Financially Distressed Companies and Auditor Perceptions of the Twelve Characteristics of Decline.

Auditing standards require auditors to carefully consider conditions and events that may give rise to substantial doubt about the client's ability to continue as a going concern (SAS No. 59, AICPA 1988b). The guidance in SAS No. 59 leads auditors to focus primarily on financial evidence. However, auditors also examine broader organizational characteristics as part of their evaluation of a client's control environment, especially since the issuance of SAS No. 55 (AICPA 1988a). This non-financial evidence might be useful in making the going concern judgment. Organizational research indicates that some characteristics do differ between healthy organizations and those in decline. The purpose of this paper is to assess whether or not auditors associate twelve characteristics of decline with client companies known to be in poor financial condition. This study employs audit managers from one national audit firm and captures their perceptions of these characteristics for a sample of actual client organizations having potential going concern problems as well as for a matched sample of companies in good financial condition. Findings reveal that auditors attribute certain decline attributes, such as no long-term planning, scapegoating, turnover, low morale, loss of slack and nonprioritized cuts, to firms having financial difficulty. This suggests that non-financial characteristics associated with organizational decline could be used by auditors to corroborate judgments regarding the financial condition of client companies.