Recent Study Finds Fewer Going Concern Issues Reported

The number of audit opinions qualified by an auditor’s uncertainty about a business’s ability to continue functioning as a “going concern” dropped in 2014. In addition, 200 companies improved enough in 2014 to permit the auditors to shed light on the going concern opinion. These trends — which were recently reported by research firm Audit Analytics — could be signs that the U.S. economy is rebounding. Here is some background on going concern issues and more results from the recent study.

Going concern assumption is fundamental

Under U.S. Generally Accepted Accounting Principles (GAAP), the going concern assumption is normally the presumed basis for preparing financial statements, unless the entity’s liquidation becomes imminent. Statement on Auditing Standards No. 126, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, requires auditors to issue a so-called “going concern opinion” when liquidation isn’t imminent, but conditions or events may raise substantial doubt about the company’s ability to continue as a going concern over the next year. 

When such issues arise, the auditor’s report will contain an emphasis-of-matter paragraph that identifies and explains the reasons for these “substantial doubts.” For comparative statements, however, no disclaimer is required if the substantial doubt that existed for the prior period is no longer applicable in the current period.

Going concern opinions continue to fall 

Audit Analytics estimates that 2,233 audit opinions were qualified by going concern issues in 2014, the lowest amount during the 15 years analyzed. In 2013, there were 2,403 going concern opinions — but 150 of those companies went out of business before the end of 2014, which is one explanation for the reduction. 

The report listed the most frequent causes contributing to a company’s financial weakness as:

• Recurring operating losses (52.3%), 
• Insufficient working capital (28.9%), and 
• Negative cash flow (28%). 

Auditors often report multiple weaknesses that lead them to question a company’s ability to operate as a going concern over the next year. For example, a distressed company might experience both recurring operating losses and negative cash flow, leading its auditors to question whether the company will be able to stay afloat for another year. 

Findings unaffected by new accounting guidance 

Audit Analytics’ report doesn’t refer to any effect from Accounting Standards Update 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. The Financial Accounting Standards Board (FASB) adopted this updated standard in August 2014. But it wasn’t in effect for the period covered by the report. It becomes effective for annual reports filed for 2016, although early adoption is permitted.

Before the FASB issued this standard, there was no guidance in GAAP for management to issue a going concern opinion. Auditors issued them under the AICPA’s auditing guidance. 

Under the new standard, management will 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). 

Management should base its assessment on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued (or available to be issued). If management identifies that a going concern issue exists, it should ask, “Can we fix it?” 

Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line. Management should also evaluate the feasibility of its plans. For instance, if it plans to sell an interest in a failing joint venture, management might consider transfer restrictions, the interest’s marketability and indirect effects that the divestiture may have on the rest of the business.

What will the future bring?

The implementation of the updated accounting rules on assessing going concern issues also may affect the number of going concern opinions issued in the future. The FASB hopes that, by shifting the responsibility for detecting going concern issues from external auditors to internal managers, the markets will find out about financial problems sooner, resulting in a higher number of qualified opinions. 

But critics worry that managers won’t see the situation as objectively as outside auditors or may feel pressure to downplay any uncertainty. As a result, managers might be less likely than auditors to report going concern issues. 

Only time will tell. In the meantime, contact your CPA for more information on going concern issues, including disclosure trends and your new role in assessing financial distress.

© 2016