After trending downward prior to the pandemic, going concern opinions increased substantially in fiscal year 2021, according to a recent report by Audit Analytics. Here’s an overview of the going concern assumption and the responsibility to identify “substantial doubt” about a company’s ability to operate as a going concern over the next year.
Evaluating future viability
The going concern assumption underlies all financial reporting under U.S. Generally Accepted Accounting Principles (GAAP). It presumes that a company will continue normal business operations into the future. However, when liquidation is imminent, the liquidation basis of accounting is used instead.
The final responsibility to decide whether there’s a going concern issue and provide related footnote disclosures shifted from external auditors to the company’s management, under Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern.
Essentially, the going concern accounting standard requires management to decide whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued. (Alternatively, this assumption may be assessed within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).
Defining substantial doubt
Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:
- Recurring operating losses,
- Working capital deficiencies,
- Loan defaults,
- Asset disposals, and
- Loss of a key franchise, customer or supplier.
Financial distress experienced during the pandemic could have caused these types of adverse conditions or events, leading to an uptick in going concern issues for the 2021 fiscal year.
After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.
Applying a consistent approach
The Auditing Standards Board’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, is intended to promote consistency between the auditing standards and accounting guidance under GAAP. The current standard requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. The standard also calls for auditors to conclude on the appropriateness of management’s assessment.
The evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level. So, the going concern auditing standard doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts or items of a financial statement.
Your auditor’s role
Management must provide appropriate documentation to prove to external auditors that its going concern assessment is reasonable and complete. Due to continued market volatility in 2022 and beyond, auditors are likely to scrutinize this assessment closely in the upcoming audit season.