Red Flag: Changing Auditors Due To Disagreement On Audit Opinion

How does your company make money?

Now, that may seen like a silly question, but it has everything do to with your firm’s ability to succeed over the long term. Your business should generate the vast majority of sales and earnings from continuing operations. Continuing operations refers to your day-to-day business.

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Connecting to the cash flow statement

If you manufacture blue jeans, for example, that’s your operating business. Profit from the sale of a building is non-operating income. You’re not in the business of selling buildings- you make blue jeans. You can also make a connection to the statement of cash flows. Customer payments for blue jeans would be a cash flow from operating activities. If you sell a building, that’s a cash flow from investing. Buying and selling assets is an investing activity.

Understanding solvency and a going concern opinion

Solvency refers to a company’s ability to survive over the long term. If you make blue jeans, you’ll generate sales and earnings from blue jean sales. You can’t rely on selling assets to make a profit. Eventually, you’ll run out of assets to sell.

Solvency relates to a going concern audit opinion. This opinion means that the auditor has serious doubts that the firm can survive over the long-term. If a business posts a loss for several consecutive years- or has a growing debt load- an auditor may issue this type of opinion.

Now, a going concern opinion is serious. The company under audit may lose its ability to borrow. Equity investors may sell their holdings. Perhaps most serious, it’s an acknowledgement that senior management does not have a plan to manage the business over the long haul.

Swisher Hygiene Dismisses Auditor

Here’s a quote from the May 2015 Charlotte Observer:

“Charlotte-based Swisher Hygiene has dismissed its accounting firm, saying it doesn’t agree with the firm’s assessment that Swisher might not be able to continue as a going concern, a term that refers to the company’s ability to stay afloat.

Swisher, which provides sanitizing services and cleaning chemicals, said its management had “several disagreements and discussions” with BDO USA about completing the audit and filing the company’s 2014 annual report, according to a securities filing Thursday.

The company said its own assessment of its finances found that “no material weaknesses and one significant deficiency” existed as of December 31, 2014, while BDO’s audit concluded that 12 material weaknesses and five significant deficiencies were present.

Swisher said a review of its bad debt write-offs and recorded bad debt reserve, as well as its process to account for its dish machine assets, had resulted in adjustments to the financial statements initially presented to BDO.

BDO therefore had expressed doubt about the company’s ability to continue as a going concern, while Swisher’s analysis found that no going concern issues were present.”

A few things struck me after reading the article:

·      Accounting requires judgment: There are certainly areas of accounting that require judgment. Bad debt policy is a good example. To estimate a reserve for bad debt, a company typically makes an estimate on percentage of accounts receivable balances that may not be collected. So, I can see some room for disagreement between the business and the external auditor.

·      Material weaknesses, significant deficiencies: A red flag for me were the huge differences in this area. The company found no material weaknesses- but the auditor found 12? That’s hard to believe- especially since auditors and clients work on identifying and improving internal controls each year.

·      Sarbanes-Oxley (SOX) Requirements: SOX raises the stakes on the importance of internal controls. Senior management is now required to review internal controls and report on any weaknesses found. With this added emphasis on controls, it’s even more unusual for a company and the auditor to have such a huge disagreement. 

Changing auditors

You can click on a link in the news story and see the Form 8-K. This form is used to report a change of auditor to the SEC. Regardless of who audits the books, will the multiple weaknesses remain? A real red flag for a potential lender of investor.

Have you dealt with a situation when a company changed auditors- due to an accounting disagreement? I’d love to hear your comments.

Ken Boyd

St. Louis Test Preparation

Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies

Co-Founder: accountinged.com

(email) ken@stltest.net

(website) www.stltest.net

Image: Calculator and Money , CC by 2.0