Behavioral Research in Accounting Volume 6, 1994 Printed in USA

The E^ect of Experience on Consensus of Going-Concern Judgments

Joanna L. Ho
University of CaUfornia, Irvine ABSTRACT Statement on Auditing Standards No. 59 requires that auditors evaluate tlie going-concern status of each client. Determining whether a firm will continue as a going concern can be a complex process. Since many data items are potentially relevant, the task is relatively unstructured. In spite of these cognitive demands, previous studies suggest significant agreement among auditors' going-concern judgments. Results of this study reveal a lack of consensus among both experienced and less experienced auditors who were given information for a problem firm. This lack of consensus may explain why auditors often disagree on the appropriate audit report for a problem firm. Also reported are models of the judgment processes of both experienced and less experienced auditors. Auditors in both groups placed more emphasis on the current liquidity and expected profitability of the client than on other financial indicators. Moreover, experienced auditors generated more positive going-concern judgments.

Prior to the issuance of Statement on Auditing Standards No. 59 (SAS 59), a going-concern evaluation was called for only if an auditor doubted a client's ability to continue in existence. Currently, cin auditor must explicitly conclude whether an audit client will continue as a going concern for up to one year from the date of the audited statements [AlCPA, 1988]. If an auditor has substantial doubt about a client's going-concern status, a modified audit report must be issued. Auditors have indicated that evaluating a client's going-concern status can be a difficult audit judgment [Chow et al., 1987]. In questionable going-concern situations, auditors often disagree on the appropriate audit report [Asare, 1990b; Campisi and Trotman, 1985; Kida, 1980; Mutchler, 1986). Kida [1980], for example, found that a firm identified as having going-concern problems did not necessarily receive a qualiJQed audit opinion. He attributed this finding in part to conflicting economic considerations (e.g., an auditor might want to
I wouid iike to thank Wiiiiam Wright and Elizabeth Davis for their contribution to the project and to the preliminary drafts of the manuscript, i am also grateful for the helpful comments of an anonymous reviewer and the editor. The data set used in this study is available upon request.

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retain an audit client but feared potential litigation initiated by the client's investors). Mutchler [1984] provides related evidence indicating that auditors disagree significantly about their reporting responsibility given going-concern uncertainties. In most audit contexts, the lack of a well-specified criterion event makes the evaluation of audit decisions difficult. Thus, audit judgment researchers and practitioners often rely on consensus as a surrogate measure of audit decision accuracy. Simileurly, regulators and the courts have often regarded consensus as a surrogate for decision quality [Libby and Lewis, 1982]. In practice, many public accounting firms use an internal consulting team to provide advice for difficult audit decisions. In contrast to Kida's [1980] "conflicting economic considerations" assumption, the current study focuses on another hypothesis^that auditors' disagreement on audit report decisions may be attributed to their lack of consensus on the perceived likelihood that a firm will continue as a going concern. If a lack of consensus on auditors' going-concern judgments is found to account for auditors' disagreement on what is the appropriate audit report to issue, then decision aids (e.g., explicit models and knowledge-based systems) may be used to overcome this problem. Much recent debate^ has occurred concerning the role of the auditor in considering and reporting on the viability of audit clients [Asare, 1990a]. SAS 59 significantly expanded the auditor's reporting obligation in two ways. First, relative to the previous auditing standard (SAS 34), the auditor must now go beyond the consideration of asset recoverability and liability classification and evaluate the client's going-concern ability. Second, SAS 59 changed the meaning of, and conditions for, and audit report to be modified given a questionable going-concern status. Even though prior studies [e.g., Campisi and Trotman, 1985; Kida, 1980] observed significant agreement among auditors' going-concern judgments, these findings may not generalize to post-SAS 59 judgments as a consequence of differences in auditing standards. Since the going-concern judgment is relatively unstructured and information-intensive, significant experience may be necessary for an appropriate judgment in uncertain client situations. In practice, experienced auditors (managers and partners) are responsible for going-concern judgments. However, after about three to four years of audit training and experience, an auditor begins to assume partial responsibility (as a supervising senior) for going-concern evaluations
'This recent debate includes different issues, such as informational value of the goingconcern report [CAR. 1978; Libby. 1979]. the consequences of the going-concern report, the ability of an auditor to identify companies experiencing going-concem problems [Altman and McGough. 1974; Kida. 1980]. and the responsibility for reporting going-concern uncertainties [AICPA. 1987].

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(especially since going-concern evaluations are now required for all audit clients). At this point in their careers, auditors have strong personal incentives to add to their knowledge and to become fully informed with regard to the going-concern evaluation process. To explore the effect of experience on going-concern Judgments, auditors at various levels of experience are evaluated with respect to their going-concern judgments. TTie results of this study reveal considerable disagreement at all levels of audit experience. Surprisingly, additional experience did not improve auditors' going-concern judgment agreement. The rest of the paper is organized as follows. The following section summarizes conclusions from previous reseeirch on going-concern judgments. The possible impact of audit experience on going-concern judgments is considered in the next section. Results are then presented on (1) the extent of judgment consensus and the impact of differentisd experience on the magnitude of going-concern judgments and (2) models of the going-concern judgment process, including the relative importance of types of information. A summaiy and discussion section concludes the paper.

PREVIOUS RESEARCH ON GOING-CONCERN JUDGMENTS

Kida [1980] obtained going-concern judgments and audit opinion decisions from 27 audit partners for 40 firms, hilf of which had actually failed. To evaluate the ability of the partners to identify problem firms, Kida converted the 40 going-concern judgments into "problemfirm" or "non-problem-firm" judgments.^ The meein number of correct judgments was 33.2 (83 percent), with a range of 24 to 37 correct. A moderate degree of correlational consensus was indicated for the going-concern judgments (a mean inter-subject Spearman correlation of .755, suggesting an r^ of approximately 57 percent). Concerning the audit opinions, however, a mean of 25 percent of the firms identified as having problems were assigned unqualified opinions. Additional response data revealed that perceived economic trade-offs such as losing a client, deterioration of client relations, or investor lawsuit, affected the auditor's willingness to issue a qualified opinion. Campisi and Trotman [1985] investigated both going-concern judgments ind audit opinion choices. Going-concern judgments for nine firms were elicited on a ten-point scale. A moderate degree of correlationcil consensus (a mean inter-subject correlation of .73, correspond[1980] used a stx-polnt scsde to elicit auditors' continuity decisions. The two endpoints were "I beiieve this firm does/does not have going-concern problems." Ratings higher them 2.5 {the midpwint) were converted into "non-probiem-firm" Judgments and those iower than 2.5 into "probiem-flrm" judgments.

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ing to an r^ of 53 percent) was exhibited by the 25 auditors. Concerning the audit opinions, when the likelihood of continuance was indicated to be very high or very low, the auditors reached a high level of consensus on the appropriate audit opinion. When a firm's going-concem status was clearly uncertain, however, the opinion choice was spread among unqualified and qualified, adverse and disclaimed opinions.^ While research on going-concern judgments suggests moderate judgment consensus, subsequent work by Kida [1984a] on fgiilure predictions'* is Eilso relevant. Kida used 73 audit managers cind partners to provide probability judgments of firm failure (defined as beinkruptcy, liquidation, or default on bond commitments). A lack of consensus is reported for all base rate conditions [p. 148]. Kida [1984b] also tested the hypothesis that the way a failure judgment is framed would result in dissimilar use of confirmatory versus disconfirmatory information. Sixty-six partners ind managers provided probability judgments of firm failure. A wide range of probability judgments was obtained [see p. 337], with negative information items (items suggesting failure) generally being regarded as more relevant than positive information items (also see Trotman and Sng [1989]). In summary, prior research suggests that auditors can identify problem firms [Kida, 1980]. Also, Kida [1980, p. 519] concludes that"... a substantial level of agreement exists between auditors when they make continuity decisions from financial statement data." This conclusion, however, was based on a correlation measure of consensus,^ and correlational measures address only the relative ordering of judgments
^Mutchler [1984] provides evidence that auditors hold differing beliefs about their reporting responsibility for going-concem uncertainties. Audit partners provided responses that ranged from the belief that violation of the going-concem assumption automatically impaired the fair presentation of thefinancialstatements to the belief that a client's going-concern status is not a problem so long as the recoverability of assets is not an issue and the classification of liabilities is correct [also see Kida. 1980]. SAS 59 [AICPA. 1988] has expanded the responsibility of the auditor and clarified when a modified audit opinion should be issued. 'A going-concem judgment is different from a judgment of the likelihood of company failure. Information that contradicts the going-concem assumption is "...information that significantly relates to the entity's inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations, or similar actions" [AICPA. 1988. p. 341.02] versus information that suggests bankruptcy or liquidation of the company [also see Asare. 1990a. pp. 50-51]. ^Using Kida's dichotomous judgments of whether a firm does/does not have goingconcem problems. Ashton [1985. pp. 180-184] reported that the number of times that two (of 25) auditors agreed with each other ranged from 16 (40%) to 39 (98%) of the 40 case judgments. Average agreement for an auditor with the other 24 auditors ranged from 24.96 (62.4%) to 33.75 (84.4%) of the 40 judgments; therefore, based on the magnitudes of the dichotomous judgments, a wide range of consensus measurements is indicated. Ashton also documents a positive correlation between consensus and accuracy for Kida's auditorsalso see Keasey and Watson [1989].

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Without considering whether the judgment distributions are actually similar (i.e., a high correlation may exist even when two judgment distributions are very different in terms of their central tendency, dispersion, and other distribution parameters).^ One could mistakenly conclude that considerable consensus exists when the judgments are, in fact, very different [of. Pincus, 1990, pp. 3-4]. Kida [1984a, 1984b] reports a lack of consensus when somewhat similar company fsiilure judgments were made. Also, most research (except Asare, 1990b) was conducted prior to implementation of the significant changes prescribed by SAS 59. In contrast to SAS 34's emphasis on asset recovery and liability classification, SAS 59 imposes a going-concern evaluation which requires broad information assimilation. Therefore, the degree of consensus of current going-concern judgments remains to be ascertained. The current study uses scale-dependent measures of consensus. With respect to the audit report, since auditors can identify problem firms and there is correlational evidence of moderate consensus on going-concern judgments, why, then, do auditors disagree on the audit report to be issued to problem firms [Campisi and Trotman, 1985]? This lack of agreement may arise from the conflicting economic tradeoffs that auditors face when issuing modified audit reports, or alternatively, because auditors do not agree on the likelihood that an identified problem firm will continue as a going concern and these differences affect their choice of audit reports.

THE GOING-CONCERN JUDGMENT AND AUDIT EXPERIENCE

The going-concern judgment requires scrupulous mental integration of numerous facts. It is a difficult and error-prone process (Ashton, 1982; Einhorn, 1972; Libby and Libby, 1989]. Auditors must choose, weigh and combine predictive facts into the going-concern judgment, a mental process not prescribed in audit manuals or indicated by decision aids. Adding to the difficulty, available data often provide ambiguous and/or conflicting implications concerning firm continuity. Knowledge of how to mentally Integrate such information in a valid and reliable way miay come only from experience. Given the complexity of the going-concern judgment, however, even auditors with considerable experience may fail to reach consensus. To improve the quality of their work, auditors have personal incentives to learn how to appropriately integrate predictive facts into going-concern judgments. While learning from past decisions can be
^For example, the product-moment correlation is computed as the covarlance (adjusting for two possibly very different meEin Judgments) divided by the product of the standard deviations (adjusting for two possibly very different degrees of Judgment dispersion).

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difficult [Einhorn, 1980], experienced professionals shovild be better informed about which facts Eire predictive, and they may produce more valid Judgments [Blattberg and Hoch, 1990]. Auditors also increase their knowledge as they participate in common, CPA firm-sponsored treiining courses. Further, experienced auditors who have served clients having financial difficulties or who have been made aware of such client situations may recognize more cleeirly just how severe problems must be before a firm can no longer be considered to be a going concern [however see Ashton, 1991].'^ Therefore, significant experience as well as training may permit experienced auditors to have reasonably well-developed schemata for going-concern situations while less experienced auditors may have less well-developed schemata [Choo and Trotman, 1991, p. 469]. This discussion leads to the following hypotheses: H1: Consensus will be higher among experienced auditors than among less experienced auditors. H2: Experienced auditors may weigh and combine going-concern information differently than less experienced auditors, hence the two groups will produce different going-concern judgments.

EXPERIMENT
Subjects One hundred andfifty-sixauditors from four multinational accounting firms completed the experimental materials. The mean (median) audit experience was 54 (32) months and the range was 12 to 300 months. One hundred and fourteen auditors from one firm participated during two staff training sessions,^ whereas 42 managers and partners, from four multinational firms, were contacted directly by the researcher. In practice, at approximately 42 months of experience, a supervising senior becomes at least pcirtially responsible for going-concern considerations (especially, given the new requirement of SAS 59 that the going-concern status o^ each audit client must be f evaluated). To address the experience effect on going-concern judgment agreement and to understand the judgments of auditors who have reached the threshold of training, experience, and responsibility where going-concern assessment is an explicit part of their profes"Client circumstances that raise substantial doubt about continuance as a going concern are relatively infrequent; therefore, even managers and partners may have limited actual experience making (difficult) going-concern judgments. ^Statistics show no significant differences between these two groups for the three ratings of interest. The mean going-concern judgments for auditors in the first and the second training sessions are 3.08 and 3.11: the two means are not significantly different (F=1.03. p<.89). Also, there are no statistical differences in these two groups' ratings of the realism of the case (5.72 vs. 6.02; F=1.06, p<.85) and of how interesUng the case was (5.66 vs. 5.85; F=1.33, p<.31).

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sional duties, subjects were divided Into two groups based on a cutoff of 42 months of audit experience. This cutoff yielded two groups of auditors; 93 "less experienced" and 63 "experienced"; the experience level of the two groups was significantly different (25.4 versus 95.8 mean months of audit experience, t=9.89, p<.001, one-tailed).^ Judgment Tasks and Materials Each subject received a comprehensive case study. The "American Computers" case was designed to be representative of the company (and industry) data and analytical procedure results that auditors use when analyzing a financially-troubled borrower in a client's loan portfolio. ^ A detailed narrative on Americein Computers' business, management and history, complete income, balance sheet, sund cash flow statements, and a listing of finemcial ratios were provided. Initially, the materials were based on actual company and industry data; then, they were adapted to a financial scenario of rapidly declining profitability' and deteriorating future prospects. The case is designed to suggest a questionable going-concern status. First, while a mix of positive and negative information was provided, the case included events identified in SAS 59 as indicators of potenticd inability to continue as a going concern. The indicators, grouped according to their nature, are as follows; - diminishing earnings, - a net loss in the most recent year; Other financial indications; - a relatively large note due very soon with no opportunity for refinancing from the lending bank; Internal matters; - loss of keyfingincingand marketing executives, - new management has limited experience in microcomputer industry, - a late response to rapidly declining computer prices, - termination of personnel in engineering and marketing that may inhibit the firm's ability to produce new products emd intensify marketing activities; and External matters; - loss of dealers, - uncertainty inherent in microcomputer industry.
*rhis result (and each of the other results) is not sensitive to selection of the cutoff point of 42 months. '"The original case was designed by Wright [1991] to investigate the effect of presentation format (i.e., tabular vs. tabular + graphics), but was revised to meet the specific needs and purposes of the current study.

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Second, the ratios in the case present a financial profile somewhat similar to that of bankrupt firms in the Altman and McGough [1974] sample. Based on their discriminant model, the z-score for American Computers suggests questionable viability of the firm. The z-score that minimized classification errors in the Altman and McGough study is 2.675. Firms with scores below 2.675 have (at least some of the) cheiracteristics of failed firms, although for z-scores between 1.81 ind2.99 there is the possibility of misclassification. The z-score for American Computers is 1.94 which is below the cutoff point and within the range of uncertain firm viability. Focusing on the borrower's financial viability, auditors were asked to provide both a going-concern judgment and a loan coUectibility assessment. The going-concern judgment was; "Given the information you have reviewed, what is your evaluation of American's ability to continue as agoing concern between August 1, 1988, and October 1, 1989?" [itcilics in the original]. The horizon for the going-concern judgment (and the loan) was approximately one year from the date of the materials. Subjects were also asked to make several intermediate judgments of financial dimensions, such as short-term liquidity, expected profitability, and financial leverage, before reaching a going-concern conclusion (see Appendix One). The elicitation of these intermediate .coftasuarf.s r.aia /irovide insight into how auditors use these cues in making going-concern judgments. The going-concern and intermediate judgments were made on a continuous seven-point Likert scale, with 7 labeled "very strong," 4 labeled "average," and 1 labeled "very weak." The loan judgment was the percentage of the loan to be collected on the due date one year hence. After subjects completed the judgment tasks, they were asked to indicate whether they considered the case interesting and realistic. For both, responses were indicated on a seven-point scale with a maximum of "strongly agree" (coded 7) and a minimum of "strongly disagree" (coded 1). The mean (standard deviation) of the "interest" responses was 5.74 (.81) and the "realism" mean (standard deviation) was 5.88 (.83), with both of the medians being 6.00." The auditors Indicated that the materials were both interesting and realistic. Procedure Subjects who were attending staff training sessions completed the case materials in a classroom setting. The time spent for completion ranged from 40 to 50 minutes. To enlist more experienced auditors to participate, the researcher contacted partners in local offices of four multinational accounting firms in southern California. These part' 'The mean ratings of "realism" and "interest" by experienced auditors were 5.98 and 5.86. respectively, which were not significantly different from those ratings by less experienced auditors (5.81 for "realism" and 5.65 for "interest").

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ners then provided lists of volunteer participants, and the researcher arranged to meet groups of volunteers either in their office conference rooms or in a conference room at the researcher's institution. As had the auditors attending the training sessions, all experienced auditors completed the case materials in a classroom setting. Their completion time ranged from 35 to 50 minutes.

RESULTS
Bflagnitudes of the Going-Concern Judgments Subjects confirmed that the status of American Computers as a going concern was uncertain. The going-concern judgments averaged 3.18, with a median of 3.00 (labeled to be "less than average ability to continue"), on the seven-point response scale. Auditors who had reached the level of actual audit responsibility for going-concern judgments reported different conclusions^more audit experience resulted in more positive going-concern judgments. The mean going-concern judgment for the 63 experienced auditors is 3.49,^2 while the mean for the 93 less experienced auditors is 2.97; and, the means are significantly different, t=2.53, p<.01.^^ Also, the Mann-Whitney U test shows that the going-concern judgments of experienced and less experienced auditors are not from the same distribution (z=2.10, p<.036). Table 1 presents the frequency distribution of going-concern judgments of the overall group and of judgments by groups with different levels of audit experience. Descriptive statistics of going-concern assessments are shown in Panel A of Table 2. The correlation for the going-concern judgments and months of audit experience is .15, p<.06.'* Unexpectedly, the correlation between the likelihood that American Computers will continue as a going concern and the percentage of the loan thought to be collectible is not significant (r=. 16, p<. 10). A further test shows that the insignificance of the correlation between the percentage of the loan thought to be collectible and the likelihood of American Computers continuing as a going concern is due to the experienced group (r=.13, p<.20). For the less experienced group, there is a significant correlation between the percentage of the loan thought to be collectible and the likelihood of American Computers continuing as a going concern (r=.26, p<.01).
'^There is no significant difference between the going-concern judgments of the 21 auditors who attended training sessions and the judgments of the 42 auditors who met with the researcher as individual groups. '^The judgment distributions are essentially symmetric and unimodal; logarithmic and square-root transformations did not result in different statistical inferences. This result is particularly important, given that multivariate normality is assumed for the models developed in the next subsection. 'This correlation is somewhat similar to levels of association reported by Ashton and Brown [1980, p. 274! and Ashton and Kramer (1980, p. 10! for internal control judgments and degrees of audit experience.

The Effect of Experience on Consensus of Going-Concem Judgments

TABLE 1 FREQUENCY DISTRIBUTION OF GOING-CONCERN JUDGMENTS

169

Going-Concem Judgment 1.00 1.10 1.40 1.50 1.60 2.00 2.10 2.20 2.40 2.50 2.60 2.70 2.80 2.90 3.00 3.20 3.30 3.50 3.70 3.80 4.00 4.10 4.20 4.50 4.90 5.00 5.20 5.50 5.80 6.00 7.00 Total

Experienced
#
3 1 0 1 0 13 0 1 0 0 0 0 0 0 12 0 0 7 1 0 6 0 2 0 1 4 1 1 1 8 0 63 % 4.7 1.6 0 1.6 0

Less Experienced

Overall # 5
1 1 2 1 32 3 3 2 4 2 1 2 2 34 1 2 11 4 1 15 1 4 1 1 5 1 2 1 10 1 156 % 3.2 0.6 0.6 1.3 0.6

#
2 0 1 1 1 19 3 2 2 4 2 1 2 2 22 1 2 4 3 1 9 1 2 1 0 1 0 1 0 2 1 93

% 2.2 0 1.1 1.1 1.1

20.6
0 1.6 0 0 0 0 0 0

20.4
3.2 2.2 2.2 4.3 2.2 1.1 2.2 2.2

20.5
1.9 1.9 1.3 2.6 1.3 0.6 1.3 1.3

19.0
0 0

23.7
1.1 2.2 4.3 3.2 1.1 9.7 1.1 2.2 1.1 0 1.1 0 1.1 0 2.2 1.1

21.8
0.6 1.3 7.1 2.6 0.6 9.6 0.6 2.5 0.6 0.6 3.2 0.6 1.3 0.6 6.4 0.6

11.1
1.6 0 9.5 0 3.2 0 1.6 6.3 1.6 1.6 1.6

12.7
0

100%

100%

100%

Consensus of Going-Concem Judgments Even for the highly experienced auditors, considerable disagreement is reveEiled by the dispersion of the audit judgments. The standard deviation of the going-concern judgments for the experienced auditors is 1.49 with a range of 1.00 to 6.00, indicating little agreement. Ilie results for the less experienced auditors are similar (i.e., a standard deviation of 1.06 and a range of 1.00 to 7.00). The interquartile ranges also indicate substantial disagreement (i.e., [2.00, 4.90] for the experienced auditors and [2.00, 3.50] for the less experienced auditors). The standard deviations of these two groups differ from each other significantly (F-2.00, p<.003). For all 156 auditors.

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the standard deviation of the judgments is 1.27, with use of the entire range of the response scale (i.e., 1.00 to 7.00). The dispersion of the going-concern judgments at different levels of audit experience is indicated in Table 1. If increasing audit experience leads to increasing judgment consensus, the expectation is greater agreement at higher levels of audit experience. Such an effect is not indicated. As can be seen from Table 1, both the experienced and less experienced auditors made judgments in the substantial range of 2.0 to 6.0. The general conclusion is that considerable disagreement exists at all levels of audit experience. Therefore, HI is not supported. Models of Going-Concem Judgments The going-concern judgments differ for the experienced and less experienced auditors. To explain these differences, models of mental integration of information were built for both groups. The intermediate judgments of current and expected liquidity, expected future profitability and current financial leverage, as well as evaluations of recent trends in these variables, were possible predictors in each judgment model. Descriptive statistics for the intermediate judgments are shown in Panel A of Table 2. Each intermediate judgment is a mental aggregation of data pertaining to that financial dimension. Having the subjects mentally aggregate many data items into intermediate judgments facilitates model building; that is, the judgment process can be modeled more psirsimoniously and reliably. Separate models were estimated for the less experienced and experienced auditors (see Panel B of Table 2). The seven intermediate judgments (see Appendix 1) were made avEiilable in a forward, stepwlse manner (with a .05 significance cutoff). A clear pattern of results is revealed. Two intermediate judgments were important for the goingconcern judgment in both models: LIQUID, which is the auditor's evaluation of the current liquidity position of American Computers, ind PROFIT, which is the expected relative profitability of American Computers over the upcoming 24 months. LIQUID was always the first to enter the stepwlse regressions in the two models. LIQUID and PROFIT are, respectively, aggregations of balance sheet and income data that are suggestive of the ability of the firm to survive as a going concern over the upcoming year. None of the other five intermediate judgments is significant in either of the models. An overall regression analysis that combined the two subsamples also shows that LIQUID and PROFIT are the two most important intermediate judgments for the going-concern judgment; their respective weights Eire .391 (t=3.775, p<.0002) and .500 (t=3.450, p<.0007). As can be seen from Table 2, one potential explanation for differences In the going-concern judgments of the experienced and less