The auditor's report and the assessment of business performance : a local investigation

Abstract

Each year approximately one percent of the registered companies wind up their operations dues to bankruptcy. There are a number of direct and indirect indicators of business health and strength. One of the continuing expectations of investors and other financial statement users is an early warning signal for companies in financial distress. Accordingly, there is an ongoing call to auditors to "red flag" those companies for which bankruptcy is inevitable or at least highly probable. The objective of this study is to establish the relationship between the auditor's report and the assessment of business performance. For a further analysis of whether the auditor's opinion consistently reflect the business position, the Z-score model as devises by Altman was applied to a sample of liquidated companies and a sample of still operating companies. Moreover, in order to provide a profound insight regarding the basis on which the auditor's opinion is made, a questionnaire was sent to the auditors who signed the audit report of the companies in the sample. The findings revealed by the study, demonstrate that there is no correlation between the Z-score results and the auditor's report. This is due to the fact that local practitioners use a combination of traditional statistical techniques and non financial indicators to assess the business's future viability. In assessing business performance, local auditors mainly base their evaluation on the business ability to continuously obtain financial support. On the other hand the Z-score model does not take such an issue into account. The study also demonstrated that the two main instances that highly demand the modification of the auditor's report are a continuous period of negative working capital and operating losses.