Management should reassess the availability of financing because it may not be easily replaced and the costs may be higher in the current circumstances. In effect, equity shareholders and other relevant parties can then make well-informed decisions on the best course of action to take with all material information on hand. The formal definition of the term “going concern” per GAAP / FASB can be found below. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. The information contained herein is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.
- US GAAP includes a two-step process that first determines whether substantial doubt about the company’s ability to continue as a going concern is raised.
- Given the significant effects of COVID-19, management may need to reassess the company’s access to financing sources; they may not be easily replaced and the costs may be higher in the current circumstances.
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- To perform walkthrough testing, the auditor must have a good understanding of the entity’s business processes, including its accounting and financial reporting processes, as well as its management and control environment.
- KPMG explains how an entity’s management performs a going concern assessment and makes appropriate disclosures.
- The administrator will assume control of the company upon being appointed and any decisions from this point onwards must be done with the interests of outstanding creditors in mind.
The bank have already indicated that they are shortly going to commence legal proceedings to force the company to cease trading and sell off its assets to generate funds to pay off some of the borrowings. An important point to emphasise at the outset is that candidates are strongly advised not to use the ‘scattergun’ approach when it comes to deciding on the audit opinion to be expressed within the auditor’s report. This is where a candidate explores all possible options rather than coming to a conclusion as to the auditor’s opinion, depending on the circumstances presented in the question. Many candidates fall into the trap of relying on ‘discussions with management/directors’ and ‘obtaining a written representation’. Candidates must appreciate that while discussion/inquiry is a valid audit procedure under ISA 500, Audit Evidence, such a procedure is always used in addition to other procedures – in other words, inquiry on its own will not generate sufficient appropriate audit evidence. Similarly ISA 580, Written Representations recognises that while written representations do provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal.
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External events that create economic uncertainty may have a significant impact on a company’s ability to continue as a going concern and might require robust assessment and entity-specific disclosures. Management typically develops plans to address going concern uncertainties – e.g. refinancing of debt, renegotiating breached covenants, and sale of assets to generate sufficient liquidity to continue to meet its obligations as they fall due. IFRS Standards do not prescribe how management should evaluate its plans to mitigate the effects of these events or conditions in the going concern assessment. Impacts from a fall and winter COVID-19 surge may bring further uncertainty to many companies. Management should continually evaluate the effects of COVID-19 on the company’s going concern assessment, including information obtained after the reporting date and up to the date the financial statements are authorized for issuance.
- Disclosures are required if events and circumstances raise substantial doubt about the entity’s ability to continue as a going concern.
- This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
- This is widely seen as the preferred route for shareholders and stakeholders alike.
- When assessing the market value of their business, owners establish what the business is worth based on similar businesses that have recently been sold.
- The threat of receiving a negative going concern opinion may motivate management to go “opinion shopping,” as was alluded to in the WorldCom and Enron business failures.
For example, if the company expects to lose a major customer in 15 months from the reporting date, it may be necessary to extend the look-forward period up to at least March 31, 20X2. US GAAP requires management’s going concern plans to meet certain conditions to be considered in the assessment. Management’s plans are ignored under Step 1, but considered under Step 2, to determine if they alleviate the substantial doubt raised in Step 1.
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Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. The reason the going concern assumption bears such importance in financial reporting is that it validates the use of historical cost accounting. The going concern assessment is inherently complex and judgmental and will be under heightened scrutiny for many companies this year due to COVID-19.
Disclosures of material uncertainties that may cast doubt on a company’s ability to continue as a going concern as well as significant judgments involved in close-call scenarios may be more frequent as a result of COVID-19, given the continued economic uncertainty. Management should critically assess the disclosure requirements of IAS 1 and consider drafting required disclosure language early in the financial reporting process. Management’s going concern assessment may be significantly affected by the current economic environment. For example, a company may have a profitable track record or prior success at refinancing. However, market conditions have changed as a result of COVID-19 – e.g. financing may be significantly more difficult and more costly to obtain now.
Impact of external events on the going concern assessment and disclosures
The auditor evaluates an entity’s ability to continue as a going concern for a period not less than one year following the date of the financial statements being audited (a longer period may be considered if the auditor believes such extended period to be relevant). If so, the auditor must draw attention to the uncertainty regarding the entity’s ability to continue as a going concern, in their auditor’s report. Separate standards and guidance have been issued by the Auditing Practices Board to address the work of auditors in relation to going concern. To meet these disclosure requirements, in our view, similar information to that in respect of material uncertainties may be relevant to the users’ understanding of the company’s financial statements, as appropriate. As mentioned earlier, it is not the auditor’s responsibility to determine whether, or not, an entity can prepare its financial statements using the going concern basis of accounting; this is the responsibility of management.
External events – e.g. a natural disaster, geopolitical unrest, climate effects or inflationary pressures – may cause economic conditions to deteriorate significantly and create economic uncertainty for many companies. Similarly, US GAAP financial statements are prepared on a going concern basis unless liquidation is imminent. Disclosures are required if events and circumstances raise substantial doubt about the entity’s ability to continue as a going concern.
This can protect investors from continuing to risk their money on a business that may not be viable for much longer. The going concern concept is a key assumption under generally accepted accounting principles, or GAAP. 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. In order to avoid the entity’s credit rating suffering any further decline, the directors have refused to make disclosures in the financial statements and have prepared the financial statements for the year ended 31 March 20X2 on the going concern basis. In times of economic uncertainty, going concern disclosures are more likely to be considered necessary. It is important that disclosures on going concern are clear and robust to meet users’ and regulators’ expectations.
It follows that when this is not the case, a detailed analysis will be necessary, which likely includes robust cash flow forecasts and a review of existing and forthcoming financial obligations. KPMG explains how an entity’s management performs a going concern assessment and makes appropriate disclosures. Q&As, interpretive guidance and illustrative examples include insights into how continued economic uncertainty may affect going concern assessments. This latest edition includes illustrative application of going concern’s most significant complexities.
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The old company now stripped of its valuable assets will be liquidated and will cease to exist as a legal entity going forwards. A financial auditor is hired by a business to evaluate whether its assessment of going concern is accurate. After conducting a thorough review (audit) of the business’s financials, the auditor will provide a report with their assessment.
