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EARLY WARNING SOLUTIONS FOR AUDITORS

Auditors have a responsibility to evaluate whether there is a substantial doubt about the entity’s ability to continue as a going concern (ISA570). In case of substantial doubt the auditor must issue a so-called Going Concern Opinion. From a stakeholder’s perspective this is the most critical moment in the auditor’s engagement (see recent survey ) and they encourage auditors to become more forward looking.

However, for the past few decades 50-75% of all Business Failures have stayed under the radar. This demonstrates that audit methodologies may not be as accurate regarding the ‘Going Concern’ risk as one may expect. Stakeholders, relying heavily on auditor’s reports for their decision making, find this difficult to accept. Auditors themselves and the audit profession as a whole are negatively impacted as well.

European Rating House was created to assist auditors in their evaluation of the Going Concern risk. Our Auditor Support Tool performs a powerful analytical review of a company’s financial statements over a 5 year period. This tool, based on the same analytical model used in our Credit Rating services, has been operational since 2003, hardly missing any business failures (<3%) while simultaneously keeping the false-warning-rate low as well (<3%).

(Historical figures)

Auditors

Audit Support Tool

% of business failures without prior warning

50-75%

<3%

% of warnings without subsequent business failure

80-90%

<3%

Using 5 subsequent years of annual accounts as basis, the Audit Support Tool assesses the DNA of the company and can recognize situations in which the Going Concern is in danger, thereby focusing strongly on the near future regarding the next 1-3 years.

The above table, and the track record of the Audit Support Tool kept since 2003, prove that a robust analytical model can unlock information that usually remains unseen when viewing spreadsheets or using pocket calculators.

If any Going Concern issues are identified via the Audit Support Tool, European Rating House can assist auditors by further defining, analyzing and finding solutions to the central issues.

In addition, the Audit Support Tool can identify any manipulation or fraud that may be occurring in the material of financial statements.

Other advantages are:

Systematic: The analysis is consistently performed according to a predefined methodology.
Objective: The analysis is consistently performed on the basis of quantitative information (i.e. half year figures, annual accounts) prepared in accordance with generally accepted accounting standards. Having an objective model as basis helps to defend the issuance of a Going Concern Opinion.
Accuracy: During financial statement audits (i.e. quarterly statements, half year figures, annual accounts) the Tool can be used during various phases, such as interim audit, hard core, roll forward, analytical review, discussion with management about provisions etc. the tool can be used to reduce the percentage of non-detection error of Business Failure from 50-75% (Auditors) to 3%. The false-warning error can be decreased from 80-90% (Auditors) to 3% as well.
Integration(1): During financial statement audits (i.e. quarterly statements, half year figures, annual accounts) the Tool can be used during various phases, such as interim audit, hard close, roll forward, analytical review, discussion with management about provisions etc.
Integration(2): The Tool can also be applied during negotiations with banks or in special investigations including, but not limited to: mergers and acquisitions, corporate recovery (esp. the inception), business valuation, and investment portfolio evaluation.
Scenarios: While discussing impairment, valuation, provisions and business continuity with management, the Tool can be used to present various scenarios showing the impact on the risk profile and rating of the organization.
Fraud: The Tool establishes a normative set of ratios and relations between financial statement items based on five consecutive years of financial statements. If the development of one single item materially deviates from the development of the other items, the Tool will flag this. Often these incredible values reflect a manipulation of the financial statements (i.e. fraud). Early warning allows timely forensic investigation of the flagged item.
Risk profile: Monitoring clients with the aid of the Auditor Support Tool can lower the burden of claims, settlements and prosecution on Auditors themselves. In effect, this should theoretically result in a decrease of insurance premium levels, and an improvement in reputation and image.