By Kay Filler, CPA, Principal
Historically originating through the lens of the independent auditor, whose auditing standards require the auditor to consider “going concern” matters and potentially include cautionary language in the auditor’s report, all companies that issue GAAP-based financial statements are now required to perform their own evaluation and provide explanatory footnote disclosures in defined circumstances.
Until August 2014, when FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, GAAP included little financial reporting mention of a company’s near-term financial prospects, even though auditors have been required to address this subject in their reports for years. The absence of specific guidelines, as usual, resulted in wide diversity in practice between companies. These new requirements are effective for 2016 calendar year financial statements and later.
Why Does This Matter?
Continuation of the reporting company is presumed as the basis of preparing financial statements until the company’s liquidation is imminent, at which time GAAP dictates that the financial statements should be presented on the liquidation basis of accounting. Discussing the liquidation basis is beyond the scope of this article, but suffice it to say that the financial statements would likely be materially different than under the “going-concern” basis.
Even if a company’s liquidation is not yet imminent, conditions could (and often do) exist that raise doubt about a company’s ability to continue as a going concern. Management is required to follow the new FASB guidance to determine whether financial statement disclosures should be included about the relevant conditions and events that raise doubts about a company’s financial condition.
Substantial Doubt about an Entity’s Ability to Continue as a Going Concern
The new FASB Codification glossary definition is “Substantial doubt about an entity’s ability to continue as a going concern exists when conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or available to be issued).”
Probable means “the future event or events are likely to occur.” While not specifically quantified by the GAAP literature, many assert probable as being in the 70-75 percent range.
Another key point to highlight, for those familiar with auditing guidance, is the time period relevant for the going concern evaluation, which is one year after the issuance date, rather than one year after the balance sheet date. What this means is that certain logistical techniques for avoiding a potential auditor’s report mention or optimizing the related disclosures becomes largely unavailable for all practical purposes. In the past, when conditions allowed, companies could merely hold up issuing their financial statements until the one-year mark from the reporting period had passed or was so shortened as to render the uncertainty for the one year moot.
What does management need to consider?
- Are there conditions or events that raise substantial doubt about the company’s ability to continue as a going concern under the definition above? Management is required to consider both qualitative and quantitative information about a number of specific relevant conditions and events that are known and reasonably knowable at the date the financial statements are issued.
- If this evaluation results in a condition meeting the definition above, management then evaluates whether its plans that are intended to mitigate those conditions will alleviate the substantial doubt and are probable of implementation. The guidance provides specific factors requiring consideration in evaluating management’s plans. Also of note is the presumption that for management’s plans to be considered probable of being implemented, those plans must have been approved before the date the financial statements are to be issued.
- If substantial doubt is raised and then alleviated by management’s plans, the company must disclose (1) the conditions or events that raised substantial doubt; (2) management’s evaluation of their significance; and (3) management’s plans that alleviated the substantial doubt.
- If substantial doubt is not alleviated by management’s plans, the relevant disclosures in (1) and (2) above, as well as management’s plans that are intended to mitigate the conditions or events that gave rise to the substantial doubt, must be disclosed. In addition, and perhaps most importantly, management must include a statement in the disclosures “that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are (or available to be-added) issued.”
An excellent tool for guiding these considerations is the decision flowchart included in the FASB ASU (page 12).
The applicability of “going concern” guidance falls disproportionately on smaller companies. Although too early to tell, we expect that this “going concern” guidance may result in changes to how private companies meet their financial reporting obligations. Obviously this issue is less prominent in a healthy economy, but what happens when the next downturn hits? Will some companies choose to report on a non-GAAP basis and, in so doing, fall outside these rules? For sure, given that the “going concern” consideration has been incorporated into GAAP, changing the scope of an independent accountant’s reporting scope from audit to review or compilation (or, for that matter, a preparation) will no longer avoid the requirements for “going concern” disclosures.
The other key take-away is that prior to this FASB guidance, the “going-concern” evaluation and all of its considerations and judgments fell upon the independent auditor, with management playing a supporting role. Now management is tasked with the full responsibility of undertaking this evaluation as part of the financial reporting process, and auditors and independent accountants are responsible for determining if management’s evaluation and conclusions (and, perhaps, financial statement disclosures) are reasonable.
Please contact us if you would like more information or resources to assist you with this new financial reporting responsibility.