About two years ago, my post, FASB Shines a Light on “Going Concern”, summarized new disclosure rules that, for the first time, placed GAAP disclosure requirements on company management when preparing financial statements, based on their required consideration of the entity’s ability to continue as a going concern. The earlier post summarizes those new requirements. Since then, existing independent auditor/accountant reporting requirements were updated to respond to the changes required of management. Without reconsidering these changes here, I wondered whether any interesting observations could be made based on management’s and auditor’s responses to these new rules, which were first effective for calendar year 2016 and fiscal year 2017 financial statements.
The “going concern” issue requires balance, unlike a three-legged stool, among competing concerns:
- The financial statement reader’s (user’s) need for information about going concern assumptions
- The Company’s (preparer’s) fear about going concern disclosures and the auditor’s going concern opinion creating a self-fulfilling prophecy
- The auditor’s liability concerns (from both the preparer’s and the user’s perspective)
As a result, the words “going concern” never invoke a tranquil, or even neutral, ambience in the world of financial reporting. No one wants to deal with it.
One area where differing interpretations and approaches crept into public company disclosures is the situation when substantial doubt about going concern was raised in the initial assessment but that doubt was alleviated by management’s plans. This “grey area” led to a FASB staff inquiry where Staff indicated when management’s concludes its plans do alleviate substantial doubt, objectives of the disclosures can be met without indicating that “substantial doubt” was raised.
To summarize, companies seem to be addressing this situation, which was highlighted initially by the new standard, in one of three ways:
- Making an explicit statement that “substantial doubt” was raised and then alleviated by management’s plans
- Describing that in the absence of management’s plans, the Company’s liquidity is questionable and that management’s plans are probable of occurring. (Essentially, this is a more descriptive approach and avoids the volatile words of “substantial doubt”)
- No explicit statement at all given the conclusion that management’s plans alleviated the “going concern” risk
A repercussion of the new structure to first consider the Company’s liquidity and then to consider management’s plans to maintain liquidity if issues are highlighted, is that users sometimes have not discerned between situations when substantial doubt was alleviated (by management’s plans) and when it was not and, thus, still exists. The longstanding “going concern” and “substantial doubt” words carry a lot of baggage.
Sears Holding Corporation, in a March 2017 filing, used the words “substantial doubt” and “going concern” to assess its liquidity problems, which was tantamount to a warning, and caused a steep drop in its share price as a result. Of note, the full disclosures also included detailed discussion of actions to mitigate the liquidity concerns, and the conclusion that the actions are probable of occurring and are likely to provide for liquidity for the one-year period after financial statement issuance. Also interesting is that Deloitte, the Company’s auditors, did not refer to “going concern” in their opinion, which implies that Deloitte was satisfied that management’s plans were probable of alleviating liquidity concerns in the required time period and that disclosures made by management were an adequate portrayal of the “going concern” situation.
The Sears story highlights the need for readers of financial statements to consider “the whole story” before drawing conclusions about a company’s ability to meet its future obligations, particularly in the one-year window.
Also interesting is what companies that are historically unprofitable and are dependent on other actions to remain liquid (such as raising capital or selling assets) might include in their disclosures that were not included before. Let’s consider Tesla.
Tesla historically included generic statements referring to current sources of liquidity and possible capital raising, though provided no specific plans. Generally, this same approach carried forward in the 2017 annual filing, with the addition of certain also general words to explain that the company can adjust its investing and operating expenditures to provide liquidity since a large amount of future expenditures is to fund growth. Still no specific disclosures. General disclosures, such as Tesla’s, require that investors and other users of the financial statements critically analyze the actual financial statement balances and other disclosures to form their own conclusions about whether additional funding is required or merely the better way to go, and to get a sense of required timing.
While additional disclosures and a more detailed framework for consideration of going concern are now required, enough interpretive room remains for management to frame a company’s liquidity condition, and words are important. The words “substantial doubt” and “going concern” are anything but neutral, based on prior guidance coming out of the auditing literature. If used, they should be the starting point of the user’s analysis, because the conditions these words describe could be probable of being alleviated. On the other side, less prescriptive wording could lead to general comments with limited communication value without considering other information in the financial statements and disclosures.