• Going, Going, Gone – Auditors Still Not "Concerned" Enough About Client Viability

    By • Jan 4th, 2009 • Category: Pure Content, The Case Against The Auditors

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    One of the things I’ll be talking about is “going concern.”


    The Big 4 stay in business whether your company stays in business or whether it fails.

    On December 5, 2008, the PCAOB issued Staff Audit practice Alert No. 3, “Audit Considerations in the Current Economic Environment.” Its purpose was to draw the attention of external auditors to some hot topics, given the upcoming calendar year end on December 31 and the current financial crisis.
    • Overall audit considerations such as planning, fraud, internal controls, substantive procedures, and communications with audit committees that may be affected by recent events in the financial markets and current economic conditions.
    Auditing fair value measurements;
    • Auditing accounting estimates;
    • Auditing the adequacy of disclosures;
    • Auditor’s consideration of a company’s ability to continue as a going
    concern; and
    • Additional audit considerations for selected financial reporting areas.

    I have a special interest in the discussions around the auditor’s considerations of a company’s ability to continue as a going concern. There have been some spirited discussions of this concept here and on other blogs where I have commented.

    On December 8, Edith Orenstein reported at the FEI Blog on this alert and also reminded us:

    “…today is the comment deadline to FASB on its Exposure Drafts released Oct. 8 on Going Concern and Subsequent Events. FASB’s ED’s would move the guidance on these matters from the auditing literature to accounting literature or GAAP, with some changes. Only a few comment letters have been filed so far, here and here, which is not unusual prior to a comment deadline, although a FASB board member recently noted at a board meeting that some constituents have indicated it is difficult to respond to all matters open for comment at the current time.”

    The audience for FASB Exposure draft on Going Concern is accounting policy decision makers at both the public and private companies that have a requirements to prepare financial statements according to GAAP. The primary change proposed is with regard to the time horizon over which an entity should evaluate its ability to continue as a going concern:

    “…the Board decided to adopt the time horizon in IAS 1 (at least, but not limited to, twelve months from the end of the reporting period), instead of the time horizon considered in AU Section 341 (not to exceed one year beyond the date of the financial statements). The Board decided to use the time horizon in IAS 1 because it avoids the inherent problems that a bright-line time horizon would create for events or conditions occurring just beyond the one-year time horizon that are significant and most likely would have to be disclosed. It also would result in a convergent approach between U.S. generally accepted accounting principles and IFRSs.

    The other proposed modifications to align the going concern guidance with IFRSs include:
    (1) using the wording in IAS 1 with respect to the type of information that should be
    considered in making the going concern assessment (all available information about the
    future) and
    (2) requiring an entity to disclose when it does not present financial statements
    on a going concern basis.

    It may seem to the naïve eye that the time horizon change is no more than accounting geek semantics…
    From “not to exceed one year beyond the date of the financial statements…” to “…at least,
    but not limited to, twelve months from the end of the reporting period…”
    seems an accountant standard-setter’s sleight of hand. But in this environment, one of “sudden” strains on liquidity, catastrophic and calamitous changes in capital markets conditions, it’s important for auditors, in particular, to evaluate audit risks that may have been previously identified but may have become become “suddenly” more significant.
    It’s also crucial for auditors to evaluate racy new risks that now may exist due to “cataclysmic” current events (e.g. those affecting the erstwhile economy, constipating credit and limiting liquidity).
    Among other things, the Gestalt of current market and economic uncertainties may create “imponderable” questions about the verisimilitude of valuations, especially of assets no one is buying that stink like very dead fish, the impairment or lack of marketability of assets characterized in the footnotes as “mobility challenged,” the reasonableness of recovery of certain assets (the “do we need to break their legs to collect” test,) and the completeness or valuation of certain liabilities reflected in financial statements, aka the “Being and Nothingness” assertions.
    In the interim, before all the votes are in at FASB on the proposal, external auditors at least have the advice from the PCAOB on how to implement the current guidance in these trying times:
    “The auditor has a responsibility to evaluate whether there is a substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited. The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report.

    The auditor’s evaluation includes considering whether the results obtained in planning, performing, and completing the audit identify conditions and events that, when considered in the aggregate, indicate there could be a substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time.

    It may be necessary to obtain additional information about such conditions and events, as well as the appropriate evidential matter to support information that mitigates the auditor’s doubt. Conditions or events that, when considered in the aggregate, indicate there could be substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time include –

    If, after considering identified conditions and events and management’s plans, the auditor concludes there is substantial doubt, he or she should consider the possible effects on the financial statements and the adequacy of disclosure about the company’s inability to continue as a going concern for a reasonable period of time, and include an explanatory paragraph in the audit report to reflect this conclusion.”

    If the auditor believes there is substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time, the auditor should obtain information about management’s plans that are intended to mitigate the effect of such conditions or events, and assess the likelihood that such plans can be effectively implemented.Such considerations also may include the effect of federal assistance or participation in a federal program.

    Negative trends – for example, recurring operating losses, working capital deficiencies, negative cash flows from operating activities, adverse key financial ratios;
    Other indications of possible financial difficulties – for example, default on loan or similar agreements, arrearages in dividends, denial of usual trade credit from suppliers,restructuring of debt, noncompliance with statutory capital requirements, need to seek new sources or methods of financing or to dispose of substantial assets;
    • Internal matters – for example, work stoppages or other labor difficulties, substantial dependence on the success of a particular project, uneconomic long-term commitments, need to significantly revise operations;
    External matters that have occurred – for example, legal proceedings,
    legislation, or similar matters that might jeopardize a company’s ability to operate; loss of a key franchise, license, or patent; loss of a principal customer or supplier; uninsured or underinsured catastrophe such as a drought, earthquake, or flood.

    We saw clean audit opinions for all of the large banks and financial services institutions up to their demise.

    That is, there were no “going concern” qualifications in the audit reports for any of these institutions directly preceding their failures, takeovers, and nationalizations less than a year later.  The answer for this curious case of exclusion, from the preeminent attorney to directors, officers and their external auditors, was, when asked at the FEI Current Issues in Financial Reporting conference: Timing. (?)
    Sorry, Mike.  I think your clients will need a stronger argument in their defense, given the fact that December 31, 2007 financial statements had no “going concern” qualifications and the worst of the crisis was soon to come. The worst of the crisis was clearly anticipated, clearly foreseeable, and readily acknowledgeable by managements from a GAAP disclosure perspective and from their auditors from the perspective of a “professional” evaluation of the verisimilitude of managements’ disclosures as of December 31, 2007 and soon to come 12/31/2008 annual reports.  The financial crisis was not sudden, it just accelerated quickly once the match, the Lehman failure, was lit.  But there had been many mile markers along the way and many of the biggest failures have been problem children for a long time.
    An interesting case is one that came up in my Google Alerts today.  I have set a Google Alert to tell me every time “going concern” appears in a story or press release and I’m now seeing a few of these comments/opinions trickle in.  The two most have heard about are Lee Enterprises and The Parent Company.
    And then there’s the unique occurrence of PricewaterhouseCoopers rewriting history when it removes a going concern opinion for Las Vegas Sands from a previous report for what they see as improved conditions now.  And then there still are no “going concern warnings for GM or Chrysler, even though they recently requested billions from US taxpayers to rescue them from imminent bankruptcy. I”ll write more about those cases in a future post.

    But I’d like to lay out the facts of another case, BankUnited Financial, a bank in Coral Gables Florida. From the South Florida Business Journal on December 15, 2008: (BankUnited Financial’s fiscal year end is September 30.) :
    “BankUnited Financial Corp., the holding company for the largest bank based in Florida, expects to lose at least $327 million in the fourth quarter and warns of “substantial doubt” of its ability to operate as a going concern if it fails to raise capital.

    In a notification of late filing with the Securities and Exchange Commission on Tuesday, the Coral Gables-based parent of BankUnited (NASDAQ: BKUNA) also acknowledged that the SEC’s Miami office began an informal inquiry into the company in October…After signing a cease and desist agreement with the Office of Thrift Supervision in September, BankUnited has been working with federal regulators, who placed restrictions on its business practices and set a Dec. 31 deadline for the bank to raise its capital-to-asset ratios.

    BankUnited, which previously said it was seeking $400 million, continues to seek more capital through an asset sale or an equity investment. The bank stated that if it does not raise the money by the end of the year, it doesn’t expect to meet the capital ratio requirement and could face “various enforcement actions regarding the bank” from federal regulators.

    “We are in negotiations with a fund to raise capital and restructure our balance sheet,” BankUnited stated in the filing. “We cannot assure you that these negotiations will be successful. If such negotiations are not successful, there is substantial doubt about our ability to continue as a going concern.”

    Philip van Doorn, senior banking analyst for The Street.com Ratings in Palm Beach Gardens, said BankUnited faces significant challenges in raising capital. It would be unlikely to receive federal aid, and it is hard for a potential investor to evaluate the bank’s finances when it’s having difficulty preparing financial statements, he said.

    After losing $209 million over the first three quarters of its fiscal year, BankUnited’s holding company said it expects a loss of $327 million in its fourth quarter ended Sept. 30. That loss would be greater than the $261.6 million loss its BankUnited savings and loan subsidiary reported to the Federal Deposit Insurance Corp. for that quarter.

    However, BankUnited cautioned that the holding company’s loss could grow “substantially larger” when it completes an analysis of how much it should reserve for loan losses to cover its payment option adjustable-rate mortgage portfolio.

    Some interesting items from the 10Q as of March 31, 2008:

    “At March 31, 2008, non-performing assets totaled $682.0 million, as compared to $208.6 million at September 30, 2007. Expressed as a percentage of total assets, non-performing assets were 4.75% as of March 31, 2008 as compared to 1.39% as of September 30, 2007. Non- performing payment option loans increased from $149.7 million at September 30, 2007 to $512.3 million at March 31, 2008, representing 85% of the total increase in non-performing loans. The increase in the level of non-performing assets is impacted by the downturn in economic conditions and housing markets, particularly in certain geographic areas that have suffered price decreases. The overall level of non-performing assets is expected to continue increasing during fiscal 2008…. “

    Real estate acquired through foreclosure has increased from $729,000 at September 30, 2006, to $27.7 million at September 30, 2007 and $73.4 million at March 31, 2008. The increase over this period is reflective of the increased levels of residential loan defaults noted throughout the nation, and especially in Florida. The Company expects loan defaults to continue and possibly increase for the remainder of fiscal 2008 and into fiscal 2009, resulting in further additions to REO.”

    “Forty-eight years old Humberto L. Lopez, CPA has served as our Senior Executive Vice President from 2001, and Executive Vice President of Finance from 1999 to 2001. He has also served as our Chief Financial Officer and the Bank’s Chief Financial Officer since 1999. He was previously a Director from 1998 to 1999 at PricewaterhouseCoopers LLP. Mr. Lopez also served as the Chief Financial Officer from 1997 to 1998, and the Regional Financial Officer from 1993 to 1996, of Barnett Bank, South Florida and its successor by merger, NationsBank, Inc. in South Florida. ” Mr Lopez has no published biography prior to 1993.

    “On July 7, 2008, the Board of Directors of the Company appointed Mr. Lucious Timothy Harris, 52, as the Company’s Principal Accounting Officer, effective immediately. Mr. Harris has served as a Senior Vice President of BankUnited, FSB, the Company’s wholly-owned subsidiary, since May 2008. From 2002 to 2008, Mr. Harris has provided independent consulting services with a focus on accounting and reporting matters to financial institutions with total assets of approximately $100 million to $55 billion. From 2001 to 2002, Mr. Harris was chief financial officer at Hamilton Bank, N.A. in Miami, Florida. From 1987 to 1999, Mr. Harris served in several accounting and reporting capacities at Union Planters Bank in Miami, Florida, successor to Capital Bank. Prior to 1987, Mr. Harris worked in the audit division of Arthur Andersen & Co., certified public accountants, in Miami, Florida. Mr. Harris is a certified public accountant and obtained an undergraduate degree in accounting from Stetson University.”

    These types of loans, where borrowers can pay less than the monthly accrued interest and let the balance grow, were major factors in the downfall of Washington Mutual and Wachovia Corp. this year…”

    The external auditor for Bank United Financial is PricewaterhouseCoopers LLP. Why is it that they didn’t question their client regarding their lack of a going concern disclosure prior to December 16, 2008?

    Thirty-nine year old Joris M. Jabouin, CPA was appointed Executive Vice President and General Auditor for the Bank in November 2004. He has served as Senior Vice President and General Auditor of the Bank since June 2003. He previously served as Vice President and Head of Audit for Dresdner Bank Lateinamerika, AG, Miami Agency from 2000 to 2003. Mr. Jabouin was a Senior Auditor with PricewaterhouseCoopers LLP from 1998 to 2000 and was an Auditor with Price Waterhouse LLP from 1996 to 1998. He was also an Associate Examiner with the Federal Reserve Bank of Atlanta from 1993 to 1996.

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    11 Responses »

    1. Francine, you state:

      “Sorry, Mike. I think your clients will need a stronger argument in their defense, given the fact that December 31, 2008 financial statements had no “going concern” qualifications and the worst of the crisis was soon to come.”

      I don’t follow your argument, since no company, to my knowledge, has issued their 12/31/08 FS, considering that was four days ago.

    2. @Anon 10:44:00 Thanks for catching my error. Meant 12/31/07. Will correct.

    3. “The worst of the crisis was clearly anticipated, clearly foreseeable, and readily acknowledgeable by managements from a GAAP disclosure perspective and from their auditors from the perspective of a “professional” evaluation of the verisimilitude of managements’ disclosures as of December 31, 2008. The financial crisis was not sudden, it just accelerated quickly once the match, the Lehman failure, was lit.”

      I’m hoping you will post your support for these statements. Perhaps you could point us to a single article projecting the failure of the banking system that was published prior to March of 2008, when all the banks would have issued their 10-Ks by? It’s difficult for me to jump to the conclusion that the auditors “should have known” there was substantial doubt as to the ability of these long-lived institutions to survive the upcoming year. I’m hoping you can point to someone who, at the time the auditors were making their assessment, had, in fact, reached the conclusion that the failure of these banks was imminent.

      I do note that the link you provided to your own February 2008 blog post did not mention going concern, nor did any of the related posts.

    4. @ClownCollege

      The clear forseeability of the crisis faced by these major institutions is my personal opinion. My support for this contention is the found in the substance of numerous blog posts about all of the major players and about the subprime issues very early in the game. Some were writing even earlier about the housing bubble and its potential impact on the economy and on banks and others that were heavily exposed.

      Look at any of my posts regarding Fannie Mae, Freddie Mac, AIG, Lehman, GM, GE/GMAC, and the mortgage lenders like New Century, Countrywide, Beezer and the ratings agencies. They started in early 2007. If I knew, surely those in the trenches certifying the books knew that a whole industry was at substantial risk?

      One of the first mentions of the lack of “going concern ” opinions in the blog was in a link to an article by Jonathan Weil re Deloitte and American Home Mortgage in August of 2007. I’m not alone here in my opinion that Big 4 are reluctant to kill the geese laying golden eggs for them like Bear Stearns and Lehman until pushed to the brink. It’s why the PCAOB had to remind them of it.
      http://www.retheauditors.com/2007/08/bloombergs-jonathan-weil-is-on-roll.html

    5. I think its more complicated than a reluctance to “kill the geese laying golden eggs.” It’s more systemic – the whole banking system was at risk, but aside from a very few wholly rotten eggs, every business in the industry was subject to the same risks and market forces (and to further complicate things, GAAP, as net asset valuations are not always based on measurable facts, but assumptions, econometric models, mark-to-market accounting, etc., all allowable under GAAP and often difficult to “audit” from a GAAS perspective).

      A going concern opinion for any of the large instititions with that much risk and paper accounting would likely have brought the entire industry down earlier – and to your point maybe this is what should have happened? But which accounting firm is going to single out a specific client based on the same systemic risks that affect everyone else? It would have to be an all or nothing approach – not something any one firm could accomplish alone. This is supposedly why we have regulators, not auditors.

      –JR

    6. JR — love your post. put my thoughts to words!

    7. Have you noticed the glaring logical flaw in this:

      “The auditor has a responsibility to evaluate whether there is a substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited. The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report.”

      The timing matter creates all sorts of problems – not least is the apparent requirement to be a crystal ball gazer – at the time of signing the report.

    8. Dennis-

      No requirement to be a fortune teller on the part of the auditors. Unfortunately. that's the erroneous conclusion that Ms McKenna would lead you to through her post. You cannot, as Ms. McKenna is prone to do, look at last year's financial statements of a company that has gone under and say "hey, look, this company went under less than a year after getting a clean opinion, therefore, the auditors' going concern assessment MUST HAVE been wrong". That is Monday morning quarterbacking, using 20-20 hindsight, whatever phrase you prefer. Anyone can sit around after the proverbial S$&! has hit the fan and point fingers saying "you were wrong, you were wrong, and you were wrong"

      The proper way to assess it is to say "was information available to the auditor, when they signed their opinion, that would have led a REASONABLE PERSON to say that there was SUBSTANTIAL DOUBT as to whether that company would survive another 12 months?".

      The distinction appears subtle, but really it's a very big distinction. One view is saying "What happens after you sign your opinion proves you were right or wrong". The other says "Did you make a reasonable decision given what you knew at that time?" The accounting standards and literature point you to the 2nd view, Ms McKenna and others point you to the 1st view.

    9. […] Today received a “going concern” opinion from its auditors, Deloitte. It’s been a long time coming. GM has been a problem child […]

    10. […] what does this tell us about the value of the “going concern” opinion to warn shareholders and the markets of companies that are fragile, in a precarious state, […]

    11. […] not surprised by PwC’s resignation at all. PricewaterhouseCoopers went through a “going concern” scare with Las Vegas Sands not that long ago and rewrote history to make it all go away. Ernst & […]

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