Abstract. The purpose of this thesis is to contribute to the literature concerning Going Concern opinions and their relative misclassifications. Firms prepare their financial statements under the Going Concern assumption, under which the firm is expected to continue operating during the normal course of business without facing bankruptcy risks. Auditors are required to deliver an opinion concerning the appropriateness of the Going Concern assumption.
Past literature refers to Type II audit misclassifications when discussing those misclassifications occurring when auditors fail to modify an audit report for Going Concern, and the client subsequently files for bankruptcy within one year from the issuance of the report. Type II audit misclassifications are often seen as “audit failures” by regulators and investors, as auditors failed to warn about the Going Concern issues of their clients, and the same also have consequences for auditors, who face potential litigation fees and reputation loss in case they do not render a GCO to a firm that subsequently fails. The focus of this thesis is for this reason on Type II audit misclassifications. Past research has broadly studied factors influencing GCO issuances and their relative misclassifications (e.g., client size, audit tenure, auditor dependency).
This study explores whether the industry the auditee belongs to can be a potential determinant of increased likelihood of Type II misclassifications. A distinction between complex industries (e.g., Construction, Financial services, IT services) and non-complex industries is made following a previous line of research and binary logistic regression models are used to analyze the association between the industries and the likelihood of Type II audit misclassifications. The hypotheses are that an increased likelihood of Type II audit misclassifications might be observed in complex industries and, specifically, in the IT services industry, as these industries are more unpredictable due to revenue-recognition and measurement processes that are heavily influenced by accruals and longer-than-average operating cycles.
The results show that the likelihood of auditors failing to issue a GCO when needed is higher when the client belongs to a complex industry and if it belongs to the IT services industry alone. These findings might be helpful for the decision-making process of those investors who positively weigh a clean audit report of a firm for their investment decisions. Further, this increased likelihood of Type II audit misclassifications in the aforementioned industries might serve as groundwork for future research and for practitioners, as additional audit procedures and audit requirements might be needed when clients belong to complex industries
