How You Define A Going Concern In Business

Going Concern

Given the expectation of continued cash flow generation from the assets belonging to a company is inherent to the discounted cash flow model. Maria L. Murphy, CPA, is a regular contributor to Compliance Week’s accounting & auditing coverage. She is a senior content management analyst, accounting and auditing products, CCH tax and accounting North America for Wolters Kluwer. For 2020, other top going concern issues included having no or limited operations , needing additional funding (14.1 percent), and debt defaults and bankruptcies (8.9 percent).

Certainly, we always have to be thinking about who the users of the financial statements are and whether a delay in the issuance of the financial statements would be acceptable or would be viewed as unacceptable by users of the financial statements. Certainly, it would be hard to deny that the pandemic and COVID-19 create events and conditions that may cause doubt about an organization’s ability to continue as a going concern. Depending on the sector in which the entity operates, it may or may not cause significant doubt. The example that everybody uses these days is, if your business happens to make toilet paper, the environment is probably not leading you to question your ability to continue as a going concern. A current definition of the going concern assumption can be found in the AICPA Statement on Auditing Standards No.1 Codification of Auditing Standards and Procedures, Section 341, “ The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern”.

Auditors write adverse opinions if the company does not use GAAP or if the firm is no longer a going concern. Disclaimers and adverse opinions are serious situations and usually result in suspension of trading in the firm’s securities. Sometimes management’s plans to alleviate substantial doubt include financial support by third parties or owner-managers .

  • And as Sears discovered, it may not be wise to do so (their shares dropped 16% after using the term substantial doubt even though management had plans to alleviate the risk).
  • As we previously mentioned, without substantial doubt, there’s no impact to the company’s financial statements.
  • If a supplier refuses to issue a credit to a company, it shows that they suspect the company to have insufficient funds to repay the purchase dues.
  • The auditor should not use conditional language regarding the existence of substantial doubt about the entity’s ability to continue as a going concern.
  • Often, management will be incentivized to downplay the risks and focus on its plans to mitigate the conditional events – which is understandable given their duties to uphold the valuation (i.e. share price) of the company – yet, the facts must still be disclosed.

First, management’s disclosure obligations differ from those of the auditor. AS 2415, on the other hand, does not require disclosure by the auditor in situations where management’s plans have alleviated the substantial doubt. The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management’s assertions embodied in the financial statements being audited, as described in AS 1105, Audit Evidence.

Auditor Decisions Regarding Going Concern

The figure represented 12.1 percent of 2020 going concern opinions, the highest proportion since 2015. Foreign company going concern opinions also fell in 2020, to 23.8 percent of all annual report opinions issued from 27 percent in 2019. The Board must put this information into the footnotes included in the financial statements and state any factors that may threaten that status. Therefore, management must include obligations that will arise over the next 12 months that might not be reflected on the current balance sheet. Aside from those four main items, other obligations may arise that aren’t necessarily contractual, including legal proceedings and any resulting settlements. Also, when assessing for obligations, remember that it’s not exclusively focused on what’s due or even known at the assessment date. Provide clear and robust disclosures, including disclosures about uncertainties identified in the going concern assessment and significant judgements involved where relevant.

Going Concern

If the auditor receives a support letter, he can still request a written confirmation from the supporting parties. For instance, the auditor may desire to check the validity of the support letter. Management intends to finance operating costs over the next twelve months with existing cash on hand and loans from its directors. The Company’s ability to obtain the new financing is not known at this time.

Written Representations When Substantial Doubt Exists

The company’s financial statements should also include its management’s interpretation of its going concern conditions and its future plans. The practice of accounting is based on generally accepted accounting principles . These are assumptions, practices, and concepts that provide the foundation for measuring and reporting the results of business activities. As logic would dictate, they greatly influence the reported financial position of a firm; thus, simultaneous audits of the same firm can produce widely varying valuations for assets, liabilities, and equity if the audits are based on different fundamental accounting assumptions. Two concepts inherent in GAAP are historical valuation of assets and liabilities and the concept of going concern. In performing the going-concern assessment, entities will need to perform additional procedures to model the impact of COVID-19 on their businesses and operations and to reflect this impact in their financial statements and forecasts.

Going Concern

If the auditor concludes there is substantial doubt, he should consider the adequacy of disclosure about the entity’s possible inability to continue as a going concern for a reasonable period of time, and include an explanatory paragraph in his audit report to reflect his conclusion. Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future. General purpose financial statements are prepared on a going concern basis, unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so. Special purpose financial statements may or may not be prepared in accordance with a financial reporting framework for which the going concern basis is relevant . When the use of the going concern assumption is appropriate, assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business. The evaluation of whether it is probable that management’s plans will be effectively implemented based on the feasibility of implementation of management’s plans in light of an entity’s specific facts and circumstances. Generally, to be considered probable of being effectively implemented, management must have approved the plan before the date that the financial statements are issued.

The auditors conduct their own evaluation to see weather the going concern assumption is appropriate or not at the time of auditing financial statements even if the company claims to be a going concern. A company is no longer a going concern when the management decides to either liquidate the entity or cease operations. When an external auditor thoroughly scrutinizes the company’s financial statements and determines that the company may no longer be a going concern, they can speculate that its assets may be impaired. This can lead to a reduction in the carrying amount of the assets to their liquidation value, and so the assets will lose the value they once held. In infrequent cases, the auditor may be unable to express an opinion about the company’s ability to remain a going concern and, thus, may issue a disclaimer to that effect. This situation can occur if limitations are imposed on the scope of the audit by the company’s management. Aside from a disclaimer, the auditor can also write an adverse opinion, if he or she concludes that the financial statements do not present the firm’s situation fairly.

Other Conditions And Events

As a result, many of the observations contained herein may also be relevant to issuers who report using IFRS. In 1988 a significant change occurred in the auditing standards with the imposition of a new requirement relating to the going concern assumption. The new standard was spelled out in Statement of Auditing Standards Number 59 of the Auditing Practices Board. It required auditors, in every audit, to explicitly evaluate whether there is substantial doubt about a company’s ability to continue as a going concern over the coming year. If the auditor has such doubt, he or she must state that opinion in the audit’s report paragraph. The going concern principle is fundamental in the world of accounting and is one of the underlying principles of the balance sheet. If a company is a going concern, it is justified in deferring the recognition of certain obligations that appear on the balance sheet, such as accounts payable.

  • Of SAS 132 states that an auditor should issue a qualified opinion or an adverse opinion, as appropriate, when going concern disclosures are not adequate.
  • The going concern assumption is a fundamental assumption in the preparation of financial statements.
  • Substantial doubt and management’s plans that alleviated the substantial doubt.
  • A qualified opinion can be a concern to investors, lenders and other stakeholders.
  • The phrase “reasonably knowable” is intended to emphasize that an entity should make a reasonable effort to identify conditions and events that it may not readily know but would be able to identify without undue cost or effort.

That means the quality of audit procedures is the place that should be questioned. If negligence is found, then the auditor might have a legal case against it. However, audits are responsible for reviewing the management assessment and considering if those assessments are in the line with their understanding or not. Related to the going concern of the company, auditors are not responsible for assessing the going concern of the company.

More Accounting & Auditing

It is the responsibility of the business owner or leadership team to determine whether the business is able to continue in the foreseeable future. If it’s determined that the business is stable, financial statements are prepared using the going concern basis of accounting.

  • If negligence is found, then the auditor might have a legal case against it.
  • If it appears the business will have to cease operations, the accountant might have to “write-down” the value of the business’s inventory or other assets, which reduces the overall value of the company.
  • If it’s determined that the business is stable, financial statements are prepared using the going concern basis of accounting.
  • If a company cannot obtain a loan or if banks or other financial institutions withdraw monetary support, it shows that lenders have low confidence in the company’s ability to repay the borrowed amount.
  • In the end, a client may be most interested in what the auditor’s report is going to look like.

The first question of course is, do you agree as an auditor that management has identified all the appropriate conditions and events that need to be considered? Have they extended that evaluation period out to the reasonable period of time? Remember, management’s evaluation is valid at the point Going Concern at which they make that evaluation based on known information. I should also just quickly point out that’s the standard issued by FASB for nongovernmental entities. This alert focuses on the considerations applicable to issuers who report their financial statements on the basis of U.S.

It will be critical for management to assess both the positive and negative impacts that climate-change has on a company’s operations and forecast cash flows. The key issue for the company is whether it will have sufficient liquidity to continue to meet its obligations as they fall due. It can determine how financial statements are prepared, influence the stock price of a publicly traded company and affect whether a business can be approved for a loan. Pertinent conditions and events giving rise to the assessment of substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time. Continuation of an entity as a going concern is presumed as the basis for financial reporting unless and until the entity’s liquidation becomes imminent. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. If and when an entity’s liquidation becomes imminent, financial statements are prepared under the liquidation basis of accounting (Financial Accounting Standards Board, 2014).

Use In Risk Management

Auditor reporting and transparency about the entity’s financial condition is information critical to our turbulent economy. Amid the economic turmoil related to the coronavirus pandemic, going concern is one of the topics that auditors are most frequently asking about in their contacts with the AICPA. The information in this article does not address audits performed in accordance with PCAOB standards. The auditor is required by the Securities and Exchange Commission to disclose in the financial statements of a publicly traded company whether going concern status is in doubt. This can protect investors from continuing to risk their money on a business that may not be viable for much longer.

In case the auditor decides to qualify their audit report, it may raise the issue of whether assets are already impaired, which may highlight the need to write down the value of the assets from their carrying value to liquidation value. However, a company can choose to justify their decisions and attempt to make the auditor believe that poor business operating conditions are only temporary. IAS 1 required management to assess whether their company is able to run for the foreseeable period or not. If the result of the assessment is found or management feels doubt about the stability of the entity, then management needs to disclose all of that significant importance in the financial statements so that users or readers could understand the situation in the company. The accountants of a company can decide what is appropriate to report in financial statements. Certain expenses and assets, such as insurance paid in advance, startup costs or tangible asset depreciation costs, may be deferred in financial reports to future accounting periods. However, if the principle does not hold true, then it is not possible to record prepaid or accrued expenses.

The standard requires the Financial Statements to properly disclose the basis of preparation of Financial Statements. If a company continues to experience substantial losses every year along with cash flow difficulties, it might be less viable in the future.

Another risk is that the bank might stop providing the overdraft facilities and will subsequently affect the entity’s operation. The seriousness of the going concern problem is depending on how likely the bank still continue providing an overdraft.

This question is asked mainly when we talk about the roles and responsibilities of management and auditor related to going concern of the company, and to answer this question, we should refer to the audit standard ISA 570. The National company is in serious financial trouble and cannot pay its obligations.

To this end, we ask you to send your thoughts and opinions on our recommendations to . The original deadline for submissions – 30 April 2021 – has been extended to 30 May 2021. When a company collapses, all stakeholders are affected, from employees to investors, and it eventually erodes the public’s trust in financial markets. Member firms of the KPMG network of independent firms are affiliated with KPMG International.

Despite this, some fund managers may be required to sell the stock to maintain an appropriate level of risk in their portfolios. A negative judgment may also result in the breach of bank loan covenants or lead a debt rating firm to lower the rating on the company’s debt, making the cost of existing debt increase and/or preventing the company from obtaining additional debt financing. They can help business review their internal risk management along with other internal controls. The auditor’s consideration of disclosure should include the possible effects of such conditions and events, and any mitigating factors, including management’s plans. So, should an auditor inquire about conditions and events that may affect the entity’s ability to continue as a going concern beyond management’s period of evaluation (i.e., one year from the date the financial statements are available to be issued or issued, as applicable)? And if substantial doubt has been alleviated by management’s plans, then management would disclose the conditions and events that gave rise to the substantial doubt as well as their plans for alleviating it, and in that case there would be no requirement to modify the standard auditor’s opinion. Although global pandemics were not included on the list of adverse conditions in either AS 2415 or Subtopic , the economic shock that COVID-19 has created will provide a basis for many companies and auditors to conduct a more searching going-concern analysis than usual in the months to come.

If substantial doubt does not exist, then going concern disclosures are not necessary. As you would expect, the answer to this question determines whether going concern disclosures are to be made and what should be included. Finally, these wouldn’t be official Embark musings unless we at least mentioned internal controls, right? As they pertain to going concern, we emphasize the fact that management still needs to consider internal controls and business processes around going concern evaluations. This is often the case when management has a debt covenant violation and wishes to obtain a waiver. For example, if a lender provided a waiver on past covenant violations, management might expect the same for a current violation and argue they intend to receive a waiver, just as they had in the past.

By doing so, the auditor is reasonably assured that the business will remain functional during the one-year period stipulated by GAAS. This makes it easy for a parent company to ensure that its subsidiaries are always classified as going concerns. If there’s significant evidence that a privately held business might not be viable under the going concern assumption, the auditor must disclose it in the audit report. Even if the business’s financials aren’t audited, an accountant who has concerns about the business’s viability should disclose those concerns to the business owner. Creditors often regard a subject to qualification as a separate reason for not granting a loan, a reason in addition to the circumstances creating the uncertainty that caused the qualification. This frequently puts the auditor in the position, in effect, of deciding whether a company is able to obtain the funds it needs to continue operating.

If the auditor concludes that the entity’s disclosures with respect to the entity’s ability to continue as a going concern for a reasonable period of time are inadequate, a departure from generally accepted accounting principles exists. Reporting guidance for such situations is provided in section 508, Reports on Audited Financial Statements. Before liquidation is deemed imminent, an entity may have uncertainties about its ability to continue as a going concern. A going concern is a business that is expected to continue to operate for the foreseeable future—which, for accounting purposes, is typically considered to be a period of at least twelve months from the date of the audit of its financial statements. A declaration that a company is a ‘going concern’ typically means that the business has the resources and ability to continue normal operations and meet all of its obligations and that there are no conditions that, when considered in aggregate, create substantial doubt about its ability to do so. The auditor’s conclusion as to whether he or she should include an explanatory paragraph in the audit report. If disclosures with respect to an entity’s ability to continue as a going concern are inadequate, the auditor also should document the conclusion as to whether to express a qualified or adverse opinion for the resultant departure from generally accepted accounting principles.