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Substantial doubt and the entropy of auditors’ going concern modifications

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  • Ittonen, Kim
  • Tronnes, Per C.
  • Wong, Leon

Abstract

Auditors need to establish a substantial doubt threshold in order to determine the type of audit report to issue, but substantial doubt is not defined in the auditing standards. Auditors are regularly criticized for having high thresholds, which results in too few going concern reports. We apply Shannon entropy from information theory as the criterion to evaluate the informational value of the audit report. Shannon entropy provides a measure of the expected information content associated with the realization of an uncertain event. First, we estimate the client’s probability of bankruptcy in our sample. Second, using the distribution of the probability of bankruptcy we calculate the entropy at each point of the probability of bankruptcy. We find that entropy is maximized at the 0.08 probability of bankruptcy.

Suggested Citation

  • Ittonen, Kim & Tronnes, Per C. & Wong, Leon, 2017. "Substantial doubt and the entropy of auditors’ going concern modifications," Journal of Contemporary Accounting and Economics, Elsevier, vol. 13(2), pages 134-147.
    • Handle: RePEc:eee:jocaae:v:13:y:2017:i:2:p:134-147
    DOI: 10.1016/j.jcae.2017.05.005
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    Cited by:

    1. Nora Muñoz-Izquierdo & María-del-Mar Camacho-Miñano & María-Jesús Segovia-Vargas & David Pascual-Ezama, 2019. "Is the External Audit Report Useful for Bankruptcy Prediction? Evidence Using Artificial Intelligence," IJFS, MDPI, vol. 7(2), pages 1-23, April.
    2. Mark Penno, 2022. "Concepts‐based Accounting Standards," Abacus, Accounting Foundation, University of Sydney, vol. 58(2), pages 209-232, June.

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    More about this item

    Keywords

    Bankruptcy; Going concern modifications; Substantial doubt; Shannon entropy; Policy and regulation;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing

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