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Explanatory Language May be Added to the Auditor's Unqualified Opinion
By Michael C. Dennis, MBA, CBF

Certain accounting situations require auditors to add explanatory language to the standard report. Adding the additional language is not regarded as a qualification because it does not lessen the auditors' reporting responsibility. Auditors add explanatory language to an unqualified opinion on matters such as these:

  • To indicate an inconsistency in the application of accounting principles;

  • To emphasize a matter of particular importance;

  • To refer to an uncertainty that could have a material impact on the company's financial statements.

A special type of significant uncertainty that is important to the credit professional concerns the ability of a company to continue as a going concern. Under generally accepted accounting principles, both assets and liabilities are recorded and classified on the assumption that the company will continue to operate. Assets, for example, may be presented at amounts that are significantly greater than their liquidation values.

Conditions that may cause the auditors to question the going-concern assumption include a bankruptcy filing, defaults on loan agreements, work stoppages, and legal proceedings. If a substantial doubt exists about the company's ability to continue as a going concern for a period of one year from the balance sheet date, the auditors modify their report by adding a final paragraph such as the one listed below relating to a bankruptcy filing:

REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Board of Directors of ABC Corporation

"In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of ABC Corporation and its subsidiaries at April 30, 2002 and April 30, 2001, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of ABC's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying consolidated financial statements have been prepared assuming that ABC Corporation will continue as a going concern, which contemplates continuity of ABC's operations and realization of its assets and payments of its liabilities in the ordinary course of business. As more fully described in the notes to the consolidated financial statements, on March 15, 2002, ABC Corporation filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. The uncertainties inherent in the bankruptcy process and ABC's recurring losses from operations raise substantial doubt about ABC Corporation's ability to continue as a going concern. ABC Corporation is currently operating its business as a Debtor-in-Possession under the jurisdiction of the Bankruptcy Court, and continuation of ABC as a going concern is contingent upon, among other things, the confirmation of a Plan of Reorganization, ABC's ability to comply with all debt covenants under the existing debtor-in-possession financing agreement, and ABC Corporation's ability to generate sufficient cash from operations and obtain financing sources to meet its future obligations. If no reorganization plan is approved, it is possible that ABC's assets may be liquidated. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of these uncertainties."

Note that a "going concern" paragraph lists a number of potential problems that could result in the company's failure. For this reason, an experienced credit manager will always take the time to read the Auditor's Opinion Letter carefully.

 
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