Clean audit reports issued to companies that subsequently fail without highlighting
going concern uncertainties lead to loss of confidence in the statutory audit function,
which often results in significant costs to both auditors and investors (Bellovary et al.,
2006; Hensher and Jones, 2007; Pasiouras et al., 2007). Prior research that compared the
outcomes of various corporate failure models with auditors reports issued prior to
bankruptcy filings indicates that such models significantly outperform auditors
opinions issued to the same companies (Mutchler et al., 1997; Kleinman and
Anandarajan, 1999; Pasiouras et al., 2007). These findings suggest that corporate failure

Pacific Accounting Review

Vol. 24 No. 1, 2012
pp. 33-50
q Emerald Group Publishing Limited
0114-0582
DOI 10.1108/01140581211221542

PAR
24,1

34

models may have a valuable role as a substantive analytical procedure that can assist
auditors in forming more appropriate going concern opinions.
The purpose of this study is to examine the practical efficacy and usefulness of
corporate failure models for assessing going concern. It also seeks to examine auditors
perceptions towards the use of corporate failure models as an analytical procedure in
this context.
A survey instrument containing an experimental case component is used in this
study. A total of 152 auditors in public practice in New Zealand participated in the study.
The results indicate that corporate failure models are highly effective in assisting
auditors to reach more appropriate going concern assessments. An analysis of auditor
perceptions indicates that such models are recognised as being able to gather relevant
audit evidence, and reduce some of the subjectivity involved in the going concern
assessment process. The results further indicate that respondents view corporate failure
models as being more effective in the planning stages than at the final stages of the audit.
Auditors also perceive the need for more explicit guidance on the use of such models for
assessing going concern. These findings have policy implications for standard setters,
auditors and the investing public.
The remainder of the paper is structured as follows: Section 2 examines the
significance of the going concern concept in auditing and the requirements of the current
auditing standards on going concern. It then examines the usefulness of corporate
failure models as an analytical procedure for assessing going concern. Section 3
describes the research objectives and hypotheses, followed by a description of the
research design in Section 4. Section 5 presents and discusses the results of the study,
while Section 6 concludes the paper with research limitations and opportunities for
further research.
2. Implications of going concern misclassification
The role of the statutory auditor is a critical one, especially in light of the current
concerns over the quality of corporate governance. By independently expressing an
opinion on whether the financial statements present a true and fair view of the entitys
financial position in accordance with GAAP, the external auditor assists users of
financial statements in making economic decisions with a higher degree of confidence
(Geiger et al., 2005; Pasiouras et al., 2007).
However, the external audit function as the principal means of adding credibility to
financial statements only prevails if it consistently arrives at proper assessments of the
fair presentation of clients financial statements (Geiger et al., 2005; Herbohn et al.,
2007). As the going concern concept is a central postulate in financial reporting,
a proper assessment of going concern is consequently critical to expressing an opinion
on whether the financial statements are presented fairly, as a going concern
(Carcello et al., 2003; Geiger et al., 2005; Herbohn et al., 2007).
Even though the going concern judgment is a critical one, prior research shows that
auditors do not always arrive at what may be, in hindsight, an appropriate audit opinion
(Herbohn et al., 2007). Auditors appear to have a bias towards not qualifying failing
clients, with typically 20-95 percent of bankrupt companies receiving unqualified audit
reports (Geiger and Raghunandan, 2002; Van Peursem et al., 2005). Citron and Taffler
(1992) show that only 20 percent of UK failed companies received going concern
qualifications before being declared bankrupt. In New Zealand, only 28 percent of failed

companies received appropriate audit qualifications (Van Peursem and Pratt, 2002). In
Belgium, fewer than 26 percent of bankrupt companies received audit qualifications
(Vanstraelen, 1999).
From the auditors perspective, an incorrect audit opinion may result in expensive
litigation, loss of the audit fee, and damage to professional reputation (Geiger et al.,
2005; Hensher and Jones, 2007). The economic and social costs of an audit failure can
also be substantial, as evidenced by the widely publicised failures of Enron and
WorldCom in the USA.
The following is a brief review of the development and requirements of the current
auditing standards on going concern, and the continuing impediments to making
appropriate going concern assessments. This is followed by a discussion of the potential
usefulness of corporate failure models as a possible decision aid for improving the
accuracy of auditors going concern judgments.
2.1 Auditing standards on going concern and impediments to assessing going concern
Since the promulgation of SAS 34 on going concern in the USA, standard setters have
continued to broaden auditors responsibility for assessing going concern as a means of
minimising the audit expectations gap (Holder-Webb and Wilkins, 2000; Bellovary et al.,
2006). SAS 59, which superseded SAS 34, requires auditors to proactively assess going
concern (AICPA, 1988). Under current auditing standards, clients going concern status
is no longer treated as a mere assumption in financial reporting without supporting
evidence (Carcello et al., 2003; Bellovary et al., 2006). Rather, it has become analogous to a
hypothesis or theory that has to be corroborated as a part of every audit with appropriate
supporting evidence.
In other jurisdictions, standard setters have followed suit with their own standards
on going concern such as SAS 130 in the UK, ASA 570 in Australia, ISA (NZ) 570 in
New Zealand and the International Federation of Accountants ISA 570 on going
concern. These auditing standards require the auditor to obtain evidence about the
appropriateness of the use of the going concern assumption in the preparation and
presentation of the financial statements. For instance, according to ISA (NZ) 570,
paragraph 6:
The auditors responsibility is to obtain sufficient appropriate audit evidence about the
appropriateness of the use of the going concern assumption in the preparation and
presentation of the financial statements and to conclude whether there is a material
uncertainty about the entitys ability to continue as a going concern.

Despite the fact that current auditing standards require an explicit assessment of clients
going concern status, there has been little change to the number of clients failing soon
after receiving clean audit reports (Geiger et al., 2005; Bellovary et al., 2006). A number of
plausible explanations exist for this continuation. They include the leeway provided for
professional judgement by current auditing standards and the effects of human
information processing limitations, which make the audit judgement a complex one
(Shelton, 1999; Arnold et al., 2001; Geiger et al., 2005).
Ambiguities in interpreting the auditing standard on going concern, especially on the
substantial doubt criterion, can allow different auditors to arrive at different conclusions
from the same audit evidence (Casterella et al., 1999; Shelton, 1999; Carcello et al., 2003).
In the USA, for example, substantial doubt is purported to exist when there is a
50-70 percent probability of events that may question the validity of the going concern

Assessing
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35

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36

postulate (Boritz, 1991). However, Asare (1992) asserts that substantial doubt has a
mean probability of 57 percent with a relatively large standard deviation of 17 percent.
This suggests that there is no single definition of the term substantial doubt, which
may result in the lack of consensus in going concern judgments.
The above issue is further compounded by the subjective manner in which auditors
assess business continuity (Matsumura et al., 1997; Shelton, 1999; Arnold et al., 2001).
As going concern assessments are mainly unstructured, with auditors professional
judgement having a large impact on the assessment of audit evidence, a variation in
audit opinions can exist between different auditors assessing the same entity
(Grant et al., 1998; Shelton, 1999; Arnold et al., 2001).
Prior research also shows that an auditors ability to process relevant and irrelevant
information is a source of difficulty associated with identifying going concern issues
(Shelton, 1999). Other reasons may also explain the apparent inability or unwillingness
of auditors to accurately identify and qualify failing companies. These include the likely
negative effect a qualified opinion would have on the client (Geiger et al., 1998a, b;
Nogler, 2004). An adverse opinion may prevent a firm from borrowing further and may
trigger the recall of its debts which would further strain its financial situation. The
auditors opinion, in effect, becomes a self-fulfilling prophecy. A number of studies
support the self-fulfilling prophecy argument, although its existence has not been
proved conclusively (Zhang and Harrold, 1997; Louwers et al., 1999; Tucker et al., 2003;
Nogler, 2004).
Moreover, audit evidence is evaluated in the presence of auditor-auditee contracting,
which is comprised of various influences on the auditor such as political and fee
pressures, making a completely objective decision less likely (Barnes and Huan, 1993;
Arnold et al., 2001). Therefore, the possible loss of the audit engagement if the company
survives following a going concern qualification, is another plausible explanation why
the majority of failed companies receive unqualified audit opinions (Louwers, 1998;
Nogler, 2004). Several studies show some evidence supporting this view, with clients
showing a higher propensity to switch auditors following an adverse or unfavourable
opinion (Tucker et al., 2003).
Despite auditors poor field record in assessing going concern, prior research based
on ex post comparisons of predictions from corporate failure models to auditors
opinions indicates that such models are more accurate than auditors assessments
(Mutchler et al., 1997; Hensher and Jones, 2007). It therefore appears that the
application of corporate failure models as an analytical procedure in conjunction with
sound professional judgement can assist auditors in improving their going concern
assessments (Chen and Leitch, 1998; Kaminski et al., 2004; Pasiouras et al., 2007). The
next section examines the potential role of a corporate failure model as an analytical
procedure for assessing going concern.
2.2 Corporate failure models as an analytical procedure for assessing going concern
The application of analytical procedures in the planning and review stages of the audit is
required under current auditing standards (ASA 520, 2006; New Zealand Institute of
Chartered Accountants, 2009). These standards require the use of analytical procedures
for planning the nature, timing, and extent of other auditing procedures, as a substantive
test to obtain evidential matter, and in the final review stages of the audit to assist the
auditor to determine whether the financial statements are consistent with their

understanding of the client (ASA 520, 2006; New Zealand Institute of Chartered
Accountants, 2009).
Statistical failure models may have a valuable role as an analytical procedure within
the audit decision process (Chung et al., 2008). Prior research indicates that corporate
failure models are more accurate than auditors assessments of going concern. The
latter inferences are drawn from ex post research, which did not investigate the value of
such models in practice (Chen and Leitch, 1998; Hensher and Jones, 2007; Chung et al.,
2008). The main challenge of using corporate failure models in this context is ensuring
that they are relevant to the industry and the data used to estimate the models are
recent. If corporate failure models are developed selectively for various industries, and
consistently updated, the key issues concerning the application of these models will be
minimised (Grice and Dugan, 2001). Models of acceptable accuracy as a decision tool
can be estimated with relative ease as demonstrated by Sun (2007). Given the fact that
commercial lenders successfully utilise statistical failure models (Aucterlonie, 1997;
Charitou et al., 2004; Aruwa, 2007), such models can, in a similar vein, also enhance the
auditors toolkit for assessing going concern.
Moreover, the link between going concern and bankruptcy is already recognised in
the auditing literature (Foster et al., 1998; Loftus and Miller, 2000; Kuruppu et al., 2003).
In particular, the literature identifies the probability of bankruptcy as the main
determinant of a qualified going concern opinion (Foster et al., 1998; Kaminski et al.,
2004), with a number of prior studies showing that a positive relationship exists
between the probability of bankruptcy and the issuance of qualified audit opinions
(Carcello et al., 2003; Geiger et al., 2005). Companies with high probabilities of
bankruptcy receive more qualified audit opinions compared to companies with low
probabilities of bankruptcy (McKeown et al., 1991; Carcello et al., 2003).
Although fraudulent financial reporting may make the application of failure models
developed from financial factors more challenging for assessing going concern,
fraud-related business failures make up only a small fraction of the total corporate
failure statistics. According to Newton (2009), only 4 percent of businesses failed due to
fraud. Hence the use of a bankruptcy prediction model based on financial factors is
justifiable as financial factors are most closely associated with incidences of corporate
failure.
Auditing standards such as those in Australia, New Zealand and the International
Standards on Auditing already recognise the possible use of statistical models as an
analytical procedure (ASA 520, 2006; New Zealand Institute of Chartered Accountants,
2009). Prior to the promulgation of these standards, the potential usefulness of statistical
models for assessing going concern has been recognised in the expectations gap
literature as far back as the late 1970s, when the Cohen Commissions Report (1978) on
auditor responsibilities first suggested their use as a means of reducing the expectations
gap (Altman, 1983; Asare, 1990). The Proceedings of the Expectations Gap Roundtable in
the USA has also explicitly identified the use of bankruptcy prediction models for
assessing the validity of the going concern postulate (Blocher and Loebbecke, 1993).
This was followed by the Auditing Standard Board calling for continued research into
going concern considerations and analytical procedures, with the latter issues identified
amongst the top four topics needing further academic research due to their importance in
auditing (Pany and Whittington, 2001).

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Despite the contribution that corporate failure models can potentially make in
improving auditors going concern assessments, there has been little research
examining the practical value of these models for assessing going concern.
3. Research objective and hypothesis
Although the going concern assessment is made in a complex setting (Hensher and
Jones, 2007; Pasiouras et al., 2007), it would seem logical that auditors would be
motivated to modify the audit opinions of clients that are at a high risk of failure, given
the substantial costs associated with going concern misclassification. Hence, the
continued high incidence of clients failing with no indication in the audit report before
their failure may be due to the difficulty associated with assessing going concern
(Grant et al., 2005; Hensher and Jones, 2007). The main objective of this study is
therefore to examine the practical efficacy of corporate failure models as an analytical
procedure for assisting auditors to form more appropriate going concern opinions. This
research objective is examined by the following hypothesis:
H1. A corporate failure model as an analytical procedure improves auditors
assessments of going concern for financially distressed companies.
The hypothesis examines whether a suitable corporate failure model can enhance
auditors going concern assessments in the presence of both mitigating and contrary
information for financially distressed companies (Shelton, 1999; Ashton and
Kennedy, 2002).
In addition, a number of ancillary research questions are concurrently examined with
the main research hypothesis, in order to gain a more comprehensive understanding of
auditors propensity to utilise corporate failure models as a decision aid for assessing
going concern. These range from questions about auditors perceptions towards the use
of such models for assessing going concern, to the adequacy or otherwise of the guidance
currently afforded by the relevant auditing standards.
4. Research design
A case study-based questionnaire was developed, with the questionnaire having three
separate sections. The first section gathered demographic data about the respondents,
who were chartered accountants in public practice in New Zealand. The second section
addressed the ancillary research questions about the perceived usefulness of corporate
failure models for assessing going concern by using a seven-point semantic differential
scale, anchored between strongly agree and strongly disagree. The scale had a
mid-point of four, with responses lower than four denoting agreement and responses
higher than four indicating disagreement. The scales were analysed with a one sample
t-test with a test value of four.
The last section of the questionnaire addressed the main hypothesis of this study.
It consisted of the case study, which included information of both a financial and
non-financial nature for three listed companies in the manufacturing sector, namely,
Company A, B and C. Company B was a failed company, while companies A and C
were going concerns. They were carefully selected so that each companys going
concern status was not obvious. Companies A and C continued in operation 12 months
after the accounting year end, while Company B was liquidated. The failed companys
cash flow had been halved from the previous year and there were redundancy

payments indicating an economically trying environment. The company was also

actively trying to reduce costs by reducing its workforce. This was partially due to
relying on exports to one market in light of the high New Zealand dollar. Company Bs
sales revenue had consequently declined by $12 million over the previous year, and it
had an accumulated deficit exceeding $49 million. In the development of the case study,
feedback was sought from academics and several chartered accountants as to the
suitability of the cases and the instrument in reflecting audit judgment in real
situations.
For each company in the case, the financial statements of the current and the
previous accounting periods were provided, together with both contrary and
mitigating factors, and other information which may or may not have a bearing on the
going concern assessment. These were presented to simulate the presence of multiple
sources of information that make the going concern assessment a complex task
(Mutchler et al., 1997; Arnold et al., 2001). The respondents were requested to examine
the information given in each profile and to assess each companys going concern
status on a seven-point semantic deferential scale anchored between going concern
and failed company. Responses lower than four indicated going concern and
responses higher than four indicated greater risk of failure.
In order to assess the practical value of a corporate failure model as an analytical
procedure for assessing going concern, two versions of the survey questionnaire were
developed. The first version included predictions from a tested corporate failure model
giving the likelihood of each of the companies failing. It also provided information
regarding the nature of the model, and its level of accuracy in predicting failed and
non-failed companies. The second version was identical to the first, but it did not
include information from the model.
The failure model used in this study was obtained from Kuruppu et al. (2003), who
developed a model that discriminates between failed companies and marginal
non-failed companies in New Zealand. This model was developed from Multiple
Discriminant Analysis employing the Wilks lambda stepwise method. Utilising a
sample of 135 public companies with an initial set of 63 plausible variables, the final
model was reduced to 12 variables. The tolerances at the final step of variable entry
were all above 0.001, which showed that the variables in the discriminant function
were not highly correlated with other variables in the function.
Furthermore, the Lachenbruch cross-validation procedure indicated that the model
was 92 percent accurate in discriminating between the two groups of companies.
This was also reaffirmed by both the proportional chance criterion and Presss Q
statistic, which showed that the developed models predictions were significantly better
than chance. The survey subsequently indicated that the majority of auditors consider
an accuracy rate of over 60 percent to be adequate for a corporate failure model to be
considered useful for assessing going concern. This suggests that auditors do not
perceive the use of such models to be a substitute for professional judgement, by
requiring models of a very high accuracy. Rather, corporate failure models are perceived
as a useful tool that can supplement the auditors professional judgement in reaching the
final audit opinion.
The survey was sent to 700 auditors in public practice, half of whom received the
survey instrument incorporating the model. After the first mailing and a second
follow-up, a total of 152 completed surveys were received. In total, 69 of the surveys

Assessing
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40

were from auditors who did not use the model while the remaining 83 were from
auditors who used the model. This is a response rate of 21.8 percent, which compares
favourably with other research conducted with less complex survey instruments (Elias
and Johnston, 2001; Constantinides, 2002). A non-response bias test was first utilised to
determine if the respondents who returned the completed surveys had substantially
different responses from those who did not return them. The test indicated that there
was no evidence of non-response bias.
As two samples were used, one of which controlled for the presence of the model in the
respondents judgement process, an independent sample t-test and the cross-tabulation
procedure using the asymptotic significance and Somers D statistics were used to test
the main hypothesis. The next section details the research findings.
5. Results
This section presents the demographic characteristics of the respondents followed by
the auditors going concern assessments in the case study. It also discusses the
auditors perceptions of the use of corporate models as a decision aid for assessing going
concern.
An analysis of the demographic characteristics of the respondents is presented in
Table I. About 26 percent of the respondents had between six and ten years of auditing
experience, with the majority of 57 percent having more than ten years of auditing
experience. Around 27 percent of the respondents in the survey were auditors from the
Big Four firms, with the remainder being from local or national audit firms. When
examined by a t-test for the equality of means, there were no significant differences
between the perceptions of auditors across Big Four firms and other firms, and the
perceptions of auditors who had previously used corporate failure models and those who
had not. The demographic information further indicated that although around 26 percent
%

Table I.
Respondents
demographic attributes

Panel A: level of auditing experience

One to five years
16.8
Six to ten years
26.2
More than ten years
57.0
Total
100.0
Panel B: respondent auditors affiliation
Big Four
27.3
Other
72.7
Panel C: familiarity with corporate failure models
No
74.2
Yes
25.8
Total
100.0
Panel D: regularity of corporate failure model use for assessing going concern
Regularly used
1.3
2
1.3
3
1.3
4
1.3
5
0.6
6
1.9
Not used
92.3

Cumulative percent
16.8
43.0
100.0

74.2
100.0
1.3
2.6
3.9
5.2
5.8
7.7
100.0

of the respondents were familiar with corporate failure models, only a relatively smaller
number of them had actually used them in practice.
5.1 Case study analyses
The case study was examined by an independent sample t-test and the cross-tabulation
procedure using the asymptotic significance and Somers D statistics. The first
company in the case, Company A, was a going concern and the appropriate responses
were expected to lie in the lower range of the seven-point scale, denoting that the
presented profile was consistent with that of a going concern. Descriptive statistics of
the audit opinions categorised by model used are shown in Panel B of Table II.
The descriptive statistics show that the mean response for the going concern
assessment made without the model was 3.62, while the mean for respondents who made
use of the model was 1.93. Both groups of respondents generally made the correct
inference that the profile of Company A was that of a going concern, although respondents
using the model were more disposed towards forming a judgement that the company was
a going concern. The standard deviation of the responses was significantly less with the
use of the model compared to opinions formed without the model. This indicates more
consistency in the expressed opinions as a result of using the corporate failure model.
The second company in the case was Company B, which was not a going concern.
Panel B of Table II shows that the mean response of respondents who did not use the
corporate failure model for this company was 3.21, indicating that they were more
disposed towards forming an opinion that the company was a going concern. On the
other hand, respondents utilising the corporate failure model had a mean response of
5.30. It shows that respondents using the model more appropriately formed an opinion
that Company B represented the profile of a failed company. These results also indicate
that the respondents continue to exercise professional judgement when using
predictions from corporate failure models, rather than relegating professional
judgment to a somewhat secondary role by relying entirely on such models.
Going concern assessments for Company C without the model had a mean response
of 4.52, which indicates that the companys profile was perceived to be more likely that
of a failed company. In contrast, going concern assessments made with the model had a
mean response of 3.15. This is less than the mid-point on the scale, indicating the
greater perceived likelihood that Company C was a going concern. The standard
deviation for the responses also illustrates that respondents making use of the model
had lower variability for the expressed opinion.
A detailed analysis of the effect of the corporate failure model on the respondents
going concern assessments is presented in Panel A of Table II. It shows a
cross-tabulation of the audit judgements for the three companies, made with and
without the use of the model.
For Company A, 26.4 percent of respondents using the model in the going concern
assessment recognised it as a going concern, with a further 54.0 percent also indicating
that it had a very strong likelihood of being a going concern. About 11.5 percent of the
respondents indicated that the company had a strong likelihood of being a going
concern. A higher response on the second rank also indicates that the respondents did
not select responses based entirely on the model. On the other hand, only 15.4, 18.5 and
9.2 percent, respectively, of respondents who made the going concern assessment
without the model appropriately indicated the first three scale ranks as being the more

Assessing
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41

Table II.
Frequency of responses
and descriptive statistics

Note: aStatistically significant

Panel A: frequency of responses by model use

1 Going concern
15.4%
26.4%
2
18.5%
54.0%
3
9.2%
11.5%
4
7.7%
5.7%
5
26.1%
2.3%
6
18.5%
7 Failed company
18.5%
Total
100%
100%
Pearson x 2 (asymptotic sig.)
0.000a
Panel B: descriptive statistics of audit opinions
Mean
3.62
1.93
SD
1.83
0.90
21.7%
38.8%
10.5%
6.6%
12.5%
7.9%
7.9%
100%
3.21
1.11

6.2%
24.6%
44.6%
7.7%
9.2%
6.2%
6.2%
100%
0.000a
5.30
1.41

2.3%
8.0%
10.3%
13.8%
23.0%
36.8%
36.8%
100%

3.9%
15.1%
25.0%
11.2%
17.1%
23.7%
23.7%
100%

Company B (failed company)

Model used
No
Yes
Total

4.52
1.40

1.5%
4.6%
16.9%
35.4%
30.7%
6.2%
6.2%
100%
0.000a

3.15
1.02

10.3%
25.3%
36.8%
9.2%
13.8%
2.3%
2.3%
100%

6.6%
16.4%
28.3%
20.4%
21.0%
3.9%
3.9%
100%

Company C (going concern)

Model used
No
Yes
Total

42

Response on seven-point scale

Company A (going concern)

Model used
No
Yes
Total

PAR
24,1

suitable indicator of the companys going concern status, which is significantly less
than for respondents who utilised the model. In summary, only 43.1 percent of auditors
who did not utilise the model in their judgement perceived that the company was a
going concern, which is in marked contrast to auditors who used the model. In the
latter group, 91.9 percent of the respondents perceived Company A to be a going
concern, which is the appropriate opinion for this company.
The cross-tabulation also indicates significant misclassification errors for
respondents making the assessment without the model. Approximately 49.2 percent
of these respondents incorrectly formed assessments that Company A was a failed
company, by indicating responses on points five, six and seven of the scale, when only
2.3 percent of the respondents using the model indicated that the profile was that of a
failed company, by marking point five on the scale. The asymptotic significance level of
the Pearson x 2 statistics further indicates that the going concern opinions formed with
and without the assistance of the corporate failure model were significantly different.
A similar analysis of responses for Companies B and C indicated that going concern
assessments made with and without corporate failure models were significantly
different. For Company B, which was a failed company, 65.5 percent of respondents
using the model in their decision concluded that the company was a failed company,
when only 16.9 percent of respondents who did not use the model concluded the same.
This resulted in the majority of respondents not using the model to inappropriately
conclude that the company was a going concern. Specifically, 75.4 percent of
respondents not relying on the model concluded that Company B was a going concern,
when only 20.6 percent of respondents using the model came to this opinion. For
Company C, respondents using the model also came to a more appropriate opinion.
Using the model, 72.4 percent of the respondents opined that the profile was that of a
going concern, when just 23 percent of respondents who did not rely on the model came
to the same conclusion. These findings suggest the value of a statistical corporate
failure model in assisting auditors to improve going concern judgement decisions.
An independent sample t-test was further utilised to conclusively examine the
statistical significance of the above findings (Rodeghier, 1996). The independent
sample t-test compared the mean values of the responses for the two groups of
respondents who made the going concern assessment with the model and those
without the model. The results of this procedure are presented in Table III, which
indicate that there are significant differences in going concern judgments made by the
two groups of respondents.

Assessing
going concern

43

5.2 Auditors perceptions of the use of corporate failure models

A one sample t-test was used to examine auditors perceptions of corporate failure
models as a decision aid for assessing going concern. Table IV presents these results.
The first ancillary research question sought information about auditors perceptions on
whether corporate failure models are useful as an analytical procedure for obtaining
Company

F-value

Sig. of F

Mean difference

t-value

Sig. (two-tailed)

A (going concern)
B (failed company)
C (going concern)

110.340
8.602
1.268

0.000
0.000
0.210

21.67
1.92
21.36

26.183
7.991
26.518

0.000
0.000
0.000

Table III.
Independent
samples t-test

PAR
24,1
Ancillary research questions

44

Table IV.
Response frequencies and
one sample t-tests

RQ1. CFM are useful as an

analytical procedure for
obtaining audit evidence on
the validity of the going
concern assumption
RQ2. CFM are more accurate
for assessing going concern
than other analytical
procedures
RQ3. CFM mitigate some of
the subjectivity involved in the
going concern assessment
RQ4. CFM can assist auditors
in the planning stage of the
audit
RQ5. CFM assist auditors in
the final stages of the audit
RQ6. Need more guidance in
the standard on going concern
RQ7. Need more guidance in
the standard on analytical
procedures

12.8 50

Scale response frequencies (%)

95% 95%
CI:
CI:
lower upper
4
5 6 7 Mean bound bound

14.7 10.9 5.8 2.6 3.2

5.1 43.6 30.8

4.5 7.1

9.6 46.8 26.3

1.9 3.8 2.6

t-test
value

2.67

2.45

2.90

211.71a

2.85

2.66

3.05

211.57a

2.69

2.48

2.89

212.63a

2.14

1.95

2.32

219.68a

34.8 36.1 16.8

7.1 3.2 1.9

12.8 48.7 20.5

7.1 4.5 5.1 1.3

2.62

2.41

2.55

212.88a

8.4 50.3 22.6

5.2 3.9 5.8 3.9

2.79

2.55

3.02

210.28a

30.3 35.5 18.1

4.5 3.9 3.9 3.9

2.43

2.18

2.68

212.52a

Note: aStatistically significant

audit evidence on the validity of the going concern assumption. The first three points
on the scale were marked by 77.5 percent of the respondents indicating their
concurrence that such models are useful in this context. The mean response for this
question of 2.67 is below the scales mid-point of four, with the 95 percent confidence
interval for the mean lying between 2.45 and 2.90. The t-test is significant, which
shows the general perception among auditors that corporate failure models are useful
for obtaining audit evidence on the validity of the going concern assumption.
When the above question was extended to inquire about the value of such models
compared to other available analytical procedures for assessing going concern in
question two, the first three points on the scale were indicated by 79.5 percent of the
respondents. The mean response on the scale was 2.85 with the 95 percent confidence
interval for the mean lying between 2.66 and 3.05. The t-test is also significant, which
shows that auditors perceive corporate failure models to be an effective analytical
procedure for assessing going concern, when compared to other available analytical
procedures.
Prior research shows that different auditors can reach different conclusions from the
same audit evidence, which indicates that the assessment of audit evidence is
subjective. In this context, question three examined whether corporate failure models
are perceived as being able to mitigate some of the subjectivity involved in the going

concern assessment. The first three points on the scale were marked by 82.7 percent of
the respondents. The mean response for this question was 2.69. The 95 percent
confidence interval lay between 2.48 and 2.89 and it is statistically significant. This
indicates that respondents perceived that corporate failure models can mitigate some of
the subjectivity involved in the going concern judgement.
Analytical procedures are often contended to be an efficient technique that can
allow auditors to plan the nature, timing and extent of audit procedures. They can also
be an efficient overall reasonableness check on the fair presentation of financial
statements (Chen and Leitch, 1998; Kaminski et al., 2004). Research questions four and
five examined auditors perceptions of the ability of corporate failure models to assist
in the planning stage of the audit in identifying areas of potential risk, and also in the
final stages of the audit when forming an overall opinion as to whether the financial
statements as a whole are consistent with their knowledge of the client.
In response to question four, the first three points on the scale were marked by
87.7 percent of the respondents. The mean response was 2.14, with the 95 percent
confidence interval for the mean lying between 1.95 and 2.32, indicating agreement that
corporate failure models can assist in the planning stages of the audit in identifying
potential risk. A similar response was obtained for research question five. About
82 percent of the respondents marked the first three points on the scale. The response
mean was 2.62, with the 95 percent confidence interval for the mean lying between
2.41 and 2.55. This indicates the general consensus that corporate failure models are
also useful in the final stages of the audit in verifying the overall conclusions formed
about the clients financial statements. The t-tests were statistically significant for both
questions four and five.
The utility of corporate failure models in identifying failed companies as shown by
this research strongly suggests that such models are valuable for making more
accurate going concern assessments, thereby helping to mitigate misclassification
errors. However, for corporate failure models to be used routinely in auditing, as are
other commonly used analytical procedures, a certain level of recognition and guidance
must be afforded by the relevant auditing standards. In this context, research
questions six and seven examined auditors perceptions of the level of guidance that
should be provided in the current auditing standards on going concern and analytical
procedures, respectively, with regard to the possible application of corporate failure
models for assessing going concern.
In response to question six, 81.3 percent of the respondents marked the first three
points on the scale. The mean response was 2.79, with the 95 percent confidence
interval lying between 2.55 and 3.02. The t-test is also statistically significant. This
indicates that the majority of respondents perceive that more guidance on the
availability of corporate failure models for assessing going concern is required in the
current auditing standard on going concern. For research question seven, 83.9 percent
of the respondents selected the first three points on the scale. The mean response was
2.43, with a 95 percent confidence interval of 2.18-2.68. The t-test is also significant.
These responses show strong concordance with the statement that guidance should be
provided in the auditing standard on analytical procedures with regard to the
availability of corporate failure models for assessing going concern.
Interestingly, more auditors stated that guidance on corporate failure models should
be provided in the auditing standard on analytical procedures compared to the auditing

Assessing
going concern

45

PAR
24,1

46

standard on going concern, by marking their responses on the first point of the scale.
Specifically, over 30 percent of the respondents very strongly believed that more
guidance on corporate failure models should be provided in the auditing standard on
analytical procedures, in contrast with about 8 percent of respondents who believed the
same for the auditing standard on going concern. This is perhaps a reflection of the
respondents perceptions of the utility of such models in the planning and review stages
of the audit as confirmed by questions four and five.
6. Summary and conclusion
This study examined the practical value and efficacy of corporate failure models in
assisting auditors to form more accurate going concern opinions. A case study
methodology was used as a proxy for the auditors decision-making environment. The
results indicate that the use of the corporate failure model was effective as a means of
mitigating human information processing limitations and consequently forming more
appropriate conclusions about a clients financial condition, which precursor the
issuance of appropriate going concern opinions. As the issuance of unqualified audit
reports to failed clients is generally perceived to be synonymous with audit failure, the
routine application of corporate failure models within the audit decision process can
have substantial benefits to the profession, in its role of adding credibility to financial
statements. It will be an effective means of minimising the audit expectations gap
through the issuance of more appropriate audit opinions.
The results further indicate that the application of corporate failure models for
assessing going concern does not lead to the relegation of professional judgement to
a somewhat secondary level within the audit decision process. On the contrary, only a
minority of respondents suggested, by selecting the endpoints of the scale, that the
models prediction was the only factor influencing their chosen going concern opinion.
The majority of respondents effectively used the contribution of the corporate failure
model together with other pertinent information to form the going concern assessment.
However, despite the potential usefulness of such models, auditors should apply them
cautiously and prudently in assessing going concern, since these models cannot be
expected to fully encompass all the factors involved in this complex auditing task.
Furthermore, auditors perceive that corporate failure models are effective in
reducing some of the subjectivity involved in assessing going concern, which may
assist in forming more consistent audit opinions for clients with similar risk and
financial condition. Interestingly, more auditors perceive that corporate failure models
are more useful in the planning stages of the audit rather than in the final stages.
Perhaps this reflects the perceived value of corporate failure models in assisting
auditors to identify high risk clients, thereby alerting them to expand the scope of the
audit, especially for new engagements. Auditors also perceive the need for more
guidance on corporate failure models in both the auditing standards on analytical
procedures and going concern.
As with all experimental research of this nature, this study is limited by the fact that
it was not applied in an actual audit engagement. This may be considered to be a
limitation in that it was not possible to observe the efficacy of the model during an
actual audit, which would have been the ideal context on which to base statistical
inferences. It would have been also ideal if the seeded company failure rate in the case
study corresponded with the stated accuracy rate for the model. In addition, it is also

possible that the order in which the case was presented to the participants in the
survey, which was after assessing auditors perceptions of corporate failure models,
may have had a sensitization effect on the subsequent going concern assessments.
Nevertheless, the case study experiment was an appropriate method for examining the
effect of a corporate failure model on audit judgement.
As the going concern assumption is a fundamental principle in financial reporting,
an attractive area for future research would be to examine the interest among financial
statement users and the profession of explicitly having a statement about clients going
concern status in the audit report, perhaps as an explanatory paragraph. This might
for example follow the Sarbanes Oxley Acts requirement in the USA for auditors to
attest to the managements assertion regarding internal control over financial
reporting. Indeed, NZ IAS 1 on the Presentation of Financial Statements requires
management to make an assessment of an entitys ability to continue as a going
concern, and it is also referred to in the audit standard on going concern (ISA [NZ] 570).
With the demonstrated capability of suitable corporate failure models to assess
impending failure with a high degree of accuracy, auditors on their part would not be
accepting any more responsibility, and hence liability, than is currently required by
law or current auditing standards in attesting to the fairness of the managements
assertion about going concern. On the contrary, they will be making a clearer
statement of clients future viability, and hence the appropriateness of the financial
statements. A change in reporting format in this manner would not require additional
resources, but it may have a positive influence on the auditors function in society of
assuring the trustworthiness of financial statements. This remains a stimulating area
for further research.
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Auditors, available at: www.pwc.com/en_CA/ca/audit-assurance/publications/sox-404-v2en.pdf (accessed 20 September 2009).
Corresponding author
Fawzi Laswad can be contacted at: f.laswad@massey.ac.nz

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