Going Concern – Sixteen Year Review
By Hector Reinoso, Manager, Assurance Services
The Financial Accounting Standards Board’s (“FASB”) new 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 (“ASU 2014-15”), is intended to provide guidance to management related to evaluating whether there is substantial doubt about a reporting entity’s ability to continue as a going concern and the related financial statement note disclosures.
A going concern is the assumption that a business will continue to operate without the threat of liquidation in the immediate future, usually for at least for the next 12 months. Under U.S. Generally Accepted Accounting Principles (“US GAAP”), typically, a going concern is assumed to be the core principle for preparing financial statements, unless and until the entity’s liquidation becomes imminent. The preparation of financial statements under this assumption is commonly referred to as the “going concern basis of accounting.”
Sometimes, liquidation is not imminent, but there is still a question as to whether the entity has the ability to continue as a going concern. The AICPA’s Statement on Auditing Standards No. 126, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, addresses what to do in this case, which is to issue a “going concern opinion.” A “going concern opinion” is an opinion qualified by an uncertainty regarding the going concern assumption.
Auditing standards requiring auditors to consider the impact of an entity’s ability to continue as a going concern have existed for several decades. However, in recent years, auditors have issued going concern opinions less and less frequently, according to the research firm Audit Analytics. According to the most recent survey, during the previous 16 years under analysis, fiscal year 2008 – the heart of the “great recession” – experienced the highest number of going concerns, with 3,354 reported. Going concern opinions decreased in each subsequent year through 2015, when an estimated 2,016 going concern opinions were expected.1 However, much of this decrease was related to company attrition from the prior year’s going concern population.
Audit Analytics analyzed the data for recent going concern opinions for fiscal year 2015 and determined the most common recurring going concern issue was the company’s recurring operating losses. This factor occurred in 52% of surveyed companies. After that, the most common issues leading to a going concern opinion were working capital/current ratio deficiency/inadequacy (29%), negative cash flow from operations (28%), net losses since inception (26%), and an absence of significant revenues (25%). It should be noted that the most recent Audit Analytics survey does not address or take into consideration the impact of ASU 2014-15 which was issued in August 2014 but did not go into effect until 2016.2
Although the presumption that a reporting entity will continue to operate as a going concern is fundamental to the preparation of financial statements, prior to the issuance of the ASU, there was no guidance in U.S. GAAP related to the concept. Due to the lack of guidance in U.S. GAAP, auditors and their clients often faced challenges in determining whether, when, and how a reporting entity should disclose the relevant information in its financial statements. As a result, the FASB issued needed guidance requiring management to evaluate whether the entity can continue to operate as a going concern and whether the deficiency can be corrected through the effective implementation of management’s future plans.
Most importantly, this ASU is effective for financial statements with periods ending after December 15, 2016, which means reporting entity management will need to perform going concern evaluations for their 2016 calendar year-end financial statements. The new ASU requires management to evaluate an entity’s ability to continue as a going concern for a period of 12 months from the “issuance date” of the financial statements, not 12 months from the date of the financial statements. As a result, the auditor will have to review management’s plan and forecast for a longer period of time to assess the financial health of the business.
With proper implementation, this new ASU should provide management with additional guidance to assist in determining whether a reporting entity is a going concern. The auditors can then ensure management is following the guidance, ensuring the investing community is receiving the information it requires in order to make informed decisions. It will be interesting to see if there will be an increase in going concerns reported by management and if going concern opinions increase in the future as a result of this new guidance.
Audit Analytics. “The People of SEC Comment Letters: 2016.” March 20, 2017.
1. As of the date of the survey, many foreign filers and non-accelerated U.S. filers with a fiscal year-end occurring on December 31 had not yet filed an annual report with the SEC. As such, Audit Analytics estimated the number of going concern opinions for 2015 based on opinions actually filed for 2015 and as extrapolated from 2014.
2. Although early adoption was allowed.