ANTHONY H. CATANACH JR. is an associate professor in the School of Business at Villanova University, as well as the Cary M. Maguire Fellow at the American College Center for Ethics in Financial Services. His professional experience includes five years as an audit manager with KPMG and six years in the financial services industry. Dr. Catanach has received numerous awards for his publication, teaching, and curriculum innovation efforts. He has authored numerous articles on a variety of accounting, finance, and management issues, as well as several business education texts..
Poor Jon Corzine! What a pity his firm declared bankruptcy on Halloween. Because he has no more tricks to play, he will be receiving few treats.
Last week Francine McKenna must have had premonition of what was to come, for she asked us whether PwC should have issued a going concern opinion. Ok, maybe she was well connected with all the movers and shakers and was on top of the news about the firm. Or maybe she read the SEC filings. At any rate, she has discussed MF Global in “Are Cozy Ties Muzzling S&P on MF Global Downgrade?” and “MF Global: 99 Problems and PwC Warned About None of Them.”
To answer the question, yes, we do think PwC probably should have issued a going concern opinion. There were plenty of breadcrumbs to reveal the cupboard was bare.
SAS No. 59 (AU section 341) seems reasonably clear about the principles. It says in paragraph 2: “The auditor has a responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited.” Paragraph 6 goes on to say the auditor should consider such things as negative trends in key financial metrics, indications of possible financial difficulties, and external matters that have occurred.
We wonder what is meant by this pronouncement and what evidence must be present to conclude that a going concern opinion is appropriate. Might that include four years (2008-2011) of massive losses, as occurred at MF Global? Might that include severely negative free cash flows for three of the last four years? Might that include an exposure to European sovereign debt that will lead to greater future losses? Might that include several downgrades in the credit ratings?
Unfortunately, our experience with Big Four practice suggests a myopic and unreasonable focus on the ability of the entity to pay its bills for the coming year is often the primary criteria driving the opinion. Indeed, the number of going concern opinions is decreasing when they likely should be increasing.
Of course, the word “substantial” that modifies “doubt” gives one pause whether sufficient evidence existed for PwC to issue such an exception. Worse, it makes one wonder whether an accounting firm ever has to issue such an opinion. Pity the standard setters.
P.S. Today we learn that MF Global is missing hundreds of millions of dollars of customer money. Gee, maybe the internal control system isn’t up to snuff.
This essay reflects the opinion of the authors and not necessarily the opinions of The Pennsylvania State University, The American College, or Villanova University.
J. EDWARD KETZ is an associate professor of accounting in the Smeal College of Business at Pennsylvania State University. He has a bachelor’s degree in political science, a master’s degree in accountancy, and a Ph.D., all from Virginia Tech. Professor Ketz has been a member of the Penn State faculty since 1981. He also has taught at the University of Connecticut and the University of Maryland. Professor Ketz has authored and edited 17 books including Hidden Financial Risk (Wiley, 2003) which examines the corporate culture and the institutional setting that engendered recent accounting scandals. Dr. Ketz has been cited in the popular and business press, including The Wall Street Journal, The New York Times, The Washington Post, Business Week, and USA Today. He also has appeared as an accounting commentator on CNN, National Public Radio, and Bloomberg Radio.
On a semi related matter, it appears as if MF Global did not want to recognise the unrealized losses on the sovereign debt it held, which from what I understand would be a against US GAAP. Is there some sort of exception that the auditors would have allowed?
http://www.reuters.com/article/2011/11/02/us-mfglobal-finra-idUSTRE7A158J20111102
“FINRA began conversations with MF Global about whether it was appropriate under Generally Accepted Accounting Principles to consider the exposure to be off balance sheet, according to the source, who was not authorized to speak publicly.
FINRA felt that regardless of GAAP, MF Global should recognize how much the market value of the sovereign debt-related holdings had declined, and consulted with the U.S. Securities and Exchange Commission, the source said.”
I was curious about this also. This is my take:
- MFG relied on Repo-To-Maturity treatment (old FAS 125) to keep the bonds off the balance sheet
-Per MFG’s 10Q, this treatment resulted in recognizing a derivative representing the forward commitment to purchase the soveriegn nonds. This should have resulted in recognizing the fair value losses that you would expect;
- In the 10Q, the Company goes to great length to describe the EFSF fund and how the maturity oft the bonds was not too far off in the future. In my mind, they were building the argument to exclude the fair value impact using an impairment type of argument (ie that they had the resources to hold to maturity so why bother with interim swings). Also, since these were fixed income instruments that mature at par, some people believe strongly that a “pull to par” treatment makes economic sense and that it should override mark-to-market (I have seen this in practice).
- The 10Q, in its footnotes related to derivatives and fair value, did not speak to the implied derivative (even though it was mentioned elsewhere in the document), which shows that its fair value impact was clearly not being addressed.
The opinion piece stated: “..There were plenty of breadcrumbs to reveal the cupboard was bare…” Do you care to back that up with any facts? Are you suggesting that the opinion rendered when they filed the Form 10-K back in Feb 2011 should have been a going concern even though equity was over $1.5 billion and they had access to credit that exceeded $1.5 billion? Are you suggesting that this was the case as of Q2 2011? You are aware that there was no Form 10-Q filed for Q3 2011, which is the quarter in which the securities had the substantial decline in value? I am just trying to understand the basis for the statement that the cupboard was bare and hence there should have been a going concern opinion.
Also, are any of you academic types aware of the obligations of the auditors to update the opinion rendered in early 2011? Do you know what the review report says in the quarterly filing? Do you think that risk factors described in the Form 10-K were insufficient? Do you think that the auditors should have been able to anticipate the market decline in Feb 2011 and therefore that opinion was wrong, or do you think the auditors had a professional obligation to withdrawal their opinion and re-issue a going concern opinion, and if so when would that have been.
I’m not an auditor, but it seems odd to point the fingers at PwC, but if you can back up the assertions that they should have issued such an opinion and describe when that should have been issued, I will be most interested. I went back to the Form 10-K to see what I could learn, and it actually appeared the disclosures were fairly robust with very direct risk factors disclosed as well. In fact the 2010 loss was a lot lower than the 2009 loss, the company said they would restructure, there was a new CFO, equity was sizable, and there were some recent debt offerings that indicated seasoned investors had confidence. I personally would not have acquired the stock, but if I did it would have been a speculative play.
Did you read our article? Negative earnings and negative cash flows for several years are indicators of going concern issues. Because of their declining fair values and not knowing if bottom has been reached, having a material amount of one’s assets in European sovereign debt instruments is an indicator of a going concern issue. Having a number of downgrades to one’s credit rating is an indicator of a going concern issue.
One may argue that we don’t know with certainty whether this rises to the level of “substantial doubt,” but our opinion is that it is sufficiently close that we conclude that substantial doubt existed.
@Duncan Idaho
MF Global had a March 30 year end. Their annual report was issued in May. There was a 10Q for the first quarter of fiscal 2012 filed at beginning of August. They issued bonds in August that included the year end numbers in the prospectus not updated ones. A 10Q has not been filed for 2Q ending Septmeber 30 but an extensive conference call with results documents was provided during the week they were circling the drain.
http://www.mfglobalinvestorrelations.com/phoenix.zhtml?c=194911&p=irol-EventDetails&EventId=4214039