Audit reporting for failed firms: Its determinants and the effect of Statement on Auditing Standards No. 59

Auditors have generally failed to give firms that fail audit reports disclosing uncertainty about continued existence (going-concern audit reports or GCARs). This lack of reporting accuracy has contributed to financial losses, increased litigation, decreased public confidence, and threatened governmental regulation. In response, the profession adopted Statement on Auditing Standards (SAS) No. 59, replacing SAS No. 34.;Results indicate that all major variables significantly affect reporting accuracy, although less well for litigation and reputation cost. The change in standard coincided with increased levels of financial distress and changes in auditor/client relationships. Controlling for these changes, SAS No. 59 increased, but not significantly, reporting accuracy for failed firms.;This study provides an investigation of the determinants and the effect of the change to SAS No. 59 on reporting accuracy for failed firms. An audit report is modeled as a joint function of the auditor's competence and the auditor's willingness to report uncertainty, itself endogenously determined by two auditor cost considerations: possible litigation and reputation costs should a firm fail without a GCAR and possible client loss and relationship costs should a firm survive with a GCAR. SAS No. 59 is hypothesized to increase reporting accuracy because the change in reporting format reduces auditors' client relationship costs. Measures of client financial distress, litigation and reputation costs, client loss and relationship costs, and postaudit environment changes are logistically regressed on reporting accuracy for 250 failed firms from 1981 to 1993. Significant univariate differences in measures by auditing standard led to logistic regression by auditing standard and with interaction terms.