Auditing firms, besides failing to warn of accounting irregularities, have given clean audit opinions to 42% of the public companies that ended up filing for bankruptcy, a study released by Weiss Ratings Inc. found.
In its report, “The Worsening Crisis of Confidence on Wall Street: The Role of Auditing Firms,” the Palm Beach Gardens, Fla.-based rating agency reported that auditing firms gave a clean bill of health to 94% of the public companies that were subsequently cited for accounting irregularities.
Among key items in the report is an assessment of the staggering loss that the bankruptcies inflicted on stockholders and figures showing individual audit firms ability to spot troubled companies.
In addition to analyzing 33 firms with accounting irregularities, Weiss Ratings also studies the audit opinions issued to 228 companies that later filed for bankruptcy between Jan. 1, 2001, and June 30, 2002. In this group, Weiss finds that auditors gave a clean bill of health to 96 of the bankrupt companies.
Weiss notes that an auditor has a responsibility to evaluate whether there is substantial doubt about an entitys ability to continue as a going concern for a reasonable period of time.
While the Weiss analysis finds that “going concern” warnings were issued on the majority of the companies that subsequently filed for bankruptcy during their regular audits, or 58%, the study finds that audit firms varied in their ability to detect potential problems.
Weiss found, for example, that while KPMG performed the audits of the least number of the companies that filed for bankruptcy (28 of the 228), the firm gave warnings on 43% of the firms it looked at. On the other hand, PricewatehouseCoopers, which reviewed 38 of the 228 now-bankrupt companies, correctly issued warnings on 63%. Arthur Andersen scored about average, identifying problems among 27, or 56%, of the 48 companies they audited that subsequently filed for bankruptcy.
The 96 companies that eventually filed for bankruptcy despite receiving stamps of approval from their auditors had a peak market capitalization of $226 billion–nearly all of which has now been lost by shareholders, according to Weiss.
Commenting on the analysis of the 33 companies that disclosed accounting irregularities after their audits (six of which also filed for bankruptcy after the irregularities were revealed), Weiss notes that the stock values of the companies dropped from a total peak market value of $1.8 trillion to only $527 billion.
The decline implies an aggregate loss to shareholders of almost $1.3 trillion, the firm said in a statement announcing the report, adding that the stock declines were due to various factors, including the accounting problems.
Only PricewaterhouseCoopers issued a “going concern” warning on any of the 33 companies involved in the accounting irregularitiesissuing two warnings among the seven audits it completed in this category, according to Weiss analysis.
The study, which can be viewed at www.WeissRatings.com/worsening_crisis.asp, was also sent to the U.S. Senate just as it began debate over new oversight rules for the accounting industry.
Its findings include a qualitative analysis of whether there was enough evidence at the time of audits to suggest that auditors missed legitimate warnings. Focusing on 45 companies that failed within 12 months of their audits, the analysis found that two or more “yellow flags” were evident for 40 of them at the time of their audits, with only one company exhibiting no yellow flags. (The report lists 14 “yellow flags” or ratios that are generally viewed as useful predictors of failure.)
Reproduced from National Underwriter Life & Health/Financial Services Edition, August 12, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.