A shadow has once again been cast over ‘going concern’ judgements, after academic research showed that three out of every four audits for collapsed companies had failed to raise the alarm over the prospect of insolvency.

The Audit Reform Lab at Sheffield University Management School looked at 250 publicly traded companies that went bust between 2010 and 2022 to find 75% of their audit reports failed to flag “material uncertainty related to going concern”.

The news comes barely six months after the government cancelled new reporting regulations intended to tackle a widely shared view that company going concern statements are not fit for purpose. Recommendations for a new audit regulator have also come to nothing since they were first published.

In its report, the Audit Reform Lab is scathing about the current audit regime writing: “Auditors are failing to perform their core function.”

They point out auditors are required to make a going concern “warning” if there is a risk a company may go bust. Cancellation of planned reforms may be a contributing factor.

The report says audit should ensure the “integrity” of company reporting but adds that the current system means auditors are “incentivised to maintain good client relationships, rather than apply the principles of professional scepticism and enforce procedure”.

“The UK government set out plans to introduce a new audit regulator but then failed to introduce them.

“Until the culture of audit is reformed and a new more effective regulator is in place, partners at audit firms will continue to reap huge financial rewards, despite continued audit failures that harm business confidence and our economy more widely.”

‘Reward for failure’

The Lab says partners at the Big Four firms—PwC, EY, Deloitte and KPMG—saw their pay rise on average 31% from 2010 to 2022.

Going concern reporting and statements have been a concern since the now notorious collapse of construction company Carillion in 2018. KPMG was last year fined a record £30m for its failed audit of the company.

A review by Sir Donald Brydon published in December 2019 recommended the introduction of a new “resilience report” in company annual disclosures to tackle the perceived weaknesses in going concern statements.

The resilience report was widely welcomed and would have seen companies report on their ability to stay afloat over the short, medium and long term. It would have been accompanied by reports on scenario testing undertaken by companies.

In his report, Sir Donald said the “going concern” statement “set the bar too high” for directors to report problems, mainly because “proposed mitigating action” could be taken into account when considering whether a warning should be published.

However, the government killed off resilience reporting in October last year, along with reporting on audit and assurance policies and measures to tackle fraud. Listed companies had spent months, if not years, gearing up for resilience reporting.

Government press releases were accompanied by statements from Julia Hoggett, chief executive of the London Stock Exchange, who, as chair of the Capital Markets Industry Taskforce (CMIT), lobbied for a “reset” of UK corporate governance to lighten the regulatory burden on companies.

Hoggett has also argued for a steep rise in chief executive pay to make the UK more competitive in attracting overseas talent to companies, an argument that has been disputed.

For corporate reporting regulator the Financial Reporting Council (FRC), the landscape has also become more complicated. It has reported on use of “going concern” statements in the past, particularly during the pandemic.

However, the FRC has recently received a new mandate from government, after being told by business secretary Kemi Badenoch that it should “contribute to promoting the competitiveness and growth of the UK economy, embedding its growth duty across its work”.

In its report, the Lab highlighted that EY gave going concern warnings at 20% of collapsed clients, PwC 23%, Deloitte 36% and KPMG 38%. Outside the Big Four, the average rate was 17%.

The Lab says it has concerns that the Big Four do not challenge audit clients enough. “Of the 250 liquidated companies, 38 declared dividends in their last set of accounts. Ten of these did so despite making a loss, and two… did so despite reporting a loss and having a negative net asset balance, which is a strong indicator of insolvency risk.”