Assessing Going Concern Issues in an Audit

The Auditing Standards Board (ASB) has unanimously voted to issue a final going concern standard. This standard will align the AICPA’s auditing guidance with accounting guidance issued by the Financial Accounting Standards Board (FASB) in 2014. Here’s a closer look at the going concern assumption and the responsibilities for identifying and disclosing “substantial doubt” about a company’s ability to operate as a going concern over the next year.

A fundamental assumption

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. When liquidation is imminent, the liquidation basis of accounting is used instead.

In 2014, the FASB issued 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. Under the updated accounting guidance, the final responsibilities to decide whether there’s a going concern issue and to provide related footnote disclosures shift from external auditors to the company’s management.  

FASB’s going concern 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 (or 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).

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. 

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. 

A consistent approach

The ASB’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 U.S. GAAP. 

SAS 132 will supersede SAS 126, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern (Redrafted). The update will be effective for audits of financial statements for periods ending on or after December 15, 2017.

At the time SAS 126 was issued, FASB standards didn’t address management’s responsibilities for evaluating substantial doubt about an entity’s ability to continue as a going concern — but the FASB was contemplating updating its guidance. After the FASB issued ASU 2014-15, the ASB issued four new auditing interpretations to SAS 126. The issuance of these interpretations represented a short-term interpretive guidance. SAS 132 will provide more detailed, long-term guidance.

In general, the ASB’s updated guidance will require 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 update also will call for auditors to conclude on the appropriateness of management’s assessment. 

In addition, the update will address uncertainties auditors face when the going concern basis of accounting isn’t applied or may not be relevant. 

The ASB decided that SAS No. 132 won’t apply to audits of single financial statements, such as balance sheets, and specific elements, accounts or items of a financial statement. Some auditors contend that the evaluation of whether there is 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.

Some ASB members expressed concern that, because of the interrelationship of all the auditing standards, highlighting exclusion of a specific standard could have unintended consequences. So, in the future, the ASB plans to perform additional research on the standard’s applicability in audits of single financial statements or specific accounts.

Tackling going concern assessments

In addition to aligning U.S. auditing standards with U.S. GAAP, the ASB will model its new guidance after international auditing standards. With all of the standard-setting bodies on the same page, it’s clear that management will need to understand how to implement effective policies and procedures to identify going concern issues, as well as how to provide the appropriate documentation to satisfy external auditors. 

© 2017