4 Things to Know About the New Going Concern Auditing Standard
The 2008 financial crisis demonstrated how quickly change can occur in the financial markets and in individual businesses, as established organizations like Lehman Brothers collapsed and other businesses, large and small, teetered on the verge of failure. The crisis was a reminder that adverse events can threaten the stability of any entity, or its ability to continue as a going concern. “Going concern” refers to the concept that users of financial statements can expect that the company will continue to operate in the near future unless conditions or events occur that may contradict that assumption. Even in a strong economy, companies can lose significant contracts, face cash flow problems or be in danger of missing loan payments.
In the past, guidance on going concern issues for private companies was only included in auditing standards, not in the accounting literature. The lack of accounting guidance often created tensions between CFOs, preparers of the financial statements and their auditors who were responsible for examining those financial statements when going concern issues arose. That problem has been addressed in recent years with the issuance of accounting standards by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB).
In light of the changes in those accounting standards, and in keeping with the Auditing Standards Board’s (ASB) goal of converging with existing international standards, the ASB has issued a new statement on auditing standards, SAS No. 132, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, to update guidance in this area. Here’s a review of some important facts CPAs should know about the standard.
The Public Interest Is Better Served
Under previous guidance, the rules regarding going concern disclosures were included in the auditing literature, not in the accounting rules. The auditor still has an important role to play in auditing going concern disclosures under the new standard, but the FASB standard now places the disclosure responsibility on management. Auditors will now review these disclosures along with other evidence as part of their audits.
There Are New Rules on Financial Support
To understand one important change under SAS No. 132, consider the hypothetical example of a successful manufacturer whose founder/CEO has recently decided to take on new debt to finance an ambitious expansion project. Since the financial crisis, banks have tightened their loan criteria and reduced the amount available under the company’s line of credit. As a result, the company pours more of its cash into the project, and the founder must pledge personal money to maintain cash flows. The company’s ability to continue as a going concern now depends on the founder’s commitment to supply that financing. SAS No. 132 contains new guidance addressing the auditor’s responsibilities when companies rely on financial support from third parties or an entity’s owner-manager.
In our example, the new rules would require the auditor to obtain sufficient, appropriate audit evidence about the owner-manager’s intent and ability to provide the necessary financial support. That evidence may be either by written evidence about their (or a third party’s) commitment or by getting that evidence directly from any third party. It could take the form of a support letter or a written representation. The standard’s application material provides illustrative wording of an acceptable third-party support letter.
The Standard Is Based on the FASB Definition of Substantial Doubt
Statement No. 132 is aligned with the recent FASB standard’s explicit definition of substantial doubt about an entity’s ability to continue as a going concern. The FASB standard established that there would be going concern issues if it is probable that the entity will not be able to meet its obligations within a year of when financial statements are issued.
Disclosures about substantial doubt are different than management use of the going concern basis of accounting. When an organization is facing significant financial distress, the use of the going concern basis of accounting may not be appropriate; that is, the liquidation basis may be required. Under SAS No. 132, the auditor is required to conclude whether management use of the going concern basis of accounting is appropriate.
This FASB standard applies to a complete set of financial statements prepared using GAAP. Some private companies prepare financial statements in accordance with special purpose frameworks, under which the going concern basis of accounting may not be relevant. However, companies still are required to make disclosures about substantial doubt.
There’s Been a Change in Timeframes
Under the previous auditing standards, the auditor was required to consider any going concern issues that might arise within a year after the financial statement date. Statement No. 132 revises that guidance in accordance with the FASB standard, which changes that timeframe to a year from the financial statements’ issuance. In other words, if the financial statements are dated December 31 but they aren’t issued until March 31, the auditing standards now require that the time horizon for considering going concern issues would now stretch to March 31 of the following year.
An Important Topic
The new auditing standard, which supersedes SAS No. 126, is effective for audits of financial statements for periods ending on or after Dec. 15, 2017, and reviews of interim financial information for interim periods beginning after fiscal years ending on or after Dec. 15, 2017. It should help auditors plan and conduct their audit since it brings consistency and greater clarity to the treatment of an important topic. For more information on the new going concern standard, visit the Audit and Attest page at aicpa.org where you will find a link to the standard, as well as a helpful explanatory memo. You may also be interested in participating in a webcast on March 28 that will provide an overview on the new standard.
Hiram Hasty, Senior Manager- Audit and Attest Standards, Association of International Certified Professional Accountants- Public Accounting.
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