The Auditor\'s Going Concern Decision and Alternative Financial Ratios

Abstract

This study contributes in two ways to the existing literature by producing new information to support an auditor’s evaluation of a company as a going concern. Firstly, instead of concentrating on viable and distressed companies, or only on distressed companies, this study analyzes an empirical dataset consisting of viable companies and companies that are in temporary financial difficulty, i.e. companies that are undergoing restructuring. Secondly, this study contributes to the existing literature by focusing on the same period of time, one year, as auditors do. Instead of static comparisons of financial ratios one year, two years, and three years prior to financial distress, this study divides the post-audit accounting period into two sub-periods. This study uses these shorter sub-periods to evaluate the usefulness of alternative financial ratios as predictors of going concern status.

The data consist of a sample of Finnish firms that have published annual financial statements during the research period, namely the accounting years 2003-2007. The sample included 106 companies that had filed their application for restructuring and, as their matched pairs, 106 viable companies that have not experienced financial distress during the research period. The data include financial statements and the date of the filed application for restructuring proceedings.

The results are drawn from a logistic regression analysis. The results indicate that, sta-tistically, the classification ability of some financial ratios diminishes significantly when the time period between financial statement and restructuring event lengthens. The best classifiers in this study, which kept their classification accuracy until the end of post-audit period, are total debt ratio, accounts payable turnover, current ratio and working capital to total assets. All other ratios lost their classification power when the time pe-riod between financial statement and restructuring event lengthened.