Presentation of the PCAOB’s
Investor Advisory Group
Working Group on Going Concern
March 28, 2012
1
Going Concern
Agenda
1.
2.
3.
4.
Overview – Anniversary of Sarbanes-Oxley Act
History
Current – Survey
Recommendations
Working Group Members
Pete Nachtwey, Chief Financial Officer, Legg Mason
Damon Silvers, Director of Policy and Special Counsel
Anne Simpson, Senior Portfolio Manager, Investment and Director of Corporate Governance, CalPERS
Lynn E. Turner, Director, LitiNomics and former SEC Chief Accountant
2
Going Concern
10 Year Anniversary Sarbanes Oxley
The Market Before and After
3
Going Concern
Ten Year Anniversary of Sarbanes-Oxley
What did we gain?
•
•
•
•
•
Public Company Accounting Oversight Board
Regulatory oversight of Auditors
Section 404 Evaluation of Internal Controls
CEO/CFO Certification of Internal Controls
Improved Financial Reporting
4
Going Concern
History
Initiatives Over the Years
Going Concern Definition
Top 10 Bankruptcies, Top 10 Issuers – TARP
Going Concern Opinions
Financial Accounting Standards Board – Current
Requirements
• Enforcement
•
•
•
•
•
5
Going Concern
History – How we got to where we are…
•
•
•
•
•
Cohen Commission
New Standard proposed
CFA weighs in
New SAS 59, Effective 1989
SOP 94-6
– Exposure draft “watered down”
• O’Malley Panel – August 2000
– FASB recommendations
– SEC urges FASB to act -
• FASB Project
– Proposal October, 2008
– Project Revised to disclosures only in 2012
6
Going Concern
Top Ten U.S. Bankruptcies 2001-2011
Top Ten Bankruptcies
Issuers by Market Cap Sector
Lehman Brothers Holding
($639B)
Financial
Bankruptcy Filing
Going
Date
ICFR Effective Concern
9/15/2008
Y
Telecom
7/21/2002
N/A - though
designated Max
risk 1999-2001
Industrials
6/1/2009
N
WorldCom, Inc.
($103.9B)
General Motors
($91.05B)
N
Opinion Signature
Date After Bankruptcy ICFR
Filing
Effective
N/A
N/A
N
Y
2009
Going
Concern
Signing
Auditor (Pre
and Post
Opinions)
Auditor
Since
N/A
E&Y
1990
N/A
N
2004
N/A
Arthur
Anderson/
KPMG
4/7/2010
N
2009
N
D&T
1918
N
12/10/2009
N
2010
N
PWC
2001
1989 /
engaged
May 2002
CIT Group ($80.45B)
Financial
11/1/2009
N
2004
Enron ($65.50B)
Energy
12/2/2001
N/A
N
N/A
N/A
N/A
Arthur
Anderson
1946
12/17/2002
N/A
N
2003
Y
Y
2003
PWC
1985
10/31/2011
Y
N
N/A
N/A
N/A
PWC
2007
4/30/2009
Y
N
04/30/2010
Y
N
D&T*
1947*
5/1/2009
Y
Y
2008
N/A
N/A
N/A
Y
2000 - 2003
Conseco Inc.($61.4B)
MF Global Holdings
($41.05B)
Chrysler ($39.30B)
Thornburg
Mortgage($36.5B)
Financial/
Insurance
Financial
Derivatives
Broker
Auto
Residential
Mortgage
Lending
Pacific Gas and Electric
($36.15B)
Utility
4/6/2001
3/1/2002
Y
N/A
KPMG
Y
2001,2002,
2003
D&T
2006
7
1999
Going Concern
Top Ten U.S.Issuers Receiving TARP Funds
Top Ten Issuers
Receiving TARP
Funds
Total
Disbursed First Date of TARP
($M)2
Disbursement
ICFR Effective
Going
Concern
Opinion
Signature
Date After
TARP
Disbursement ICFR Effective
Going Concern
Signing
Auditor
(Pre and
Post
Auditor
Opinions) Since
AIG4
69,835
9/16/2008
N
N
3/2/2009
Y
N
PwC
1980
General Motors5
50,745
12/29/2008
N
N
3/4/2009
N
Y
D&T
1918
Bank of America
45,000
10/28/2008
Y
N
2/25/2009
Y
N
PwC
1984
Citigroup
45,000
10/28/2008
Y
N
2/27/2009
Y
N
KPMG
1969
JPMorgan Chase
25,000
10/28/2008
Y
N
2/27/2009
Y
N
PwC
1965
Wells Fargo
25,000
10/28/2008
Y
N
2/23/2009
Y
N
KPMG
1931
Goldman Sachs
10,000
10/28/2008
Y
N
1/22/2009
Y
N
PwC
1926
Morgan Stanley
PNC Financial
Services
10,000
10/28/2008
Y
N
1/28/2009
Y
N
D&T
1997
7,579
12/31/2008
Y
N
3/2/2009
Y
N
PwC
2006
6,599
11/14/2008
Y
N
2/23/2009
Y
N
E&Y
2003
U.S. Bancorp
8
Going Concern
Going Concerns Per Year
Percentage of Going Concerns
100%
90%
% of Auditor Opinions with Going Concern Uncertainty
80%
70%
60%
50%
40%
30%
20%
16.4%
2000
15.9%
16.4%
2001
2002
14.4%
15.2%
16.1%
17.4%
2003
2004
2005
2006
19.9%
21.0%
19.4%
18.6%
2007
2008
2009
2010
10%
0%
Fiscal Year
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Going Concerns
2795
2998
2817
2552
2554
2709
2864
3300
3328
2994
2875
16997
18819
17191
17766
16794
16784
16462
16610
15848
15395
15503
16.44%
15.93%
16.39%
14.36%
15.21%
16.14%
17.40%
19.87%
21.00%
19.45%
18.54%
Total Auditor Opinions
% of All Opinions
NOTE – The majority of Going Concerns were issued for non-accelerated filers, i.e. 2010 -with only 46 for large accelerated filers,
or < 3%, Audit Analytics, "Going Concern Overview”, July 2011
9
Going Concern
Going Concern Percentages by Filer Status
Non-Accelerated Filers
Fiscal
Year
Large
Accelerated
Acc. Filers
Filers
Total
Small Reporting Company (subset)
All
Going
Concerns
Total
Auditor
Opinions
Percentage
Going
Concerns
Total
Auditor
Opinions
Percentage
Going
Concerns
Total
Auditor
Opinions
Percentage
Going
Concerns
Total
Auditor
Opinions
Percentage
Other (subset)
Going
Concerns
Total
Auditor
Opinions
Percentage
Going
Concerns
Total
Auditor
Opinions
Percentage
10 Partial
3
1657
0.18%
43
1739
2.47%
2590
11347
22.83%
2008
4019
49.96%
31
153
20.26%
2636
14743
17.88%
2009
7
1725
0.41%
67
1935
3.46%
2920
11735
24.88%
2291
4312
53.13%
65
181
35.91%
2994
15395
19.45%
2008
23
1951
1.18%
144
2175
6.62%
3161
11722
26.97%
1915
3675
52.11%
499
790
63.16%
3328
15848
21.00%
2007
7
2038
0.34%
85
2237
3.80%
3208
12335
26.01%
346
1055
32.80%
1820
2950
61.69%
3300
16610
19.87%
2006
4
1983
0.20%
77
2287
3.37%
2783
12192
22.83%
19
23
82.61%
1735
3071
56.50%
2864
16462
17.40%
2005
2
1326
0.15%
61
2760
2.21%
2646
12698
20.84%
12
14
85.71%
934
1946
48.00%
2709
16784
16.14%
2004
1
6
16.67%
56
3673
1.52%
2497
13115
19.04%
8
10
80.00%
456
1226
37.19%
2554
16794
15.21%
2003
0
1
0.00%
40
3492
1.15%
2512
14273
17.60%
7
9
77.78%
1280
2760
46.38%
2552
17766
14.36%
2002
0
1
0.00%
49
2473
1.98%
2768
14717
18.81%
2
6
33.33%
1393
3297
42.25%
2817
17191
16.39%
10
Going Concern
Current Accounting Standards
• International Accounting Standards – IAS 1 Management
shall make an assessment of an entity’s ability to continue
as a going concern. Prepare financial statements on a
going concern basis unless intend to liquidate or cease
trading or no realistic alternative but to do so. Significant
doubt on ability to continue as a going concern.
• Financial Accounting Standards Board - Currently no
guidance in GAAP about going concern and/or the point in
time at which an entity ceases to be a going concern
11
Going Concern
FASB – Current requirements
• FASB Statement No 107 – Requires disclosures about
Concentration of Credit Risk
• SOP-94-6-1 Requires disclosures if the Concentration
makes the enterprise vulnerable to the risk of a near-term
severe impact
– Since hurdle was so high did not see disclosures
– Risk and Uncertainties existing
•
•
•
•
Nature of Operations
Use of estimates in the preparation of financial statement
Certain significant estimates
Current vulnerability due to certain concentrations
12
Going Concern
Auditing Standards and Guidance
• PCAOB Auditing Standards – GAAS AU 341
• International Auditing and Assurance Standards – ISA 570
• European Commission – “Impact Assessment – Amending
Directive 2006/43/EC on statutory audits of annual
accounts and consolidated accounts”
• Institute of Chartered Accountants in England & Wales –
“Guidance for Directors of UK Companies 2009”
• American Institute of Certified Public Accountants – SAS 59
Redrafting
13
Going Concern
Enforcement
• Investors surprised by demise of companies during
financial crisis without warnings or red flags
• Lack of going concern opinions
• Lack of disclosure of enforcement actions – so far
• Standards are only worthwhile when they are followed and
enforced
14
Going Concern
Going Concern Survey
• Respondents included investors, some of whom were also
members of:
–
–
–
–
–
–
–
Council of Institutional Investors (CII)
Chartered Financial Analyst (CFA)
International Corporate Governance Network (ICGN)
Asian Corporate Governance Network (ACGA)
Global Peer Group ESG Exchange
Global Investors Governance Network (GIGN)
40 respondents to survey
15
Going Concern
Is the Concept Going Concern Important?
5.00% 2.50% 0.00%
27.50%
65.00%
Yes, very important
Somewhat
Very little
No, not important at all
Not sure
16
Going Concern
Should There Be a Change in the Term Going
Concern?
37.5%
40%
35%
27.5%
30%
30.0%
25%
17.5%
20%
15%
15.0%
10%
5%
0%
Definition
Triggers
Responsibility
No need to
change
Not sure
17
Going Concern
When Should a Company Be Identified As a
Going Concern?
10.0%
17.5%
22.5%
50.0%
There is "substantial
doubt" (80+%)
More likely than not (51%
chance)
Reasonably possible
(<51%)
Not sure
18
Going Concern
Should the Assessment be Based on a Time
Period Assessment?
Limited to the next 12 months
2.5% 5.0% 5.0%
27.5%
60.0%
Limited to next 12 months but
also considered foreseeable
events
The foreseeable future (1-3
years)
Other
Not sure
19
Going Concern
Whose Responsibility to Report to Investors on
Going Concern?
90%
77.5%
80%
67.5%
70%
60%
52.5%
50%
40%
30%
17.5%
20%
10%
2.5%
0%
Management
Auditors
Audit Committee
PCAOB - SEC
Not sure
20
Going Concern
What Disclosures Should be Provided to
Investors?
100%
90%
92.5%
85.0%
80%
67.5%
70%
60%
52.5%
57.5%
55.0%
57.5%
55.0%
47.5%
50%
40%
30%
20%
10%
0%
Reasonably Expected courses New borrowings Raising of new
detailed
of action that bear
capital
discussion of the on fin flexibility
company's ability
to generate
sufficient cash
Liquidating of
assets
Reducing costs
Reducing
dividends
Reducing levels
of services or
products
Filing for
bankruptcy
21
Going Concern
How Should This Information be Disclosed?
80%
67.5%
70%
60%
60.0%
50.0%
50%
40%
30%
20%
10%
2.5%
0%
An unaudited MD&A
Footnotes of financials
Included in auditor's
report
Other
22
Going Concern
Recommendations Disclosures - FASB
• Strengthen Going Concern Definition
• Require Management Disclosure – When aware of conditions
and events that is reasonably foreseeable that an entity may not
meet its obligations:
1.
2.
3.
4.
5.
6.
If reasonably estimable – pertinent conditions and events giving rise to the
assessment, including when event is anticipated to occur.
Possible effects of conditions and events.
Possible discontinuance of operations.
Management’s evaluation of the significance of conditions and events that
bear on financial stability and any mitigating factors.
Whether plans to mitigate events can be effectively implemented and the
likelihood.
Recoverability or classification of recorded asset amounts or the amounts of
classification of liabilities.
23
Going Concern
Current Issues with Auditing Standards - AU 341
• Lack of specific objectives auditor should achieve
• Auditor is not required to design their audit specifically to
look for evidence with respect to Going Concern
• No requirement for auditor to communicate with audit
committee
• Auditor not required to consider public domain information
that is contrary to evidence management has presented.
24
Going Concern
Current Issues with Auditing Standards Cont’d.
• No requirement for auditor to gain understanding and
evidence of management’s key assumptions in their plans
for mitigating the risks associated with the business that
may result in it being more likely than not it will fail.
• Auditor not required to conclude as to whether
management’s key assumptions provide a reasonable
basis for management’s conclusion.
25
Going Concern
Recommendations – Audit Standards - PCAOB
• Refine Auditing Standards
– Include basic objectives the PCAOB expects auditors to achieve
– Auditors should be required to design the audit to obtain evidence
with respect to Going Concern
– Auditors should be required to consider evidence available to
them in the public
– Auditors should be required to understand the plan and its key
assumptions, check for consistency of assumptions and data,
recognize key omissions, understand factors specific to the
industry, and see past historical trends of the company
26
Going Concern
Recommendations – PCAOB
• Refine Auditing Standards
– Auditors should be required to communicate to the audit
committee how they reached their conclusion on going concern.
• Disclosures
– Communicate to the audit committee whether or not they have
concerns as to whether it is reasonable to expect the company
may not continue as a Going Concern and basis for conclusion.
• Roles
– Board should include a statement of basic objectives it expects
the auditors to achieve and the process the audit committee uses
in its oversight when there is a going concern issue.
27
Going Concern
Recommendations – SEC
• Disclosure of not just risks, but also how risks are mitigated
– in plain English
• Key Performance Indicators
– Some but not all companies provide information in public domain
– Factors critical to success and understanding of the company, its
operations and cash flows
– Varies greatly by industry, e.g.
• Backlogs, sales per square foot and customer, plant
utilization, tonnage shipped, etc.
28
Going Concern
Summary Recommendations
• Standard Setters - Strengthen Definition - Define Triggers
– Move auditing standard from Substantial Doubt to More Likely than Not
– Require disclosure when Reasonable Possibility exists that the company is no
longer a going concern
• Independent auditor ultimately must make assessment
– Extend the period of evaluation to 12 months plus foreseeable events beyond
12 months
• Key Performance Indicators
– Management to disclose in SEC filings
• Audit Committee’s Role
– Enhanced Communication between auditor and audit committee
– Summary of discussion to shareowners
• Regulators – Disclosures – Mitigating Risks
29