Multi‐risk level examination of going concern modifications

Purpose – The literature has revealed auditors' going concern risk disclosures are examined in research as a homogenous risk class. This is despite the various going concern modifications auditors are entitled to give pertaining to this issue. A five‐level risk class is established in this paper derived from Australian Auditing Standard pronouncements to examine the appropriateness of auditors' going concern reporting relating specifically to the likelihood of firm failure. Design/methodology/approach – Time is necessary to reveal the appropriateness of going concern reporting therefore a longitudinal research methodology was adopted. The research focuses on all Australian listed companies within the building industry in 1989 and follows all of the reporting of going concern by auditors and directors through until 2007. The building industry was selected because of its volatility, which increased the possibility of going concern reporting allowing a more in‐depth focus in the research. All auditors' going concern modifications were examined along with all indications of going concern problems identified by directors. To properly investigate the appropriateness of auditors' reporting, all sampled audit reports were examined using Altman's Z ‐score model which were matched with a risk class model using the relevant requirements to report in order to determine the appropriateness of the auditors' and directors' opinions. Findings – The level of under reporting of going concern risk by auditors (75 per cent) implies they are more affected by the agency relationship found in literature than directors who are found to have an incidence of underreporting of 57 per cent. Research limitations/implications – Literature classifies auditors along with directors as part of the agency problem. Altman's Z ‐score bankruptcy prediction model is used because of its enduring nature, reliability and ability to be externally calculated to independently compare the going concern reporting performance of auditors and directors as part of the contribution to this research area. Originality/value – The paper for the first time examines going concern reporting at a multi‐risk level rather than the binomial level used in research previously. The approach is developed in this paper using auditing pronouncements. These risk levels are linked with an independent measure being the Altman Z ‐score to determine the appropriateness of auditors' and directors' reporting of going concern issues.