Auditors warn of high failure rate risk for companies

THERE has been a worrying increase in the number of auditors' reports warning of the possibility that companies listed on the stock exchange could fail in the next 12 months.

By InvestSMART · 26 Sep 2012

By InvestSMART ·
26 Sep 2012

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THERE has been a worrying increase in the number of auditors' reports warning of the possibility that companies listed on the stock exchange could fail in the next 12 months.

The Tasmanian wood-chipper, Gunns, went into voluntary administration yesterday, less than a year after KPMG warned of the group's ability to continue operating as a going concern.

The mid-tier accounting firm RSM Bird Cameron yesterday released a review of listed company accounts lodged with the ASX for the 2011 reporting season, covering balance dates from June 2011 to May this year.

The review sampled 1042 listed companies, representing 52 per cent of ASX-listed companies.

It found that 15 per cent of audit reports included going concern-related issues.

It follows a similar report from 2008, where just 6 per cent of the reports sampled - a smaller survey of 315 companies - included going concern-related issues.

The phrase "going concern" refers to the likelihood that a company will continue to operate for at least the next year.

Jason Croall, a director of RSM Bird Cameron, said the rise in the number of auditor reports emphasising going concern-related issues was worrying because it could indicate a higher failure rate for companies.

However, it might also indicate that auditors were responding to a rise in legal actions against them by becoming more conservative and looking for ways to decrease potential exposure, he said.

"The question that I have is, with an increased prevalence of these, does it dilute investors' ability to really sort through the stocks that have a real going concern from the ones that just have a comment in there for, you know, cover your backside sort of stuff [by auditors]?" he said.

He also said he was concerned that the number of audit reports could increase to 20 per cent in the next two years as auditors continue to mitigate the potential risk of being sued.

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Frequently Asked Questions about this Article…

What did the RSM Bird Cameron review find about auditor 'going concern' warnings in ASX company reports?

RSM Bird Cameron reviewed 1,042 ASX-listed company accounts for the 2011 reporting season (balance dates June 2011 to May this year) and found 15% of audit reports included going concern-related issues. The sample represented about 52% of ASX-listed companies.

What does 'going concern' mean and why does it matter to everyday investors?

A 'going concern' refers to the likelihood a company will continue operating for at least the next 12 months. For investors, a going concern warning in an audit report signals increased risk that the company could struggle or fail within the year.

Why is an increase in going concern warnings worrying for investors?

The article notes auditors' increased going concern warnings could indicate a higher failure rate for companies, making it harder for investors to identify risky stocks. RSM director Jason Croall said the rise is worrying because it may reflect real financial stress across companies.

Could auditors be issuing more going concern warnings because of legal risk rather than actual company failure?

Yes. Jason Croall suggested some auditors may be more conservative and include going concern comments to reduce potential legal exposure. That could mean some warnings are driven by auditor caution rather than imminent company collapse.

What example did the article give of a company affected after a going concern warning?

The article cites Tasmanian wood-chipper Gunns, which went into voluntary administration less than a year after auditors at KPMG warned about the group's ability to continue as a going concern.

How did the 2011 prevalence of going concern warnings compare with the 2008 review?

In 2011 the RSM review found 15% of audit reports had going concern issues, up from 6% in a smaller 2008 survey of 315 companies, indicating a notable increase in such warnings.

Is the share of audit reports with going concern warnings expected to rise further?

Jason Croall warned it could. He said the number of audit reports including going concern issues might increase to about 20% in the next two years as auditors continue to mitigate the risk of being sued.

How should everyday investors respond when they see a going concern warning in an audit report?

Investors should pay attention to going concern warnings and read the surrounding auditor commentary and company disclosures for context. The article highlights that rising prevalence of these warnings can make it harder to distinguish truly distressed companies from cases where auditors are being extra cautious.