Going concern as a sign of company`s financial distress

Abstract

Information regarding business financial position is crucial to the stakeholder especially to the investors and creditors. The ability to predict as early as possible the potential business failure would reduce substantial losses by providing ample warning to the interested parties. Therefore, many scientific models have been developed by researchers to assist users in predicting impending financial distress since as the early as 1930s such as linear discriminant analysis, logit analysis, recursive partitioning, survival analysis and the latest model is neural network. Previous studies had demonstrated that all these models have shown high predictive accuracy, indeed, there is no superior method in term of prediction. The possible reason posits on these results may come from the underlying principle applied to all models where the models are susceptible to financial ratios analysis. Nevertheless, there were a few cases where companies collapse just after making high returns for a past few years. Thus, the prediction ability of financial ratios is questionable. Therefore, some researchers had integrated the financial ratios with other qualitative variables in the prediction studies. One of the useful non-financial indicators in predicting bankruptcy is auditor’s opinion. Auditor’s opinion is the best platform to convey a professional judgment regarding the company’s viability status as the auditor’s opinion is an expression of company’s financial and other matters that may affect its continuity in future. One of the auditor’s opinion that may sign as early warning of company’s viability is going concern opinion. Going concern is an assumption a company will continue operate for a foreseeable future and has no intention to liquidate its operations. Thus a going concern exception issued by auditors seems to indicate financial problem. Therefore, going concern is seen to be a tool of increasing the prediction ability of the financial distress model. In view of this point, this study aims to provide a basis for understanding of going concern opinion in predicting a financial distress company. Using multivariate discriminant analysis, a sample of 52 companies that are represented by equal number of PN4 and Non-PN4 companies are obtained. The results indicate that the financial distress companies tend to receive going concern opinion from the auditors as far as two years prior to reclassification of the companies under PN4 status. Going concern also improve the predictive accuracy of the model used in this study as it can predict accurately as far as two years prior to PN4 status compared to the model without going concern as a variable. Thus, these results suggest that going concern opinion is useful as an indicator of the future prospects of company.