Study on PSA 570

A Study on the Recently Redrafted Philippine Standard on Auditing 570 “Going Concern”

Armedilla, Princess Kate
Jordan, Michael
Llanes, Janice
Roxas, Michelle
Sulit, Elaine
Introduction
Being one of the bedrocks in accounting assumptions, going concern contributes a big role in an entity’s existence. This assumption covers the views of an entity’s ability to continue in business for the foreseeable future, with neither the intention nor the necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to laws and regulations. Going concern should also be the basis in making general purpose financial statements in order for the business to prevent or avoid instances that will hasten the company’s ultimate failure.

However, while the going-concern assumption has been described as one of the most important concepts in accounting, other professional guidance elaborates on when the going-concern assumption is no longer valid as a basis for auditing and financial reporting. Similarly, there has been relatively little discussion or justification in the academic literature for the going-concern assumption, or when it is no longer valid as a basis for auditing and financial reporting. Paton and Littleton (1940) have asserted that “the possibility of an abrupt cessation of activity cannot afford a foundation in accounting”. However, while this assertion is generally satisfactory for the vast majority of reporting entities at any given time, it conflicts with the fact that financial statements should be prepared on a liquidation basis when companies are being liquidated (or they are soon to be liquidated). Contrary to Paton and Littleton (1940), Sterling (1968) argues that the going-concern assumption is unnecessary as a principle in accounting as some entities operate for a finite period rather than on an indefinite continuing basis.

On the other hand, shareholders, lenders, creditors, regulators and other users of the financial statements rely on the auditor to give timely warning of impending corporate failure. When auditors neglect to give such a warning and companies subsequently fail, regulators and the business press react by expressing serious concerns about the quality, objectivity, and independence of public auditors (House of Lords Select Committee on Economic Affairs 2011).

PSA 570 requires the auditor’s responsibility to obtain sufficient and appropriate audit evidence about the appropriateness of the management’s use of going concern assumption in the preparation and presentation of financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

On the other hand, as described in PSA 200 (Revised and Redrafted), the potential effects of inherent limitations on the auditor’s ability to detect material misstatements are greater for future events or conditions that may cause an entity to cease to continue as going concern. The auditor cannot predict such future events or conditions. Accordingly, the absence of any reference to going concern uncertainty in an auditor’s report cannot be viewed as a guarantee as to the entity’s ability to continue as a going concern.

Background of the Study

This study highlights the standards relating to the Going Concern assumption as viewed in the business entities in the Philippines. Moreover, thus study was carried out upon previous important economic events and rigorous research on those events being conducted and then published in peer-reviewed journals regarding the subject.

The purpose of this review is to synthesize and discuss prior the auditor’s decision to issue an opinion modified for going-concern uncertainty in establishing current auditing standards for public companies.

There could be distinctions between the international and local standards regarding going concern. These might result to conflicts on the part of the auditors and other users of information. There could be confusion on which standard should they rely or base in making economic decisions. Thus, the researchers considered it essential to undertake this study.

Statement of the Problem

This study entitled “A study on the recently redrafted PSA 570 Going Concern” aims to come up with conclusions with regards to the following inquiries:
1. What does PSA 570 concerns about?
2. Why is PSA 570 redrafted?
3. How is the recently redrafted PSA 570 diverse from the older one?
4. Does PSA 570 (redrafted) answer the dilemma of going concern uncertainty?
5. How do the various users respond to PSA 570 GOING CONCERN (redrafted)?
Accountants in Public Practice
Accounting professors
Business entities

Objectives of the Study

This research paper shall attempt to discuss the following objectives:
Discuss the contents of PSA 570 “Going Concern” (redrafted)
Identify the reasons of altering PSA 570.
Determine the similarities and differences of the old PSA 570 and PSA 570 Redrafted.
Analyze whether PSA 570 redrafted gave to a solution with regards to going concerns uncertainty faced by business enterprises in the Philippines.
Gather and confer the opinions of different sectors: accountants in public practice, accounting professors, and business enterprises in the Philippines.

Significance of the Study

This study is conducted to provide enough and clear assistance to the following:
Internal and External Auditors, for them to get updated with the newly imposed auditing standard which is PSA 570 (redrafted) and to apply them in accordance with the latest updates in generally accepted auditing standards in the Philippines.
Preparers of financial statements, for them to gain additional knowledge with regards to the entity’s ability to continue as a going concern.
Students and instructor, for them to have a comprehensive understanding of the said new auditing standard in order to widen their knowledge and share them to appropriate individuals.
Future researchers, for them to have this study as a reference or guide for their own research and might also be an open agenda for further studies in relation with it. This study shall be a significant attempt in improving knowledge and awareness to related parties.

Scope and Limitation

This study shall deal with the Philippine Standard on Auditing (PSA) 570 GOING CONCERN (redrafted) which is imposed by Auditing and Assurance Standard Council (AASC), the body authorized by law to promulgate and establish auditing standards in accordance with generally accepted auditing standards in the Philippines. This paperwork shall distinguish the difference made and similarities with the older version of PSA 570 and the reasons behind this alteration. Opinions collected from local and international auditing firms and individual auditors, outlook of some accounting professors, and some articles and journals taken from different auditing organizations’ websites shall be the basis in conducting this study.

This activity limits its undertaking with the going concern assumption to be used in examining financial statements of an existing entity. Only prohibiting other related topics which will interrupt the concentration with the said coverage.

Definition of Terms

Philippine Standards on Auditing. This deals with the auditor’s responsibility to consider laws and regulations when performing an audit of financial statements. PSA does not apply to other assurance engagement in which the auditor is specifically engaged to test and report separately on compliance with specific laws and regulation. Going Concern. It assumes a company will continue to operate in the foreseeable future. The significance of going concern becomes apparent when the value of running business is compared with the value of being liquidated. Superseding standards. It indicates that the standard has been replaced by more recent standards. The replacement does not bear the same designation. Sometimes a standard superseded in part by another standard and the earlier edition remains current until there are replacements available that cover all other content of the original standards. Economic Decision Making. It is the act of deciding on matters of the economy. Economic decision is routinely conducted by finance ministers, economic advisors, heads of major central banks and business leaders and can profound effects on a major economy.

CHAPTER II
Review of Related Literature
Prior to SAS 34, the authoritative literature provided little guidance on when the auditor should consider modifying the audit opinion based on uncertainty that the entitiy could continue as a going concern. SAS 34 was issued in response to the preponderance of cases where the auditor’s judgment was called into question after a business failure. SAS 34 in paragraphs 7 and 8 required auditors to consider contrary information and mitigating factors, and in paragraph 3 required management’s plans when evidence of audit procedures suggested there may be a question as to the company’s ability to continue as a going concern. According to paragraph 4, contrary information included negative cash flow from operations, recurring operating losses, debt default, loss of key personnel, and litigation. Paragraph 5 presents mitigating factors that may offset the effects of contrary information, including the ability to dispose of assets, the availability of sources for borrowing or capital, and the capability to reduce expenses or delay expenditures. Paragraph 9 required auditors to review management’s response to the contrary information (plans for asset disposal, borrowing, or delay of expenditures) to assess the effects and feasibility of the plans. Based on this evaluation, the auditor must judge the appropriateness of modifying the audit opinion to indicate an uncertainty about the entity’s going concern status.
Problems continued after the issuance of SAS 34: “Questions [remained] about whether auditors had been taking sufficient responsibility for evaluating a client’s ability to continue in existence” (Goldstein, 1989). Furthermore, companies were still failing after receiving an unqualified audit opinion. SAS 59 was one of the nine “expectation gap auditing standards” issued in 1988 to address the differences between public expectations and auditors’ responsibilities. SAS 59 increases the auditor’s responsibility for going concern evaluation in an effort to improve external auditor communications.Some, however, believe that SAS 59 adds little to the authoritative guidance.
There are three noteworthy changes from SAS 34 to SAS 59. First, SAS 59 requires auditors to consider going concern status for every audit engagement. SAS 34 required going concern consideration only when audit procedures indicated that there may be a question as to the company’s going concern status. SAS 59, paragraph 5, does not require, however, that audit procedures be designed specifically to address the going concern issue. Therefore, the change from SAS 34 to SAS 59 is not a requirement of additional audit procedures, but rather a requirement of going concern consideration in every audit. Second, SAS 59 requires that the audit report be modified if there is substantial doubt about the entity’s going concern status. SAS 34 required a qualified audit report if there was uncertainty regarding the recoverability of assets and the classification of liabilities. Third, SAS 59 requires an explanatory paragraph in the audit report regarding the substantial doubt; SAS 34 merely required a qualified “subject to” opinion. (Bellovary, 2006)
Several studies have been conducted to determine how SAS 34 and SAS 59 affect audit reports. As the authoritative guidance places more responsibility on auditors, one would expect auditors to issue more going concern–modified audit reports (Huss, 1995). The work of Raghunandan and Rama supports this expectation; they found that auditors are more likely to issue going concern opinions post–SAS 59 than pre–SAS 59.
Carcello et al. provide evidence that auditors were more likely to issue going concern–modified audit reports post–SAS 34 than pre–SAS 34. Carcello et al. found the likelihood to modify audit reports is not significantly different when comparing pre–SAS 59 to post–SAS 59. Geiger et al. reported similar results, and found that the mean probabilities of bankruptcy pre–SAS 59 and post–SAS 59 are not significantly different. They go on to state that this “indicates that auditors are not issuing going-concern modified opinions to differently stressed clients after the implementation of SAS No. 59.”
Other studies that investigated whether the going concern opinion adds value to the decision-making process have yielded mixed results. Kevin C.W. Chen and Brian K. Church found that the market’s reaction is less severe when a going concern opinion has been issued as opposed to when a non–going concern opinion has been given. They concluded that the going concern opinion has informative value to explain excess returns around a bankruptcy filing (Leftwich, 1984)
Betty C. Brown and Alan S. Levitan (1986) reported that companies that receive going concern opinions show significantly poorer market performance than companies that do not receive going concern opinions. Brown and Levitan, however, concluded that the auditor’s opinion may not be the only factor affecting performance, because the differences in performance begin three to five weeks prior to year-end. (C. Chow and S. Rice, 1982)
The preponderance of evidence suggests that the going concern opinion adds no valuable information to the decision-making process. Clive S. Lennox (1999) found that a change in going concern qualification has no significant impact and therefore concluded that the audit report modified for going concern does not provide valuable information. (Umar, 1982)
Despite evidence suggesting that the going concern opinion does not have informative value, several individuals have criticized the current literature and called for additional guidance in the area of going concern. Hian Chye Koh and Larry N. Killough (1990) asserted that the problems with SAS 34 continue to appear with SAS 59 because the statements contain essentially the same guidance. This assertion would appear valid given that the same questions that arose after SAS 34 was released continue to be asked post–SAS 59:
Where are the auditors?
Why are businesses failing shortly after receiving an audit report that does not indicate substantial doubt about the entity’s ability to continue as a going concern?
Are auditors taking enough responsibility for going concern assessment?
Jonathan Weil (2001) reported that during the wave of “dot-com” failures in 2000, only three of the 10 publicly held dot-com companies that filed for bankruptcy received going concern opinions on their most recent audit report. In some cases, the going concern opinion comes too late. Weil referred to one case in which the company had a fiscal year ending in June. The company received a going concern opinion released in October, and went bankrupt in November. Another critic, Martin D. Weiss of Weiss Ratings, Inc., in “The Worsening Crisis of Confidence on Wall Street” (2002), stated that more than 40% of public companies that filed for bankruptcy between January 1, 2001, and June 30, 2002, received unqualified opinions on their most recent audit report. Weiss called this a “breakdown with disastrous consequences” and recommended creating a clearer definition of the auditor’s responsibility. Weiss submitted his report to the U.S. Senate during its debate of the Sarbanes-Oxley Act (SOA), in support of the new legislation. The Senate used Weiss’ report as part of the consideration for the controls put in place by SOA. If the situation is so “disastrous,” why did Congress not factor the issue of going concern assessment into the new legislation?
Elizabeth Venuti, in “The Going-Concern Assumption Revisited: Assessing a Company’s Future Viability” (The CPA Journal, May 2004), reported that, post–SAS 59, nearly 50% of bankrupt companies did not receive a qualified going concern opinion on their most recent audit report. She also points out that “twelve of the 20 largest bankruptcy filings in U.S. history took place in 2001 and 2002,” and that none of the 12 received qualified going concern opinions on their most recent audit report. Venuti believes the issue goes much deeper, stating “modifications to the concept statements and auditing standards appear to be necessary.” She refers to the International Standards on Auditing (ISA), which provides in its glossary the following definition of the going concern assumption:
Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading, or seeking protection from creditors pursuant to laws or regulations. Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business.
Venuti questions whether companies such as WorldCom and Enron would have received a going concern opinion had SAS 59 used “similar language.”
In the case of a business failure, auditors are exposed to the risk that financial statement users will sue them for not issuing a going concern opinion to warn users that the entity may not continue in existence for another year beyond the date of the audited financial statements. There is also the chance that a company will sue its auditor for issuing a going concern opinion “in error” (i.e., when the client does not fail). To assess the risks of litigation, the authors searched for data regarding auditor litigation cases and outcomes. They began with searches of Internet search engines, journal/newspaper databases, and the SEC website for the topics of “going concern” and “auditor litigation.” The authors also contacted the SEC directly via telephone to substantiate the findings of the SEC website search, which returned no instances of auditor litigation for going concern issues. Per the conversation with the SEC, auditor litigation for going concern issues is not a primary concern or focus for the SEC.
The authors also searched the auditor litigation database compiled by Zoe-Vonna Palmrose (“Empirical Research in Auditor Litigation: Considerations and Data,” Studies in Accounting Research #33, American Accounting Association, 1999), which includes 1,071 instances of auditor litigation involving the Big Eight firms and audits from 1960 through 1995. A keyword search of “going concern” returned 41 cases, 14 of which were fraud-related, where fraud was the primary focus of the case; the going concern issue played a secondary role. In fraud cases, the procedures for evaluating going concern status are not useful and the opinion is not meaningful. A review of the 27 cases that were not fraud-related showed that 10 had going concern as a primary issue, not just as part of a long list of other issues. In five of the 10 cases, the case was either dismissed or the auditor was not held liable. In three of the cases, the auditors settled for amounts up to $5 million. In the other two cases, the outcomes were unknown. In conclusion, less than one-half of 1% of the 1,071 cases involved successful litigation of auditors for going concern issues.
An examination of articles regarding auditor litigation revealed few instances of litigation for going concern issues. Carcello and Palmrose, in “Auditor Litigation and Modified Reporting on Bankrupt Clients” (1994) found that out of 655 public companies that went bankrupt between 1972 and 1992 and were audited by “Big” firms, 83 received going concern opinions on their last financial statement before bankruptcy or litigation. Of the 83 companies that received going concern opinions, only five were the subject of auditor litigation. Carcello and Palmrose do not provide specifics or the outcomes of the cases.
Geiger and Raghunandan concluded that the reform act relieved auditors’ concern for exposure to litigation and has led auditors to issue fewer going concern opinions. The results of this study, combined with the low number of cases of auditor litigation for going concern issues, has led the authors to believe that litigation in this area is not a serious threat to practitioners.

CHAPTER III
RESEARCH DESIGN AND METHODOLOGY The paper’s design, method, and procedures are summarized in this portion.

Methods of Research The purpose of this study is to describe Philippine Standards on Auditing 570 “Going Concern” (redrafted). In order to meet this purpose, the researchers use the qualitative design. Wikipedia defines qualitative research as a method of inquiry employed in many different academic disciplines, traditionally in the social sciences, but also in market research and further contexts. Qualitative research also aims to gather an in-depth understanding of human behavior and the reasons that govern such behavior. The qualitative method investigates the why and how of decision making, not just what, where, when. In the conventional view, qualitative methods produce information only on the particular cases studied, and any more general conclusions are only propositions.

Data and Reference Sources PSA 570, the existing auditing standard on the auditor’s consideration of an entity’s ability to continue as a going concern, discussion papers issued by IAASB, related articles posted on the web, published opinions of CPAs in public practice, and published works of former researchers were used as reference and sources of data in conducting this study.

Data Gathering Procedure The above mentioned data were collected by the researchers through web search and library work. Researches include any form of gathering of information and facts for the development of knowledge. The researchers studied PSA 570, the existing auditing standard on the auditor’s consideration of an entity’s ability to continue as a going concern.

Analytical Treatment of Data Collaboration and teamwork which is the work done by several associates with each doing a part but all subordinating personal prominence to the efficiency of the whole, was essential in the process of making this study. Aside from the facts gathered by the researchers, brainstorming of ideas was also conducted in order to provide answers to the statement of the problem and to come up with the final output.

Research Paradigm A conceptual paradigm of the study is presented below: