What are the current audit requirements for going concern issues?
Here are the two main points to remember:
- If substantial doubt about continued existence is present, the auditor has several issues to address including an addition to the auditor’s report and additional communications in the representation and governance letters.
- FASB has proposed a standard that, if passed, will require certain going concern disclosures; at present, U.S. GAAP provides no guidance about going concern disclosures.
SAS 126, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, was effective for years ending on or after December 15, 2012, and is the most recent audit guidance. Based on the standard, the auditor should evaluate and conclude, based on audit evidence obtained, whether substantial doubt exists about the reporting entity’s ability to continue as a going concern for a reasonable period of time.
How does the standard define a “reasonable period of time”?
A period of time not to exceed one year beyond the date of the financial statements being audited.
If substantial doubt exists, what are the considerations for the audit?
- Additional auditor’s report language
- Additional disclosures
- Additional representation letter language
- Additional communications to those charged with governance
- Additional work paper documentation
1. Additional Auditor’s Report Language
If the auditor concludes that substantial doubt exists, an emphasis-of-matter paragraph should be added to the auditor’s report such as:
Emphasis of Matter Regarding Going Concern
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect this matter.
The words “substantial doubt” and “going concern” must be used in the paragraph, and conditional language should not be used in addressing the “substantial doubt” conclusion.
2. Additional Disclosures
Consider whether sufficient disclosure has been made about the condition of the company and the plans of management.
The Financial Accounting Standards Board is presently reviewing a proposed standard (ASU 2013-300) that would require certain going concern disclosures.
U.S. GAAP presently provides no going concern disclosure guidance. (Perform a word search of a disclosure checklist and you will see no FASB references for going concern issues; all going concern disclosures are the result of auditing standards.)
FASB updated its Going Concern project information on April 1, 2014; the website says the Board is pursuing an approach that would “require disclosures when there is substantial doubt similar to disclosures provided today under existing auditing standards.” The website goes on to say, “the assessment period for substantial doubt would be one year from the date the financial statements are issued (or, for nonpublic entities, the date financial statements are available for issuance).” Note that this assessment period is different from the one required by SAS 126 (i.e., a period of time not to exceed one year beyond the date of the financial statements); remember, however, the FASB standard is still subject to deliberation and may change.
3. Additional Representation Letter Language
Written representations should be obtained from management regarding:
- The plans that are intended to mitigate the adverse effects of conditions or events that indicate there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time and the likelihood that those plans can be effectively implemented, and
- Whether the financial statements disclose all the matters of which management is aware that are relevant to the entity’s ability to continue as a going concern, including principal conditions or events and management’s plans
4. Additional Communications to Those Charged with Governance
The following should be included in the auditor’s communication to those charged with governance:
- The nature of the conditions or events identified
- The possible effect on the financial statements and the adequacy of related disclosures in the financial statements
- The effects on the auditor’s report
5. Additional Work Paper Documentation
The auditor should document the following:
- The conditions or events that led the auditor to believe that there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time.
- The elements of management’s plans that the auditor considered to be particularly significant to overcoming the adverse effects of the conditions or events.
- The audit procedures performed to evaluate the significant elements of management’s plans and evidence obtained.
- The auditor’s conclusion as to whether substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time remains or is alleviated. If substantial doubt remains, the auditor also should document the possible effects of the conditions or events on the financial statements and the adequacy of the related disclosures. If substantial doubt is alleviated, the auditor also should document the auditor’s conclusion as to the need for, and, if applicable, the adequacy of, disclosure of the principal conditions or events that initially caused the auditor to believe there was substantial doubt.
- The auditor’s conclusion with respect to the effects on the auditor’s report.
Going Concern in Compilations and Reviews
Though this post is about going concern issues in audits, let me briefly say that an emphasis-of-matter paragraph pertaining to going concern can be added to compilation or review reports but is not required. See my previous post.
FASB Guidance Issued Subsequent to This Post
In August 2014, FASB issued its new going concern guidance; click here to see the related post.