After peaking in the fiscal year 2008, the estimated total of going concerns for the fiscal year 2019 fell to the lowest amount in 20 years, according to a recent study by Audit Analytics. Unfortunately, the COVID-19 pandemic caused financial distress that could bring an end to this downward trend for the fiscal year 2020.

A fundamental assumption

The going concern assumption underlies all financial reporting under U.S. Generally Accepted Accounting Principles (GAAP). It presumes that a company will continue normal business operations into the future. When liquidation is imminent, the liquidation basis of accounting is used instead.

The final responsibilities to decide whether there’s a going concern issue and provide related footnote disclosures shifted from external auditors to the company’s management, under Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. Essentially, the going concern accounting standard requires management to decide whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern 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, to prevent auditors from holding financial statements for several months after year-end to see if the company survives).

Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:

  • recurring operating losses
  • working capital deficiencies
  • loan defaults
  • asset disposals
  • loss of a key franchise, customer, or supplier

Financial distress experienced during the pandemic could cause these types of adverse conditions or events, potentially leading to an uptick in going concern issues for the 2020 fiscal year — and possibly beyond.

After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs or dispose of an asset or business line.

A consistent approach

The Auditing Standards Board’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, is intended to promote consistency between the auditing standards and accounting guidance under U.S. GAAP. The current auditing standard requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. The standard also calls for auditors to conclude on the appropriateness of management’s assessment.

The evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level. So, the going concern auditing standard doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts, or items of a financial statement.

Auditors as gatekeepers

Management is responsible for making the going concern assessment. They must provide appropriate documentation to prove to external auditors that management’s assessment is reasonable and complete. Due to market volatility during the pandemic, your KraftCPAs auditors are likely to scrutinize this assessment even more closely in upcoming audits.

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