Living with a Scarlet Audit Letter

Given a going-concern qualification, companies struggle to defy their auditors' prediction that they won't survive the year.
Sarah JohnsonOctober 21, 2009

By the time an audit firm announces that it doubts one of its clients will be able to continue as a going concern for the next 12 months, the company in question is usually in the midst of a public downward spiral. It likely has liquidity problems, financing issues, and a plummeting stock price.

Clearly, it is an auditor’s duty to share doubts about a client’s viability with the market via a qualified audit opinion. But “going concern” opinions from auditors usually make the company’s situation even worse. “It is very much a near death sentence for companies,” says Al King, former managing director of the Institute of Management Accountants and vice chairman at valuation firm Marshall and Stevens.

Such a qualification can result in tougher-to-get and more expensive financing deals, just when the company is most in need of a break. Indeed, once hit with a going-concern qualification, companies may succumb to a “self-fulfilling prophecy,” say accounting observers. The pariah status such an opinion confers all but forces investors, suppliers, and lenders to turn away, often driving a company on the brink of bankruptcy into a Chapter 11 filing.

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As companies today struggle with ruptured covenants, leery banks, and a reeling economy, King laments that the “binary” rules — either “you’re OK or you will fail” — guiding accounting firms don’t allow auditors a wider range of possible warnings. Typically, an auditor’s opinion letter expresses “substantial doubt” about a company’s ability to last as a going concern over the next 12 months — a brand of fear and doubt it must bear for a full year from the day its annual report is issued.

Many companies are in this situation today. Last year, 21% of companies registered with the Securities and Exchange Commission had their going-concern status questioned — the highest proportion of companies this decade, according to research firm Audit Analytics. Moreover, the number of businesses filing for Chapter 11 increased 113% in the first half of this year, compared to the same period in 2008.

Experts predict a similar percentage of going-concern opinions will be filed for 2009 10-Ks. “Companies that got a going-concern opinion last year — if they’re still around — probably have not worked their way out [of their current condition],” says Rick Ueltschy, managing executive of accounting firm Crowe Horwath’s audit and financial advisory group. “And we’ll see more companies that have continued to have financial conditions deteriorate over the year added to the list,” he says 

Indeed, the prospect has finance executives biting their nails. Nearly one quarter of 846 CFOs and controllers surveyed by Grant Thornton said they were more worried about the ability of their companies to continue as a going concern than they were a year ago.

To be sure, a going-concern qualification doesn’t always mean the end — through bankruptcy court or liquidation — is imminent. But it does portend a yearlong battle for the CFOs at the finance helm of these companies. They are tasked with reassuring creditors and business partners that, with the forebearance of their counterparties, they will survive and eventually prosper.

“Depending on the nature of the relationships with counterparties, frequent, early, and frank communication of issues and the way forward can often be an approach that can be successful,” advises Chris Wright, managing director at consultancy Protiviti.

Rod Sherwood, CFO of radio network Westwood One, has had to stay in frequent contact with creditors and business partners since his company received a going-concern qualification earlier this year. “It’s key to anticipate where the company is headed and the impact of an uncertain economy well ahead of time, so that you can take action and proactively renegotiate any agreements so you’re ahead of any events that would occur,” says Sherwood.

Sherwood’s most recent renegotiation was with debt holders. Last week, the company announced it will avoid default by securing a waiver with senior note holders and a lender on debt covenants that would have been measured December 31. The more lenient terms come with a price tag, of course: the company has promised to put $15 million toward paying down senior notes, assuming an upcoming stock offering is successful and a sale-leaseback of one of its properties occurs by March (if those two sales don’t occur under the terms, then the company will have to pay down $3.5 million of its senior notes).

Reworking finances has been Sherwood’s main task since joining Westwood One more than a year ago. After the company reported a net loss of $427.6 million for 2008 and a 10% decline in revenue, its accounting firm, PricewaterhouseCoopers expressed its doubts about Westwood’s viability, citing the fact that the company had overdue debt. The company had been in the process of refinancing, but didn’t strike a deal until after its annual report was issued.

As if Westwood didn’t have enough headaches reassuring business partners and suppliers, its customers — advertisers — are well aware that many media properties are in dire straits. “We worked hard to make sure that our advertising customers knew that we would be around for the future, and that we had the right momentum in the marketplace to continue focusing on revenue generation and top line growth over time,” Sherwood tells

Accounting experts recommend companies consider looking at their going-concern status now, even if they’re only at the half-way mark of their reporting year (most companies’ annual reports aren’t due until early next year). “To have a going-concern discussion [with your auditor] toward the end is not a good thing to do,” says Russ Wieman, national partner of audit and advisory services at Grant Thornton. “It’s a complicated issue that needs a lot of discussion, a lot of vetting. Putting it off could put you at risk for not delivering your audited financials on time.”

According to Mike Kelly, managing director and leader of the strategic value advisory practice at financial advisory firm Duff & Phelps, auditors are increasingly expecting companies to do self-assessments of their going-concern risk before they’ll reach their own conclusion. “Auditors have a higher expectation that management will assume greater responsibility for the going-concern risk assessment process,” Kelly says.

Standard-setters have a similar expectation: Next month, the Financial Accounting Standards Board will revisit a proposed rule that would formalize management’s responsibility when it comes to considering a company’s going-concern status. While companies opine on their viability in annual reports, there is currently no accounting rule that governs how they do so.