Going Concern Reporting Failure - A Conceptual Framework - Essay Example

Going Concern Reporting Failure - A Conceptual Framework Introduction Going concern uncertainty has become a great challenge to the modern business world because a failure to report going concern uncertainty may end up in business collapse. A going concern can be simply defined as a business that operates in the market without the threat of liquidation in the foreseeable future, commonly considered as within 12 months. According to the conceptual framework of the IFRS, the underlying assumption to prepare financial statements for a business entity is that the firm has the potential to continue its operations at least for the next year. One of the basic accounting principles is that a company will exist long enough to accomplish its objectives and to carry out commitments, and it will not undergo liquidation in the foreseeable future. If the accountant sincerely believes that the company would not exist for a long time, he is required to disclose this assessment in the financial statement. Hence it is to be noted that the going concern assumption is fundamental to the preparation of financial statements of a company. The major problem with the going concern reporting is that this concept is not well defined in generally accepted accounting principles (GAAP) and therefore this concept is largely subject to the discretion of the accountant regarding when a business should report it. It seems that financial reports often fail to depict the going concern uncertainty of an entity properly, and such a situation will lead to many ethical challenges. This paper will explore the ethical challenges of going concern reporting failure with specific focus given to the going concern uncertainty in the Kuwait banking sector. Going concern reporting failure In the highly competitive modern market environment, the concept of going concern uncertainty is of great significance because even a slight change in the state of affairs can notably affect the share prices of the company. It is to be noted that going concern uncertainty does not necessarily reflect the future prospects of a company or its business failure. However, serious questions about a company’s ability to keep running its activities as a going concern have to be disclosed in the annual report like in the case of any associated material uncertainty. Accounting standards like IFRS and UK GAAP require directors to report going concern uncertainty in the annual reports and auditors to state this aspect in the audit report (ICAEW, 2013). If the aspects of this uncertainty have been adequately disclosed in the annual report, the auditor will issue an unqualified report including an ‘emphasis of matter’ paragraph describing those disclosures. In contrast, if the uncertainty aspects have not been adequately addressed, the auditor will issue a qualified report stating the inadequacy of those disclosures (Ibid). The technicalities of going concern uncertainty reporting are not understandable enough even to accounting professionals, and therefore this aspect may cause misunderstanding in the market environment. While reporting going concern uncertainty, an auditor should be concerned about several aspects of the business, particularly the effects on the financial statements. It is particularly relevant for the auditor to consider pertinent conditions and events that raise strong doubts about the firm’s ability to continue as a going concern for a foreseeable future. In addition, it is necessary to examine the possible effects of such conditions and events and the way the management evaluates the significance of those issues. Finally, considering the recoverability of recorded assets and the payability of liabilities it is inevitable to report going concern uncertainty accurately. The last decade witnessed the drastic effects of going concern uncertainty reporting failures when US corporate giants like Enron and WorldCom filed bankruptcy protection under Chapter 11 (Dembinski et al, 2006). The auditors of these companies could not accurately report the going concern uncertainties with the business, and as a result Enron and WorldCom continued their operations on the strength of an illusionary corporate image. Evidently such a poor audit report misled investors and other stakeholders, and finally they lost millions of their share money. Sometimes company directors influence auditors to produce an unqualified audit report in favour of the company despite substantial doubts regarding going concern uncertainty. To prevent this dangerous situation, today governments and companies take immense efforts to ensure the authenticity and accuracy of reporting going concern uncertainty. Hence today businesses and regulators give particular importance to the concept of corporate governance. According to Roberts (n.d.), the concept of corporate governance in the UK business environment reflects the balance of power between the board of directors and the general body meeting. In UK, the term ‘governance’ refers to UK Corporate Governance Code, which is a well defined set of corporate governance principles that are aimed at the performance improvement of companies listed on the London Stock Exchange. Causes of reporting failure There are many reasons why an organisation’s financial report fails to reflect the going concern uncertainty accurately. In most cases, the board of directors manipulate the financial statements so as to keep the stakeholder confidence in the company and to attract more investors. It is clear that people would buy the shares of a company only if the company is financially sound enough to offer adequate returns to its shareholders. People are less likely to trust a company which is facing going concern uncertainty troubles because such a company would undergo liquidation in the near future. In addition, some companies deliberately omits the reporting of going concern uncertainty in their financial statements with intent to maintain their creditworthiness and hence to raise immediate funds in times of emergencies (International Standard on Auditing, n.d.). To make it clear, banks or other financial institutions would be reluctant to lend money to a business which is likely to face the threat of liquidation in the foreseeable future. A company needs to remain a going concern in the view of stakeholders because a poor performing company may not receive grants or other subsidies from government or other institutions concerned. Sometimes going concern reporting failures could be attributed to auditors’ lack of knowledge in such reporting procedures. In short, the reporting of going concern uncertainty can have a significant effect on the long term sustainability of a business, and therefore board of directors may try to influence accountants and auditors in every possible way so as to obtain an unqualified audit report. Ethical challenges of reporting failure Going concern reporting failure has many ethical challenges because this issue would mislead the business decisions of stakeholders. While analysing the literature, it seems that many ethical theories describe the numerous ethical challenges associated with the failure of going concern reporting. The stakeholder theory is of significant relevance in this regard. It is considered as a theory of organisational management and business ethics, and clearly defines the groups that constitute stakeholders of a corporation (Weiss, 2008, p. 42). In the traditional viewpoint, shareholders were the only owners of a company and hence the management has a binding fiduciary duty to give first priority to the needs of stockholders and to increase value for them. In contrast to this approach, the stakeholder theory states that wider groups of people are influenced by the operations of a firm, including stockholders, customers, suppliers, employees, creditors, communities, governments, political parties, trade associations, and investors. The theory recommends numerous techniques by which the management can effectively meet the interests of its stakeholders. Obviously the going concern reporting failure would hurt the interests of a company’s stakeholders, and therefore the management would fail to meet the interests of its stakeholder groups. To illustrate, an inaccurate going concern reporting may provide stakeholders with misleading views concerning the sustainability of an organisation, and consequently, existing shareholders would buy more number of shares. New investors my hugely invest in the business. Undoubtedly shareholders and other investors would lose their money in the future as the company’s actual financial position is not what they expected. Referring to the stakeholder theory, inappropriate going concern reporting would cause the management to fail safeguarding the long term business interests of its stakeholders. The Utilitarian ethical theory also points to the ethical consequences of going concern reporting failure. Utilitarianism is a theory of normative ethics or simply a philosophical theory of morality that prioritises the happiness of the majority population. According to this ethical theory, actions maximising happiness and reducing suffering are justified (Kimbrough & Lautar, 2006, p. 9). In other words, maximum happiness and minimum suffering are the two underlying assumptions of the Utilitarian approach. When an organisation fails to disclose going concern uncertainty, the situation would cause great troubles to the whole stakeholder groups, and hence maximum happiness cannot be achieved. This ethical theory says that happiness of an individual or a group of people should be sacrificed only if this action can make more number of people happy. In the case of going concern reporting failure, it is clear that the action would increase the happiness of board of directors only, who are fewer in numbers as compared to total number of stakeholders. Therefore the board of directors should sacrifice their happiness to safeguard the interests of more number of people and report the going concern uncertainty accurately. According to Stuart Mill’s definition of Utilitarian ethics, “actions are right in proportion as they tend to promote happiness, wrong as they tend to produce the reverse of happiness” (as cited in Bykvist, 2010, p.21). This theory of normative ethics also suggests that an action that can increase the happiness of the greatest number of people is justifiable even if it would physically or mentally harm some others but fewer in numbers. In the case of proper going concern reporting, the action can meet the happiness of the greatest number of people (stakeholders) even though it may hurt the interests of a few others (board of directors). In the opinion of Taranovsky (2003), one of the central concepts of this ethical theory is that an individual’s happiness should never be considered more important than that of others, and there is no supportable reason to abide by a rule of conduct which is detrimental to the happiness of the majority of the population. In short, the happiness of stakeholders, particularly investors and shareholders, should not be considered more important than the happiness of board of directors. Deontological ethics is another theory reflecting the ethical challenges of going concern reporting failure. Deontology or Deontological ethics is a normative ethics theory that assesses the morality of an action through scrutinising that particular action’s adherence to a rule or rules. The deontological ethics is sometimes referred to duty, obligation, or rule based ethics because rules and regulations bind people to their duty (Kimbrough & Lautar, 2006, p.572). Referring to corporate laws and generally accepted accounting principles, companies are required to fairly and accurately report going concern uncertainty so as to keep stakeholders informed of the current position of the organisation. According to the deontological ethics, the accounting principles concerned bind board of directors and the auditor to do their duty, which is to ensure flawless going concern reporting. Clearly, when an organisation is not interested to report going concern uncertainty, officials concerned fail to carry out their legal duties, and their act is unethical in the perspective of deontology. According to the deontology approach, people are morally obliged to act in accordance with a certain set of rules and regulations regardless of the outcomes Moreland & Geisler, 1990, p.144).. Sometimes a fair going concern uncertainty reporting may lead to business failure but board of directs and other officials concerned are supposed to do their legal duties in spite of the dreadful effects. Going concern reporting failure is actually deceitful to stakeholder because they are misled by the false business information and the situation may cause them to lose huge losses in money and time. Evidently such a reporting failure would affect investors’ and bankers’ substantially because they are the ones who mainly interact with the company in terms of money. Generally investors consider net profitability, the amount of dividend paid in the last fiscal year, and the going concern report before they actually make an investment decision. A false going concern report may convince investors to invest in a financially struggling organisation, which is less likely to generate potential returns for investors. As a result, the investors would gradually lose their money. Similarly bankers and other financial institutions consider the going concern report of an organisation so as to assess its creditworthiness. Going concern reporting failure may cause bankers to lend money even to financially underperforming organisations that would undergo bankruptcy procedures in the foreseeable future. Due to this failure, bankers may lose millions of money and the situation in turn would affect their business sustainability. In short, going concern reporting failure raises many ethical concerns. Going concern uncertainty in Kuwait banking sector Going concern uncertainty has become a great issue in the Kuwait banking sector because auditors keep silence on reporting the ongoing concern aspects of banks. Recently some investigations identified that a number of Kuwaiti banks actually do not maintain a strong financial position as stated in their audited financial reports. An examination of the audit findings on the banks indicate that auditors were not interested in exploring and reporting the financial distress of the banks. Evidently, failure in reporting the going concern uncertainty in the Kuwait banking sector has serious consequences not only on the Kuwaiti banking industry but also on the whole economic progress of the nation. It is clear that banks represent the financial centre of a nation and they play an inevitable role in the overall development of the economy. When auditors keep silence on banks’ going concern uncertainty, bankers are allowed to continue their operations despite their grave financial difficulties. Furthermore, Kuwaiti people will not be informed of the actual financial status of banks, and therefore they may deposit huge amounts in financially unsound banks. It is obvious that a bank in severe financial crisis cannot use its clients’ money effectively, and the situation may cause the clients to lose their money. Referring to the recent experiences from the United States, bank scandals may lead the economy to strong financial crisis or even recession, and the situation in turn would adversely affect the nation’s economic growth. During the 2008-09 global financial crisis, many Kuwaiti banks were exposed to business failure because auditors paid little attention to the aspect of going concern uncertainty. Many Kuwaiti banks survived the recent global recession only because of the immense efforts taken Kuwait’s Central Bank. Over this period, the central bank took steps to guarantee deposits in domestic banks and thereby to regain people’s confidence the country’s banking sector (Paris, 2008). Experts indicate that banks those had been facing extreme financial difficulties were given clean audit opinions, and hence stakeholders could not recognise the real financial status of such banks. In addition, the central bank also failed to take proactive steps to strengthen those banks due to auditors’ negligence to report going concern uncertainty. Conclusion From the above discussion, it is clear that going concern reporting is particularly inevitable for a business regardless of its nature and size. This auditing practice assists the management and stakeholders to obtain a true and fair view of the state of affairs of the organisation. Ethical theories including stakeholder theory, Utilitarian ethical approach, and deontological ethics describe the ethical challenges of going concern reporting failure. Evidently, this audit failure adversely affects the financial interests of stakeholders, particularly investors and bankers. The financial crisis in the Kuwait banking industry over the 2008-09 period could be attributed to going concern uncertainty reporting failure to a great extent. References Bykvist, K. 2010. Utilitarianism: A Guide for the Perplexed. US: Bloomsbury Academic. Dembinski et al. 2006. Enron and World Finance: A Case Study in Ethics. Palgrave. [online] available at: http://www.strongwindpress.com/pdfs/TuiJian/Enron%20and%20World%20Finance%20-%20A%20Case%20Study%20in%20Ethics.pdf [accessed 8 April 2014]. DeNisco, S. M & Barker, A. M. 2012. 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