Pressure Mounts for Tougher Audit Warnings on Troubled Companies

International regulators, under rising pressure from shareholders, are considering tighter auditing and disclosure requirements to warn investors about companies at risk of collapse.

The move follows the lead of the U.K.'s accounting watchdog, the Financial Reporting Council, which announced in September that auditors will have to more “robustly challenge” company director statements about why their corporations are unlikely to fold. The heavier requirements on “going concern” statements only applied to the U.K., but the International Auditing and Assurance Standards Board—which sets audit requirements followed by national regulators in Europe and elsewhere—told Bloomberg Tax it could be next in line.

“Going concern is a topic that has been raised by a number of our stakeholders,” IAASB chair Tom Seidenstein said in an email.

Investor groups—concerned about the failures of companies like Carillion Plc and the retailer BHS Ltd.—want greater disclosure of problems hidden away in a company’s subsidiaries as well as financial ticking time bombs that go beyond the standard, one-year “going concern” warning. It is a tricky timing issue for auditors who know that qualifying a company’s going concern statement would effectively sound the death knell for the firm. But its importance was underscored by the demise of travel agent Thomas Cook Group Plc. in September.

Auditors Ernst & Young LLP signed off on the travel agent as a going concern in November 2018, less than a year before it collapsed. Only in May 2019 did EY qualify that it had “significant doubt” Thomas Cook would continue as a going concern, giving investors little warning of its imminent collapse.

Seidenstein explained that the IAASB had already forced auditors to highlight any concerns they had over a company’s going concern claims, and said that it could consider a wider review.

“We will certainly take into account key national developments, including those in the U.K. on going concern,” Seidenstein said.

Some U.K. accounting leaders voiced support for a broader push.

“We decided to act unilaterally on this,” Mark Babington, the FRC’s director of U.K. auditing standards and competition said in a phone call Oct. 2, “but we want to see this happen internationally.”

Babington said the Financial Reporting Council had already spoken to countries including Australia, the Netherlands and Japan about increasing auditor scrutiny of going concern statements, and pointed out that the FRC had acted the same way over extended auditor reports. These were introduced by the FRC for the U.K. alone in 2013 and subsequently adopted by the IAASB and the U.S., he said.

“A spate of recent scandals, from Thomas Cook to Carillion, have highlighted that going concern disclosure is not adequate,” Babington said.

As with Thomas Cook, auditors signed off on Carillion’s “going concern” assurances less than a year before its collapse.

“It’s hard for auditors to qualify the going concern statement because it would be the death knell for the company,” Babington said. “It’s the nuclear option.”

Going Beyond ‘Viability’ Statements

The FRC has been trying to improve matters for several years, according to Babington, not only by hiking auditing requirements but also by requiring large U.K. companies to make a viability statement from 2014, saying that their company was not likely to go bust longer term and explaining why.

Viability statements, however, are not part of the statutory accounts and are not audited.

“We want to see these moves replicated by the IAASB,” Babington said, “and also to see changes to IAS 1,” the international accounting standard that requires companies to make a viability statement.

“IAS 1 says companies must state they are viable for at least the next 12 months,” Babington said, “and almost all companies interpret that as meaning they only need to look ahead for a year. They should be pressured to discuss any wider threats to their viability, not just short-term ones.”

The International Accounting Standards Board said that it was not looking at making changes to viability statement requirements, and had no immediate plans to do so.

That hasn’t stopped investors from seeking more data.

“We’re not receiving the information we need,” Liz Murrall, the Investment Association’s director of stewardship & reporting, told Bloomberg Tax.

Murrall highlighted the recent U.K. corporate collapses as evidence that companies were not giving sufficient warning that they could fold.

“They take a boilerplate approach to these things,” Murrall said, meaning that companies have used a formulaic approach to going concern and viability statements. “Viability statements are of little use. They’ve become standardized as either three- or five-year statements, whereas we need a clear explanation of what dangers they face, and why they have chosen to use a particular timescale.”