Going Concern: How to Understand the Accounting and Auditing Standards

ASU 2014-15 and SAS 132 are shaking up going concern decisions

Are you preparing financial statements and wondering whether you need to include going concern disclosures? Or maybe you’re the auditor, and you’re wondering if a going concern paragraph should be added to the audit opinion. You’ve heard there are new requirements for both management and auditors, but you’re not sure what they are.

This article summarizes (in one place) the new going concern accounting and auditing standards.

going concern

Going Concern Standards

For many years the going concern standards were housed in the audit standards–thus, the need for FASB to issue accounting guidance (ASU 2014-15). It makes sense that FASB created going concern disclosure guidance. After all, disclosures are an accounting issue. 

Accounting Standard

ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, provides guidance in preparing financial statements. This standard was effective for years ending after December 15, 2016.

GASB Statement 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards, is the relevant going concern standard for governments. GASB 56 was issued in March 2009. (GASB 56 requires financial statement preparers to evaluate whether there is substantial doubt about a governmental entity’s ability to continue as a going concern for 12 months beyond the date of the financial statements. As you will see below, this timeframe is different from the one called for under ASU 2014-15. This post focuses on ASU 2014-15 and SAS 132.)

Meanwhile, the Auditing Standards Board issued their own going concern standard in February 2017: SAS 132.

Auditing Standard

Auditors will use SAS 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, to make going concern decisions. This SAS is effective for audits of financial statements for periods ending on or after December 15, 2017. SAS 132 amends SAS 126The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern.

So, let’s take a look at how to apply ASU 2014-15 and SAS 132.

Two Stages of Going Concern Decisions

In the past, the going concern decisions were made by auditors in a single step. Now, it is helpful to think of going concern decisions in two stages:

  1. Management decisions concerning the preparation of financial statements 
  2. Auditor decisions concerning the audit of the financial statements

First, we’ll consider management’s decisions.

Stage 1. Management Decisions

 

ASU 2014-15 provides guidance concerning management’s determination of whether there is substantial doubt regarding the entity’s ability to continue as a going concern.

Going Concern

What is Substantial Doubt?

So, how does FASB define substantial doubt? 

Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.

What is Probable?

So, how does management determine if “it is probable that the entity will be unable to meet obligations when due within one year”?

Probable means likely to occur

If for example, a company expects to miss a debt service payment in the coming year, then substantial doubt exists. This initial assessment is made without regard to management’s plans to alleviate going concern conditions. 

But what factors should management consider?

Factors to Consider

Management should consider the following factors when assessing going concern:

  • The reporting entity’s current financial condition, including the availability of liquid funds and access to credit
  • Obligations of the reporting entity due or new obligations anticipated within one year (regardless of whether they have been recognized in the financial statements)
  • The funds necessary to maintain operations considering the reporting entity’s current financial condition, obligations, and other expected cash flows
  • Other conditions or events that may affect the entity’s ability to meet its obligations

Moreover, management is to consider these factors for one year. But from what date?

Timeframe

The financial statement preparer (i.e., management or a party contracted by management) should assess going concern in light of one year from the date “the financial statements are issued or are available to be issued.”

So, if December 31, 2017, financial statements (for a nonpublic company) are available to be issued on March 15, 2017, the preparer looks forward one year from March 15, 2017. Then, the preparer asks, “Is it probable that the company will be unable to meet its obligations through March 15, 2018?” If yes, substantial doubt is present and disclosures are necessary. If no, then substantial doubt does not exist. As you would expect, the answer to this question determines whether going concern disclosures are to be made and what should be included.

Substantial Doubt Answer Determines Disclosures

If substantial doubt does not exist, then going concern disclosures are not necessary.

If substantial doubt exists, then the company needs to decide if management’s plans alleviate the going concern issue. This decision determines the disclosures to be made. The required disclosures are based upon whether:

  1. Management’s plans alleviate the going concern issue
  2. Management’s plans do not alleviate the going concern issue

1. What if Management’s Plans Alleviate the Going Concern Issue?

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):

  1. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
  2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  3. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern

Management’s plans should be considered only if is it probable that they will be effectively implemented. Also, it must be probable that management’s plans will be effective in alleviating substantial doubt.

So, if management’s plans are expected to work, does the company have to explicitly state that management’s plans will alleviate substantial doubt? No. 

When management’s plans alleviate substantial doubt, companies need not use the words going concern or substantial doubt in the disclosures. 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). Rather than using the term substantial doubt, consider describing conditions (e.g., cash flows are not sufficient to meet obligations) and management plans to alleviate substantial doubt.

Sample Note – Substantial Doubt Alleviated

An example note follows:

Note 2 – Company Conditions

The Company had losses of $4,525,123 in the year ending March 31, 2017. As of March 31, 2017, its accumulated deficit is $11,325,354. 

Management believes the Company’s present cash flows will not enable it to meet its obligations for twelve months from the date these financial statements are available to be issued. However, management is working to obtain new long-term financing. It is probable that management will obtain new sources of financing that will enable the Company to meet its obligations for the twelve-month period from the date the financial statements are available to be issued.

Notice this example does not use the words substantial doubt.

2. What if Management’s Plans Do Not Alleviate the Going Concern Issue?

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the notes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are available to be issued (or issued when applicable). Additionally, the entity should disclose information that enables users of the financial statements to understand all of the following:

  1. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
  2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  3. Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern

Sample Disclosure – Substantial Doubt Not Alleviated

An example disclosure follows:

Note 2 – Going Concern
 
The financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future.  The Company had losses of $1,232,555 in the current year. The Company has incurred accumulated losses of $2,891,727 as of March 31, 2017. Cash flows used in operations totaled $555,897 for the year ended March 31, 2017.
 
Management believes these conditions raise substantial doubt about the Company’s ability to continue as a going concern within the next twelve months from the date these financial statements are available to be issued. The ability to continue as a going concern is dependent upon profitable future operations, positive cash flows, and additional financing.
 
Management intends to finance operating costs over the next twelve months with existing cash on hand and loans from its directors. Management is also working to secure new bank financing. The Company’s ability to obtain the new financing is not known at this time.
 
Notice this note includes a statement that substantial doubt is present. Though management’s plans are disclosed, the probability of success is not provided.

ASU 2014-15 Summary

ASU 2014-15 focuses on management’s assessment regarding whether substantial doubt exists. If substantial doubt exists, then disclosures are required. Here’s a short video summarizing 2014-15:

Thus far, we’ve addressed the stage 1. management decisions. As you can see management’s considerations focus on disclosures. By contrast, auditors focus on the audit opinion. Now, let’s look at what auditors must do.

Stage 2. Auditor Decisions

 

SAS 132 provides guidance concerning the auditor’s consideration of an entity’s ability to continue as a going concern.

Going Concern

Objectives of the Auditor

SAS 132, paragraph 10, states the objectives of the auditor are as follows:

  • Obtain sufficient appropriate audit evidence regarding, and to conclude on, the appropriateness of management’s use of the going concern basis of accounting, when relevant, in the preparation of the financial statements
  • Conclude, based on the audit evidence obtained, whether substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time exists
  • Evaluate the possible financial statement effects, including the adequacy of disclosure regarding the entity’s ability to continue as a going concern for a reasonable period of time
  • Report in accordance with this SAS

These objectives can be summarized as follows:

  1. Conclude about whether the going concern basis of accounting is appropriate
  2. Determine whether substantial doubt is present
  3. Determine whether the going concern disclosures are adequate
  4. Issue an appropriate opinion 

In light of these objectives, certain audit procedures are necessary.

Risk Assessment Procedures

In the risk assessment phase of an audit, the auditor should consider whether conditions or events raise substantial doubt. In doing so, the auditor should examine any preliminary management evaluation of going concern. If such an evaluation was performed, the auditor should review it with management. If no evaluation has occurred, then the auditor should discuss with management the appropriateness of using the going concern basis of accounting (the liquidation basis of accounting is required by ASC 205-30 when the entity’s liquidation is imminent) and whether there are conditions or events that raise substantial doubt. 

The auditor is to consider conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. What is a reasonable period of time? It is the period of time required by the applicable financial reporting framework or, if no such requirement exists, within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable). The governmental accounting standards require an evaluation period of “12 months beyond the date of the financial statements.”

Auditors should consider negative financial trends or factors such as:

  • Working capital deficiencies
  • Negative cash flows from operating activities
  • Default on loans
  • A denial of trade credit from suppliers
  • Need to restructure debt
  • Need to dispose of assets
  • Work stoppages or other labor problems
  • Need to significantly revise operations
  • Legal problems
  • Loss of key customers or suppliers
  • Uninsured catastrophes
  • The need for new capital

The risk assessment procedures are a part of planning an audit. You may obtain new information as you perform the engagement.

Remaining Alert Throughout the Audit

The auditor should remain alert throughout the audit for conditions or events that raise substantial doubt. So, after the initial review of going concern issues in the planning stage, the auditor considers the impact of new information gained during the subsequent stages of the engagement.

Audit Procedures When Substantial Doubt is Present

If events or conditions do give rise to substantial doubt, then the audit procedures should include the following (SAS 132, paragraph 16.):

  1. Requesting management to make an evaluation when management has not yet performed an evaluation
  2. Evaluating management’s plans in relation to its going concern evaluation, with regard to whether it is probable that: 
    1. management’s plans can be effectively implemented and 
    2. the plans would mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time
  3. When the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in evaluating management’s plans: 
    1. evaluating the reliability of the underlying data generated to prepare the forecast and 
    2. determining whether there is adequate support for the assumptions underlying the forecast, which includes considering contradictory audit evidence
  4. Considering whether any additional facts or information have become available since the date on which management made its evaluation

Sometimes management’s plans to alleviate substantial doubt include financial support by third parties or owner-managers (usually referred to as supporting parties). 

Financial Support by Supporting Parties

When financial support is necessary to mitigate substantial doubt, the auditor should obtain audit evidence about the following:

  1. The intent of such supporting parties to provide the necessary financial support, including written evidence of such intent, and
  2. The ability of such supporting parties to provide the necessary financial support

If the evidence in a. is not obtained, then “management’s plans are insufficient to alleviate the determination that substantial doubt exists.”

Intent of Supporting Parties

The intent of supporting parties may be evidenced by either of the following:

  1. Obtaining from management written evidence of a commitment from the supporting party to provide or maintain the necessary financial support (sometimes called a “support letter”)
  2. Confirming directly with the supporting parties (confirmation may be needed if management only has oral evidence of such financial support)

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.

If the support comes from an owner-manager, then the written evidence can be a support letter or a written representation.

Support Letter

An example of a third party support letter (when the applicable reporting framework is FASB ASC) is as follows:

(Supporting party name) will, and has the ability to, fully support the operating, investing, and financing activities of (entity name) through at least one year and a day beyond [insert date] (the date the financial statements are issued or available for issuance, when applicable). 

You can specify a date in the support letter that is later than the expected date. That way if there is a delay, you may be able to avoid updating the letter.

The auditor should not only consider the intent of the supporting parties but the ability as well.

Ability of Supporting Parties

The ability of supporting parties to provide support can be evidenced by information such as:

  • Proof of past funding by the supporting party
  • Audited financial statements of the supporting party
  • Bank statements and valuations of assets held by a supporting party

After examining the intent and ability of supporting parties regarding the one-year period, you might identify potential going concern problems that will occur more than one year out.

Conditions and Events After the Reasonable Period of Time

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)? Yes.

Suppose an entity knows it will be unable to meet its November 15, 2018, debt balloon payment. The financial statements are available to be issued on June 15, 2017, so the reasonable period goes through June 15, 2018. But management knows it can’t make the balloon payment, and the bank has already advised that the loan will not be renewed. SAS 132 requires the auditor to inquire of management concerning their knowledge of such conditions or events. 

Why? Only to determine if any potential (additional) disclosures are needed. FASB only requires the evaluation for the year following the date the financial statements are issued (or available to be issued, as applicable). Events following this one year period have no bearing on the current year going concern decisions. Nevertheless, additional disclosures may be merited.

Thus far, the requirements to evaluate the use of the going concern basis of accounting and whether substantial doubt is present have been explained. Now, let’s see what the requirements are for:

  • Written representations from management
  • Communications with those charged with governance
  • Documentation

Written Representations When Substantial Doubt Exists

When substantial doubt exists, the auditor should request the following written representations from management:

  1. A description of management’s plans that are intended to mitigate substantial doubt and the probability that those plans can be effectively implemented
  2. That the financial statements disclose all the matters relevant to the entity’s ability to continue as a going concern including conditions and events and management’s plans

Communications with Those Charged with Governance

Remember that you may need to add additional language to your communication with those charged with governance.

When conditions and events raise substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, the auditor should communicate the following (unless those charged with governance manage the entity):

  1. Whether the conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time constitute substantial doubt
  2. The auditor’s consideration of management’s plans
  3. Whether management’s use of the going concern basis of accounting, when relevant, is appropriate in the preparation of the financial statements
  4. The adequacy of related disclosures in the financial statements
  5. The implications for the auditor’s report

Documentation Requirements

When substantial doubt exists before consideration of management’s plans, the auditor should document the following (SAS 132, paragraph 32.):

  1. 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.
  2. The elements of management’s plans that the auditor considered to be particularly significant to overcoming the conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern, if applicable.
  3. The audit procedures performed to evaluate the significant elements of management’s plans and evidence obtained, if applicable.
  4. The auditor’s conclusion regarding 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 should also 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 should also document the auditor’s conclusion regarding 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 and management’s plans that alleviated the substantial doubt.
  5. The auditor’s conclusion with respect to the effects on the auditor’s report.

Opinion – Emphasis of Matter Regarding Going Concern

If the auditor concludes that there is substantial doubt concerning the company’s ability to continue as a going concern, an emphasis of a matter paragraph should be added to the opinion.

An example of a going concern paragraph is as follows:

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency, and has stated that substantial doubt exists about the company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

The auditor should not use conditional language regarding the existence of substantial doubt about the entity’s ability to continue as a going concern. 

Opinion – Inadequate Going Concern Disclosures

Paragraph 26. 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.

SAS 132 Summary 

Now, let’s circle back to where we started and review the objectives of SAS 132.

The objectives are as follows:

  • Conclude about whether the going concern basis of accounting is appropriate
  • Determine whether substantial doubt is present
  • Determine whether the going concern disclosures are adequate
  • Issue an appropriate opinion 

Conclusion

As you can see ASU 2014-15 and SAS 132 are complex. So, make sure you are using the most recent updates to your disclosure checklists and audit forms and programs.

Finally, keep in mind that going concern is also relevant to compilation and review engagements.

How to Report Debt Covenant Violations

Violations may require debt to be shown as current

How does a debt covenant violation affect the presentation of debt on a balance sheet? In this article, I will tell you how to report debt covenant violations.

If a debt covenant violation occurs, the debt should be classified as current unless the lender provides a waiver for at least one year from the balance sheet date or the debtor is able to cure the violation subsequent to the balance sheet date but before the issuance date (or date available for issuance) of the financial statements.

Some loans provide for a grace period. If the violation is cured during the grace period, the debt–other than current maturities–will be reported as as long-term. Also if the cure has not already occurred but the company demonstrates it is probable that it (the cure) will occur within the grace period, then, again, the debt will be reported as long-term.

report debt covenant violations

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Report Debt Covenant Violation

The main consideration in classifying long-term debt is whether the amount is due or callable within one year of the balance sheet date. (By definition, a liability is current when due within one year of the balance sheet date.) If due or callable within the year subsequent to the period-end, the amount generally should be reported as current. (One exception: when it is probable the cure will occur within the grace period.) If a debt covenant violation is timely cured, then the debt is no longer callable and will, therefore, remain long-term. The same is true if the creditor provides a waiver that extends one year beyond the balance sheet date.

Note–Even minor violations of debt agreements may allow the creditor to call a loan.

FASB Codification Guidance

470-10-45 of the FASB Codification provides the following guidance:

Some long-term loans require compliance with quarterly or semiannual covenants that must be met on a quarterly or semiannual basis. If a covenant violation occurs that would otherwise give the lender the right to call the debt, a lender may waive its call right arising from the current violation for a period greater than one year while retaining future covenant requirements. Unless facts and circumstances indicate otherwise, the borrower shall classify the obligation as noncurrent, unless both of the following conditions exist:

a. A covenant violation that gives the lender the right to call the debt has occurred at the balance sheet date or would have occurred absent a loan modification.
b. It is probable that the borrower will not be able to cure the default (comply with the covenant) at measurement dates that are within the next 12 months.

Is Disclosure Required if a Waiver is Obtained?

If the company obtains a waiver for one year from the balance sheet date, must the financials disclose this fact (that a waiver was obtained)?

The AICPA answers this question–in Q&A section 3200 (paragraph 17)–with the following:

The authoritative literature applicable to nonpublic entities does not address disclosure of debt covenant violations existing at the balance-sheet date that have been waived by the creditor for a stated period of time. Nevertheless, disclosure of the existing violation(s) and the waiver period should be considered* for reasons of adequate disclosure. If the covenant violation resulted from nonpayment of principal or interest on the debt, inability to maintain required financial ratios, or other such financial covenants, that information may be vital to users of the financial statements even though the debt is not callable.

*Emphasis added by CPA-Scribo

Translation: It is wise to disclose the debt covenant violation and the existence of the waiver.

FASB’s Current Work on a New Standard

On January 10, 2017, the FASB issued the Exposure Draft, Debt (Topic 470): Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent). Click here for more information.

Additional Information About Auditing Debt

See my post about how to audit debt here.

Do Loan Guarantees Create Liabilities?

Sometimes loan guarantees create liabilities

Can a loan guarantees create liabilities that go on the balance sheet of the guarantor?

Yes.

Loan Guarantees Create Liabilities

Picture from AdobeStock.com.

Recording Loan Guarantees

FASB 5 (now ASC 450) has been with us for some time. It states that a company should record a contingent liability if two things occur:

  1. The liability is subject to estimation (you can calculate it)
  2. It is probable that the liability will be paid

ASC 450 addresses these contingent liabilities.

FIN 45 (now ASC 460) was issued in the early 2000s to clarify that some loan guarantees create liabilities–even when there is no loan default. ASC 460 deals with noncontingent liabilities. And it’s the noncontingent piece that confuses everyone (including me). So let’s first take a look at noncontingent liabilities.

Noncontingent Liability

ABC Co. guarantees a $2,000,000 loan of XYZ Co. (an unrelated entity); in exchange, XYZ agrees to pay a fee of $50,000.

Should ABC Co. record a liability for the guarantee? Yes.

What’s the entry?

                                                         Dr.                 Cr.

Accounts Receivable                $50,000

Guarantee Liability                                           $50,000

The standard allows the guarantor to use the guarantee fee as a practical expedient to valuing the loan guarantee.

What if there is no guarantee fee? For instance, let’s say ABC Co. guarantees a loan for Sidewalk Safety Nonprofit, Inc. This guarantee is provided to the nonprofit free of charge. How would ABC Co. record this guarantee?

First ABC Co. would need to determine the value of the guarantee. If Sidewalk Safety’s interest rate is 8% without the guarantee, but now it’s 4%, then you can compute the differential using present value calculations. Let’s say the result is $40,000, what is the entry?

                                                                       Dr.                Cr.

Guarantee Expense (Contribution)      $40,000

Guarantee Liability                                                       $40,000

Guarantee of Related Party Debt

What if the loan guarantee is for an entity owned by the same parties? If the guarantee is on the debt of a related entity under common control, ASC 460-10-25-1 exempts the guarantor from the requirement to record the guarantee liability.

Next, we’ll see how to relieve the guarantee liability.

Guarantee Liability – In Subsequent Periods

After inception, the fair value liability (for both examples above) is taken to income as the guarantor is released from risk; the liability is to be adjusted to fair value at the period end.

ASC 460 does not provide detailed guidance as to how the guarantor’s initial liability should be measured after its initial recognition. Depending on the nature of the guarantee, the guarantor’s release from risk is recognized with an increase to earnings using one of three methods:

  1. Systematic and rational
  2. Deferring until expiration or settlement of the guarantee
  3. Remeasurement at fair value (for guarantees accounted for as derivatives)

You now know how to account for the noncontingent liability, but what if the guaranteed party defaults on the loan. Now the guarantor needs to record the loan as a liability.

Contingent Liability

For example, what if Sidewalk Safety defaults on the loan? Then ABC Co. needs to book a liability for the remaining debt. Sidewalk Safety’s default triggers ASC 450.

This is the contingent piece of the equation (for which no amount is typically recorded at the inception of the guarantee). Upon Sidewalk Safety’s default, the debt amount is subject to estimation and payment is probable. ABC Co. is on the hook for the remaining debt.

Debt Issuance Costs Have a New Parking Place

If ASU 2015-03 has not already been adopted, do so for December 31, 2016 year-ends

Debt issuance costs have a new parking place. For some time now, such costs were booked as a deferred charge (an asset). Now, debt issuance cost will be netted with the related debt

This change is required by Accounting Standards Update No. 2015-03, Interest – Imputation of Interest, Simplifying the Presentation of Debt Issuance Costs (Subtopic 835-30).

If you have not already done so, you need to adopt this standard for years ending December 31, 2016. This is a change in accounting principle.

debt issuance costs have a new parking place

Debt Issuance Costs

Accounting for Debt Issuance Costs

ASU 2015-03 (ASC 835-30) states the following (bold emphasis mine):

To simplify the presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.

Solve Accounting Problems Quickly: The Crystal Ball

You already have a crystal ball (but you may not know it)

Do you ever need to solve accounting problems quickly?

I often hear the words, “Hey Charles, I’ve got a quick question,” and they launch into their issue, hopeful I can look into my crystal ball and give them an answer. As it turns out, I do have one. I keep it on my desktop. You probably have one too.

Most CPAs, when confronted with an accounting Gordian Knot, begin their quest to cut through the problem with their mighty sword–the GAAP Guide. Ah, an excellent choice for sure, but is it the best place to start? Or how about the granddaddy of them all? The FASB Codification. Another fine choice, but it’s an 800-pound gorilla. So where’s the best place to start? The crystal ball.

solve accounting problems

And what is the crystal ball? It’s your disclosure checklist.

You say, “but it’s just a laundry list of accounting requirements.” Yes, but it’s a great pointer (to answers).

To solve accounting problems quickly, do a word search in your disclosure checklist. My checklist is in Word, so I use the find feature (click control, find) to locate a keyword. Try to use a unique word where possible–such as noninterest or contingent. You may have to click next a few times to locate the relevant text. Once you find the relevant text, the pathway to your solution lies before you: the checklist provides you with the applicable FASB Codification ASC section (e.g., 850-10-50-5). You can key the number in the FASB Codification or your research library to find your answer.

Now you can provide a quick answer to that difficult question (and look like a genius). When your peers ask, “How did you find the answer so quickly?” Tell them, “My crystal ball.”

How to Account for Cash Overdrafts

Alternative presentations for negative cash balances

How should you account for cash overdrafts (also called negative cash balances) on a balance sheet and in a cash flow statement?

It is year-end and your audit client has three bank accounts at the same bank. Two of the accounts have positive balances (the first with $50,000 and the second with $200,000). The third account has a negative cash balance of $400,000. Since a net overdraft of $150,000 exists, how should we present cash in the financial statements?

Cash overdrafts

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Balance Sheet

In the balance sheet, show the negative cash balance as Cash Overdraft in the current liabilities. Or you can also include the amount in accounts payable.

If you are netting the three bank accounts, consider using the Cash Overdraft option. If you bury the overdraft in accounts payable, the financial statement reader may think, “there is a mistake, where is cash?” Using Cash Overdraft communicates more clearly. (The right of offset must exist in order to net bank accounts. The right of offset commonly exists for multiple bank accounts with one bank.)

Some companies have multiple bank accounts with multiple banking institutions. In such cases, the net balance of one bank might be positive and the net balance of the second bank might be negative. Then the company would reflect the positive balance as cash and the negative cash balance (of the second bank) as an overdraft.  

Suppose a company has bank accounts with two different banks and the net balance of the first bank is $1,350,000 and the net balance of the second bank is an overdraft of $5,000. Then show cash as one amount on the balance sheet ($1,345,000). The $5,000 overdraft is not material.

Cash Flow Statement

Some companies do not include cash overdrafts in the definition of cash; instead, they include the overdraft in accounts payable. Consequently, the company treats the overdraft as an operating activity (change in accounts payable). So, the company includes the overdraft as a change in a liability in the operating section of the cash flow statement. (Some accountants treat overdrafts as a financing activity, but overdrafts clear quickly. Therefore, an operating activity classification is more appropriate.)

Alternatively, include the overdraft in the definition of cash (rather than in accounts payable). In doing so, you combine the cash overdraft with other cash (that with positive balances) in the cash flow statement. The beginning and ending cash–in the cash flow statement–should include cash overdrafts.

FASB ASC 230-10-45-4 requires that the total amounts of cash and cash equivalents in the cash flow statement agree with similarly titled line items or subtotals in the balance sheet. If a cash overdraft is included in the definition of cash, the cash captions in the statement of cash flows should be revised accordingly (e.g., Cash (Cash Overdraft) at end of year).

If the balance sheet contains a positive cash balance in assets and a cash overdraft in liabilities, provide a reconciliation at the bottom of the cash flow statement (or in a disclosure). In the reconciliation, show the composition of cash (cash overdraft)–one line titled Cash, one line titled Cash Overdraft, and a total line titled Total Cash (Cash Overdraft)

One Other Consideration

If checks are created but not released by year-end, reverse the payment. Merely printing checks does not relieve payables. Payables are relieved when payment is made (checks are printed and mailed, or electronic payments are processed).

Restricted Cash

FASB recently issued a new standard dealing with how restricted cash is to be reported in the cash flow statement. Click here for more information.

Balance Sheet Classification of Deferred Taxes: Noncurrent

Deferred tax classification is changing

The balance sheet classification of deferred taxes is changing. This article tells you how.

Balance Sheet Classification of Deferred Taxes

On November 20, 2015, the FASB issued Accounting Standards Update (ASU) 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.

Balance sheet classification of deferred taxes

Current U.S. GAAP requires entities to separate deferred income tax liabilities and assets into current and noncurrent on a classified statement of financial position. ASU 2015-17 directs that deferred income tax liabilities and assets be shown as noncurrent (alone).

Current GAAP requires the netting of current deferred tax assets and liabilities as one number and the netting of noncurrent tax assets and liabilities as a second number–provided they relate to one taxing jurisdiction (federal taxes are not netted with state taxes, for example). The new standard will require the netting to be presented as a noncurrent number.

Effective Dates

Effective dates are as follows:

  • Public business entities – Fiscal years beginning after December 15, 2016, including interim periods within those fiscal years
  • All other entities – Fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018
  • Early application is permitted

Application

The standards can be applied as follows:

  • Prospectively to all deferred tax liabilities and assets, or
  • Retrospectively to all periods presented

If prospectively applied, then disclose the change in accounting principle and the fact that prior periods were not adjusted.

If retrospectively applied, then disclose the change in accounting principle and quantitative effects of the accounting change on prior periods.

The full standard can be seen here.

GASB 63 and 65 (Deferred Outflows and Deferred Inflows) – A Summary

GASB 63 and 65 provide guidance regarding deferred outflows and inflows in governments. This article provides an overview of those standards.

  • Statement No. 63 – Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position
  • Statement No. 65 – Items Previously Reported as Assets and Liabilities

What are the effective dates for Statements 63 and 65?

  • GASBS 63 is effective for periods beginning after December 15, 2011; earlier application encouraged
  • GASBS 65 is effective for periods beginning after December 15, 2012; earlier application encouraged

It is best to implement GASBS 63 and 65 at the same time.

What is the purpose of these changes?

To put it succinctly, GASB is using one of its conceptual statements (specifically Concepts Statement 4) to make revisions to reporting requirements (to include deferred outflows and deferred inflows).

Prior to GASBS 63 and 65, debit balances were reported on the statement of net position (balance sheet) as assets; similarly, all non-equity credits were reported as liabilities. The new standards add deferred outflows and deferred inflows to the mix.

All debit balances in the statement of net position will be reported as:

  • Assets
  • Deferred Outflows

Assets represent present service capacity to the government; deferred outflows (e.g., prepaid bond insurance) represent the consumption of net position applicable to future reporting periods.

Liabilities represent amounts to be paid; however, some amounts previously reported as liabilities (e.g., deferred property taxes) involve no future payment. Consequently, with the implementation of GASB 63, all non-equity credits in the statement of net position will be reported as:

  • Liabilities
  • Deferred Inflows

The difference in liabilities and deferred inflows is primarily resources that are going out and resources that are coming in. Liabilities normally represent a future surrender of resources; deferred inflows do not.

What are the main points of GASB 63?

This statement distinguishes assets from deferred outflows of resources and liabilities from deferred inflows of resources.

Additionally, many of your financial statement titles (e.g., Statement of Net Position), categories (e.g., Assets and Deferred Outflows of Resources), and notes will change. Net Assets will now be labeled Net Position.

The five elements of the statement of net position are:

  1. Assets
  2. Deferred Outflows of Resources
  3. Liabilities
  4. Deferred Inflows of Resources
  5. Net Position

The three categories of net position are:

  1. Net Investment in Capital Assets
  2. Restricted
  3. Unrestricted

Note – The requirement to change to a statement of net position (rather than a statement of net assets) – a GASBS 63 change – occurs one year earlier than the requirements of GASBS 65; you are required to change the term net assets to net position even though you may not have any deferred outflows or inflows until GASBS 65 is implemented – possibly a year later. Again it is easier to simply implement both GASBS 63 and 65 at the same time (both can be early adopted).

What are the main points of GASB 65?

  • It identifies the specific items to be categorized as deferred inflows and deferred outflows.
  • It clarifies the effect of deferred inflows and deferred outflows on the major fund determination.
  • It limits the use of the term deferred in financial statements.

What are some examples of specific items to be categorized as deferred inflows and deferred outflows?

  • The gain or loss from current or advance refundings of debt (the gain or loss will no longer be netted with the related debt but will be shown separately as a deferred outflow or a deferred inflow)
  • Prepaid insurance related to the issuance of debt
  • Property taxes received or accrued prior to the period in which they will be used

How should debt issuance costs be treated?

Debt issuance costs should be expensed when incurred. GASB concluded that debt issuance costs do not relate to future periods, and, therefore, should be expensed.

If your government has debt issuance costs (recorded as assets), you will need to remove them as you implement these standards (using a prior period adjustment).

How should cash advances related to expenditure-driven grants be recorded?

Cash advances from expenditure-driven grants should be recorded as unearned revenue (a liability). The key eligibility requirement for an expenditure-driven grant is the use of funds (which does not occur until funds are spent). Any grant funds received prior to meeting eligibility requirements will be shown as a liability. It is improper to use the word deferred for this line item; for example, deferred revenue is not appropriate. The more appropriate title is unearned revenue.

How do these standards affect the determination of major funds?

Assets should be combined with deferred outflows of resources and liabilities should be combined with deferred inflows of resources for purposes of determining which elements meet the criteria for major fund determination.