GOING CONCERN ACCOUNTING AND AUDITING ISSUES
By Larry L. Perry, CPA
CPA Firm Support Services, LLC
LEARNING OBJECTIVES
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Understand the fundamental concepts of the going concern assumption.
Identify information contrary to the going concern assumption.
Understand managements’ and auditors’ responsibilities for detecting, disclosing
and reporting on going concern issues.
Be able to prepare financial statements, footnotes and auditors’ and accountants’
reports when going concern problems are present.
INTRODUCTION—THE STATE OF THE STANDARDS
Preparing and reporting on entities with going concern issues is not new. During the
1970s, auditors became responsible for identifying and evaluating information contrary to
the going concern assumption. Depending on the severity of the uncertainty, the
reporting choice at that time was either a “subject to” opinion or a disclaimer of opinion.
In 1989, the Auditing Standards Board (ASB) issued Statement on Auditing Standards
(SAS) No. 59, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going
Concern. When an auditor identified information contrary to the going concern
assumption, he/she was required to obtain information about management’s plans to
overcome the threats to continued existence and to evaluate the appropriateness and
reasonableness of such plans and related footnote disclosures. This standard included an
illustration of an explanatory audit report paragraph that should be used when substantial
doubt exists about the entity’s ability to continue as a going concern. When such doubt
existed, the standard stated that it was a departure from generally accepted accounting
principles (GAAP).
In 2013, this statement was redrafted as SAS No. 126, The Auditor’s Consideration of an
Entity’s Ability to Continue as a Going Concern, with no change to practice. Depending
on the severity of the threat to continued existence of the entity, an emphasis of matter
paragraph, a qualified or disclaimer of opinion due to the uncertainty or an adverse
opinion when the liquidation basis of accounting is required but not used.
In October 2008, the Financial Accounting Standards Board (FASB) issued an exposure
draft of a proposed accounting standard, Going Concern, which was recently issued in
2014 as ASU 2014-15 (ASC Subtopic 205-40). This exposure draft requires
management of reporting entities to identify and evaluate information contrary to the
going concern assumption, develop a plan to overcome the threats to continued existence
and disclose relevant information in footnotes to financial statements. Auditors are,
under SAS No. 126, responsible for evaluating the appropriateness and reasonableness of
management’s conclusions, disclosures and plans.
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ACCOUNTING AND AUDITING STANDARDS IN THE UNITED STATES
ASU 2014-15, Going Concern (Subtopic 205-40)—Disclosure of Uncertainties about
an Entity’s Ability to Continue as a Going Concern
Why Issued?
Under generally accepted accounting principles (GAAP), continuation of a reporting
entity as a going concern is the underlying premise for preparing financial statements
unless and until the entity’s liquidation becomes imminent, when the liquidation basis of
accounting is the appropriate financial reporting framework. Preparation of financial
statements under this premise is called the going concern basis of accounting. Financial
statements should be prepared under the liquidation basis of accounting in accordance
with Subtopic 205-30, Presentation of Financial Statements—Liquidation Basis of
Accounting if and when an entity’s liquidation becomes imminent
In circumstances when an entity’s liquidation is not imminent, there may be
circumstances that raise substantial doubt about the entity’s ability to continue as a going
concern. In those situations, financial statements should be prepared under the going
concern basis of accounting, with the amendments in this Update guiding the
considerations for proper disclosures..
This Update provides guidance in GAAP about management’s responsibility to evaluate
whether there is substantial doubt about an entity’s ability to continue as a going concern
and to provide related footnote disclosures.
Major Provisions
Management has responsibility to assess the reporting entity’s ability to continue as a
going concern. Financial statements must be prepared on a going concern basis unless
management either intends to liquidate the entity or to discontinue operations, or in
circumstances where liquidation or discontinuance are the only alternatives.
In assessing whether the going concern assumption is appropriate, management shall
take into account all available information about the future, which is at least, but is
not limited to, 12 months from the date financial statements are available for issue
(for non-issuers) or issued (for issuers). When an entity has a history of profitable
operations and ready access to financial resources, management may conclude that the
going concern basis of accounting is appropriate without detailed analysis. When
contrary information is present, management may need to consider a wide range of
factors relating to current and future profitability, debt repayment requirements, and
potential sources of replacement or additional financing to determine that the going
concern basis is appropriate.
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Management is responsible for identifying information about certain conditions or events
that may indicate there could be substantial doubt about the reporting entity’s continued
existence. The following are examples of those conditions and events:
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Negative trends, for example, recurring operating losses, working capital
deficiencies, negative cash flows from operating activities, and adverse key
financial ratios.
Other indications of possible financial difficulties, for example, default on loan or
similar agreements, arrearages in dividends, denial of usual trade credit from
suppliers, restructuring of debt, noncompliance with statutory capital
requirements, and a need to seek new sources or methods of financing or to
dispose of substantial assets.
Internal matters, for example, work stoppages or other labor difficulties,
substantial dependence on the success of a particular project, uneconomic longterm commitments, and a need to significantly revise operations.
External matters that have occurred, for example, legal proceedings, legislation,
or similar matters that might jeopardize an entity’s ability to operate; loss of a key
franchise, license, or patent; loss of a principal customer or supplier; and an
uninsured or underinsured catastrophe such as a drought, earthquake, or flood.
If management believes there is substantial doubt about the entity’s ability to continue as
a going concern, management must develop appropriate and reasonable plans to
overcome the identified threats to the entity’s continued existence. Management’s plans
and considerations may include the following:
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Plans to dispose of assets:
o Restrictions on the disposal of assets, such as covenants limiting such
transactions in loan or similar agreements or encumbrances against assets.
o Apparent marketability of assets that the entity plans to sell.
o Possible direct or indirect effects of disposal of assets.
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Plans to borrow money or restructure debt:
o Availability of debt financing, including existing or committed credit
arrangements, such as lines of credit or arrangements for factoring
receivables or sale-leaseback of assets.
o Existing or committed arrangements to restructure or subordinate debt or
to guarantee loans to the entity.
o Possible effects on the entity’s borrowing plans of existing restrictions on
additional borrowing or the sufficiency of available collateral.
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Plans to reduce or delay expenditures:
o Apparent feasibility of plans to reduce overhead or administrative
expenditures, to postpone maintenance or research and development
projects, or to lease rather than purchase assets.
o Possible direct or indirect effects of reduced or delayed expenditures.
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Plans to increase ownership equity:
o Apparent feasibility of plans to increase ownership equity, including
existing or committed arrangements to raise additional capital.
o Existing or committed arrangements to reduce current dividend
requirements or to accelerate cash distributions from affiliates or other
investors.
Disclosure:
When management identifies information that causes substantial doubt about the entity’s
ability to continue as a going concern, footnotes to financial statements must disclose this
information:
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Pertinent conditions and events giving rise to the assessment of substantial doubt
about the entity’s ability to continue as a going concern.
The possible effects of those conditions and events.
Management’s evaluation of the significance of those conditions and events and
any mitigating factors.
Possible discontinuance of operations.
Management’s plans to mitigate the effect of the uncertainties and whether
management’s plans alleviate the substantial doubt about its ability to continue as
a going concern.
Information about the recoverability or classification of recorded asset amounts or
the amounts or classification of liabilities.
When financial statements are not prepared on a going concern basis, the basis of
preparation and the reasons why the entity is not regarded as a going concern must be
disclosed in the footnotes.
AU-C 570 (SAS No. 126) The Auditor’s Consideration of an Entity’s Ability to
Continue as a Going Concern
This section of the AICPA Professional Standards contains guidance for auditors when
evaluating whether there is substantial doubt about an entity's ability to continue as a
going concern. An entity’s continuance as a going concern is assumed when no contrary
information of significance can be identified. Information that significantly contradicts
the going concern assumption includes an entity's inability to meet its obligations without
the sale of assets, debt modification, changes in its operations, or other plans.
Responsibilities of Auditors
Auditors have a responsibility to evaluate whether there is substantial doubt about the
entity's ability to continue as a going concern for a reasonable period of time, not to
exceed one year beyond the date of the financial statements. Practically speaking,
however, auditors should also consider conditions and events that affect the going
concern assumption which are identified by management and extend beyond the one year
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limitation. As stated above, ASU 2014-05 requires a look forward period of one year
from the date financial statements are available for issue (non-issuers) or are issued
(issuers).
The auditor’s objectives are to evaluate whether there is substantial doubt about the
entity’s ability to continue as a going concern for a reasonable period of time, determine
the possible financial statement effects and adequacy of disclosures regarding this
uncertainty and determine the need for audit report modifications.
Auditors should evaluate whether there is substantial doubt about an entity's ability to
continue as a going concern for a reasonable period of time by following the guidance in
AU-C 315, Understanding the Entity and Its Environment and Assessing the Risks of
Material Misstatement:
 The auditor should consider whether the results of procedures performed in
planning, gathering audit evidence relative to the various audit objectives, and
completing the audit identify conditions and events that, when considered in
the aggregate, indicate there could be substantial doubt about the entity's
ability to continue as a going concern for a reasonable period of time. It may
be necessary to obtain additional information about such conditions and events,
as well as the appropriate audit evidence to support information that mitigates
the auditor's doubt.
 If the auditor believes there is substantial doubt about the entity's ability to
continue as a going concern for a reasonable period of time, she/he should (1)
obtain information about management's plans that are intended to mitigate the
effect of such conditions or events, and (2) assess the likelihood that such plans
can be effectively implemented.
 After the auditor has evaluated management's plans, she/he concludes whether
there is substantial doubt about the entity's ability to continue as a going
concern for a reasonable period of time. If the auditor concludes there is
substantial doubt, she/he should (1) consider the adequacy of disclosure about
the entity's possible inability to continue as a going concern for a reasonable
period of time, and (2) include an explanatory paragraph (following the
opinion paragraph) in the audit report to reflect his conclusion. If the auditor
concludes that substantial doubt does not exist, she/he should consider the need
for disclosure.
Audit Procedures
Designing special procedures to detect information contrary to the going concern
assumption usually is not necessary. The results of performing procedures in an audit
plan (program) should be sufficient to identify and evaluate contrary information.
Auditing procedures that can reveal contrary information include:
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Risk assessment procedures
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Analytical procedures
Substantive tests of balances
Subsequent events reviews
Debt covenants reviews
Reading minutes of board and committee meetings
Obtaining lawyer’s letters
Identification and Evaluation of Contrary Information
Information contrary to the going concern assumption may be identified by auditors as a
result of performing auditing procedures. The significance of such information depends
on engagement circumstances. Conditions and events contrary to the going concern
assumption from AU-C 570 are similar to those from ASU 2014-15:
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Negative trends—for example, recurring operating losses, working capital
deficiencies, negative cash flows from operating activities, adverse key financial
ratios.
Other indications of possible financial difficulties—for example, default on loan
or similar agreements, arrearages in dividends, denial of usual trade credit from
suppliers, restructuring of debt, noncompliance with statutory capital
requirements, need to seek new sources or methods of financing or to dispose of
substantial assets.
Internal matters—for example, work stoppages or other labor difficulties,
substantial dependence on the success of a particular project, uneconomic longterm commitments, need to significantly revise operations.
External matters that have occurred—for example, legal proceedings, legislation,
or similar matters that might jeopardize an entity's ability to operate; loss of a key
franchise, license, or patent; loss of a principal customer or supplier; uninsured or
underinsured catastrophe such as a drought, earthquake, or flood.
Auditors’ Evaluation of Management’s Plans
Auditors should obtain information about management’s plans and evaluate their
appropriateness and reasonableness. Management’s plans may be appropriate and
reasonable if they are likely to mitigate the contrary information for a reasonable period
of time and if such plans can be effectively implemented.
Section AU-C 570 states that auditors’ evaluation of management’s plans may include
theses considerations:
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Plans to dispose of assets.
— Restrictions on disposal of assets, such as covenants limiting such
transactions in loan or similar agreements or encumbrances against assets.
— Apparent marketability of assets that management plans to sell.
— Possible direct or indirect effects of disposal of assets.
Plans to borrow money or restructure debt.
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— Availability of debt financing, including existing or committed credit
arrangements, such as lines of credit or arrangements for factoring
receivables or sale-leaseback of assets.
— Existing or committed arrangements to restructure or subordinate debt or
to guarantee loans to the entity.
— Possible effects on management's borrowing plans of existing restrictions
on additional borrowing or the sufficiency of available collateral.
Plans to reduce or delay expenditures.
— Apparent feasibility of plans to reduce overhead or administrative
expenditures, to postpone maintenance or research and development
projects, or to lease rather than purchase assets.
— Possible direct or indirect effects of reduced or delayed expenditures.
Plans to increase ownership equity.
— Apparent feasibility of plans to increase ownership equity, including
existing or committed arrangements to raise additional capital.
— Existing or committed arrangements to reduce current dividend
requirements or to accelerate cash distributions from affiliates or other
investors.
When management’s plans are supported by prospective financial information, the
auditor should consider the adequacy of support for significant assumptions underlying
that information. The auditor's evaluation of such information should be based on
knowledge of the entity and its environment and the qualifications of its management.
The evaluation should include:
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Reading the prospective financial information and underlying assumptions.
Comparing prospective financial information in prior periods with actual results
and comparing prospective information for the current period with results
achieved to date.
Beyond the requirements in Section AU-C 570, it may be necessary in some high risk
situations to inspect the documentation supporting the prospective information.
Marketing plans for new products, details of sales back orders, contracts and agreements
for purchase and wage commitments, debt modification agreements and studies of market
values of assets selected for disposition are examples of such documentation. In addition,
the feasibility of management’s plans and the mathematical accuracy of related financial
information should be evaluated.
Auditors’ Evaluation of Financial Statement Effects
After identifying and evaluating contrary information and concluding there is substantial
doubt about the entity's ability to continue as a going concern for a reasonable period of
time, auditors must evaluate the effects of this information on the financial statements
and the adequacy of the footnote disclosures.
Section AU-C 570 indicates disclosures that may be necessary:
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The conditions and events causing the substantial doubt about the entity's ability
to continue as a going concern for a reasonable period of time.
The possible effects of such conditions and events.
Management's evaluation of the significance of those conditions and events and
any mitigating factors.
Possible discontinuance of operations.
Management's plans (including relevant prospective financial information).
Information about the recoverability or classification of recorded asset amounts or
the amounts or classification of liabilities.
If management’s plans are sufficient to eliminate the substantial doubt about the entity’s
continued existence, auditors should consider whether disclosure of the substantial doubt
is necessary. Ordinarily, the threats to continued existence and management’s plans
should be included in a footnote to answer questions of financial statement readers and to
prevent the statements from being misleading.
Written Representations
When the auditor believes there is substantial doubt about the entity’s ability to continue
as a going concern for a reasonable period of time, the auditor should obtain written
representations from management. These should include their plans to mitigate the
adverse effects, the likelihood those plans can be implemented and that the financial
statement disclosures include all relevant matters regarding the threats to continued
existence and management’s plans.
Consideration of the Effects on the Auditor’s Report
If an auditor determines management’s plans are not appropriate and reasonable, and
substantial doubt about continued existence remains, the audit report should include an
explanatory paragraph after the opinion paragraph to state that conclusion. Section AU-C
570 states “the auditor's conclusion about the entity's ability to continue as a going
concern should be expressed through the use of the phrase ‘substantial doubt about its
(the entity's) ability to continue as a going concern’ [or similar wording that includes the
terms substantial doubt and going concern].
Depending on engagement facts and circumstances, auditors may elect to include an
explanatory paragraph to emphasize and reference footnote disclosures and express an
unqualified opinion, express a qualified opinion or issue an adverse opinion as described
in AU-C Section 705, Modifications to the Opinion in the Independent Auditor’s Report..
Report examples are discussed later in these materials.
An example of an explanatory paragraph in the auditor's report describing an uncertainty
about the entity's ability to continue as a going concern for a reasonable period of time
from Section AU-C 570 follows:
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Emphasis of a Matter Regarding Going Concern
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note X to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note X. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
When auditors determine management’s plans and related disclosures are not appropriate
or reasonable, a departure from generally accepted accounting principles or other
reporting framework exists. A qualified (except for) or an adverse opinion may result due
to the departure from GAAP. Nothing precludes the issuance of a disclaimer of opinion
when the threat to continued existence is imminent or has a pervasive affect on financial
statements.
When substantial doubt existed at the date of prior period financial statements presented
on a comparative basis, and that doubt has been removed in the current period, the
explanatory paragraph included in the auditor's report on the prior period financial
statements should not be repeated.
Communication with Persons Charged with Governance
When substantial doubt about the entity's ability to continue as a going concern for a
reasonable period of time remains, the auditor should communicate with persons charged
with governance. Matters to be communicated include the nature of the contrary
information, the possible effects on the financial statements and footnotes and the effects
on the auditor’s report.
Audit Documentation
After identifying and evaluating the contrary information the auditor still believes there is
substantial doubt about an entity’s continued existence, audit documentation should
contain all this information:
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The contrary information that led the auditor to believe there is substantial doubt
about the entity's ability to continue as a going concern for a reasonable period of
time.
The elements of management's plans that the auditor considered significant for
overcoming the threats to continued existence.
The auditing procedures performed and evidence obtained to evaluate the
appropriateness and reasonableness of management's plans.
The auditor's conclusion as to whether substantial doubt remains or is alleviated.
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o If substantial doubt remains, the auditor also should document the possible
effects of the contrary information on the financial statements and the
adequacy of the related disclosures.
o If substantial doubt is alleviated, the auditor also should document the
conclusion as to the need for disclosure of the principal conditions and
events that initially caused him or her to believe there was substantial
doubt.
The auditor's conclusion as to whether an explanatory paragraph should be
included in the audit report. If management’s plans or disclosures are inadequate,
the auditor also should document the reasoning for expressing a qualified or
adverse opinion.
CONCERN ABOUT GOING CONCERN
In certain industries, geographic regions and economies, some reporting entities are
concerned about maintaining future profitable operations. An auditor shared that he is
concerned about not only going concern issues affecting his clients but is also concerned
about economic effects on their customers, suppliers and lenders that may not be readily
apparent. These concerns are important considerations for planning every attest
engagement.
Some Practical Planning Questions for Audits and Reviews
Here are some practical questions auditors and accountants may wish to incorporate in
the planning documentation of every audit and review engagement for the foreseeable
future.
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Do risk assessment procedures reveal any information contrary to the goingconcern assumption? Such information may include current and expected
recurring operating losses, cash flow problems, defaults on debt obligations,
inability to obtain financing or renewals of existing credit lines, an industry
significantly affected by regulation or competition, customers and vendors with
going-concern problems, decreasing assets valuations, statutory noncompliance,
and external matters such as lawsuits, loss of franchise or licenses, etc.
Does management have any concerns about the entity’s ability to continue in
business for at least a year or possibly longer from the date of the financial
statements?
What are management’s plans to mitigate any revealed threat to continued
existence?
Are management’s plans realistic and are they capable of carrying them out?
What procedures will be necessary for the engagement team to evaluate
management’s plans to overcome going-concern problems?
What effects are the going-concern issues likely to have on the basis of
preparation of the entity’s financial statements?
What effects are the going-concern issues likely to have on the accountant’s or
auditor’s report?
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The effectiveness of audits and reviews will continue to be evaluated based on the
adequacy of engagement planning and other procedures. Identifying and evaluating
going-concern issues early must be an integral part of every engagement performed by
accountants and auditors.
MANAGEMENT’S AND AUDITOR’S EVALUATION OF CONTRARY
INFORMATION
The left side of the following table includes conditions and events (contrary information)
that, when considered in the aggregate, could indicate there is substantial doubt about an
entity’s ability to continue as a going concern for a reasonable period of time. Evaluation
considerations for each condition or event are mentioned on the right side of the table.
CONTRARY INFORMATION
EVALUATION CONSIDERATIONS
History of operating losses
Low or no working capital
Negative cash flows from operations
Financial ratios with negative variances
Loan or contract defaults
Trade credit denials or cancellations
Loan modifications or work outs
Inability to find refinancing sources
Selling assets to sustain cash flow
Labor problems
Depending on the success of a main project
Long-term unprofitable commitments
Required revisions to operations
Significant adversarial disputes
Loss of dealership, franchise, license, etc.
Major customer or vendor loss
Natural disasters and inadequate insurance
The history, amounts and causes of losses
and likelihood of change in the future
Trends, causes and debt covenants
Past sources of cash flow and reasons for
changes
Trends, causes and corrective actions
Current status, affect on operations, reasons
Which creditors, affect on operations,
replacements of vendors
Terms, affect on future operations, new
debt covenants
Types of financing desired, severity of
need
Asset values compared to cash flow needs,
affect on operations of sale
Nature of any disputes, type of job
vacancies, contract alternatives
Nature of project or product, profitability,
likelihood of completion, future affects
Affect on operations, termination effects,
alternative markets
Technological changes, new regulations,
costs to change
Nature of lawsuits or claims, expected
outcomes, worst-case effects
Operational alternative, acquisition of new
patents, licenses, etc., affects on operations
Replacement alternatives, affect on
operations
Claim and recovery options, costs of
returning to business, affect on operations
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THE NATURE AND EXTENT OF MANAGEMENT’S PLANS AND AUDITORS’
EVALUATIONS
After discussing the accounting and auditing standards for the going concern assumption,
a significant practical question often remains. The question is: How much work is
necessary to evaluate management’s plans, particularly if it contains prospective
information? Like other decision making for accounting and auditing engagements,
professional judgment is the key. Professional judgment, defined as the accountant or
auditor’s knowledge, experience and wisdom, is always risk driven. The assessed levels
of risk determine the amount of work necessary in an engagement’s circumstances. The
higher the risk at the financial statement and assertion levels is, the greater the evidence
that is necessary to reach conclusions.
To illustrate the nature of management’s plans, and the amount of related audit work that
is necessary, here is a real-life example that occurred in the late 1970s that parallels
compliance with the accounting and auditing standards discussed above .You may
remember, or may have read about, the 1979 government bailout of Chrysler Motors.
Lee Iacocca, formerly CEO of Ford, took the top leadership role at Chrysler for the
express purpose of rescuing the company from the brink of bankruptcy and collapse. His
actions, plus a government loan guarantee of $1.5 billion, turned losses into profits and
re-established the company as an industry leader. Here is a summary of Iacocca’s plan
and the auditors’ response to that plan.
Chrysler’s Management Plan
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The K-Car Series market potential. With increasing gas prices, the sale of 8cylinder cars deteriorated. Iacocca envisioned a 4-cylinder, fuel efficient car with
front-wheel drive. Their market studies indicated a strong sales potential for this
vehicle. The core of management’s plan was the development and manufacture
of the K-Car series.
Union wage concessions. Chrysler successfully negotiated wage concessions
from union workers. These concessions enabled the manufacture and sale of the
K-Cars at affordable prices.
Plant closings and re-tooling. As production of larger automobiles was curtailed
due to decreasing demand, management closed numerous production plants.
Other plants were re-designed and re-tooled to produce the new K-Cars.
Cost analysis. The costs of plant closings and re-designs, the cost of designing
and building new production lines and the costs of tools and dyes for the new cars
were analyzed and projected for five years.
Reductions in executive compensation and other expenses. Many executive
positions were eliminated and executive compensation was reduced. Other
operating expenses were trimmed wherever possible.
Management’s five-year plan. All the actions above became elements of
management’s five-year plan. This forecast was built on a thorough analysis of
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facts and circumstances and indicated that an initial loan of $1.5 billion could be
entirely repaid in five years through the company’s profitable operations.
Management’s plan became reality in five-years!
The Auditors’ Dilemma
Chrysler’s auditors in 1979 were faced with a dilemma: What kind of audit opinion could
they express on Chrysler’s financials? Years of losses had eliminated retained earnings
and eaten away most of the stockholders’ equity. Debt was sky high and defaults were
imminent. Sales were deteriorating and operating costs were ballooning. The going
concern assumption was nearly non-existent.
These facts pointed to probable business discontinuance and the presentation of the
financial statements on the liquidation basis of accounting. If these circumstances
affected currently issued financial statements, failure to prepare financial statements on
the liquidation basis would normally require an adverse opinion in the auditor’s report.
At that time, imminent threats to business continuance were regarded as material
uncertainties, often resulting in a disclaimer of opinion.
Since management had developed a plan to overcome the threats to business continuance,
the auditors had a second option. If they could determine the appropriateness and
reasonableness of management’s plans, they could express a qualified opinion known at
that time as a “subject to” opinion. As we’ve discussed in these materials, under current
accounting standards the auditors may choose between an “emphasis of matter” report
paragraph, a qualified opinion, a disclaimer of opinion or an adverse opinion, depending
on engagement facts and circumstances. In the reporting section below, the reasoning for
selecting these alternatives is discussed.
In this case, the auditors chose to perform auditing procedures that were similar to what
we currently know as procedures for an examination of prospective financial information.
Section AT 301.29 of the AICPA Professional Standards says the following about such
examinations:
.29 An examination of prospective financial statements is a professional service
that involves—
a. Evaluating the preparation of the prospective financial statements.
b. Evaluating the support underlying the assumptions.
c. Evaluating the presentation of the prospective financial statements for
conformity with AICPA presentation guidelines.
d. Issuing an examination report.
Remember, in the Chrysler example the risk associated with the financial statements is
very high due to imminent threats to continued existence of the reporting entity. As
mentioned earlier, higher engagement risks require more evidence to mitigate the risks.
Here is a brief summary of how the Chrysler auditors satisfied themselves as to the
appropriateness and reasonableness of management’s plans.
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Reports and sales projections of market analysts and company management were
read and evaluated.
Contracts approved by labor unions, suppliers and others were examined in
support of forecasted costs and expenses.
Cost studies related to plant closures and the production of the K-Car were
studied and evaluated.
All significant assumptions and related forecasted effects were considered in light
of supporting documentation.
The final five-year plan was evaluated for appropriateness and reasonableness.
As a result of these procedures, the Chrysler auditors were satisfied the five-year plan
was appropriate and reasonable and were able to issue a qualified opinion. In succeeding
years as confidence grew through the operating results that supported management’s
assumptions, the auditors were satisfied management’s plans were working and the
qualification of the audit report was removed.
A Model for Today
A practical question that could be asked at this point is: Is an auditor required to examine
prospective financial information which supports management’s plans for alleviating
threats to continued existence? Section AU-C 570 contains no specific required
procedures for evaluating management’s plans. As discussed above, an auditor is
responsible for using professional judgment to evaluate the appropriateness and
reasonableness of management’s plans for corrective action. Professional judgment is
risk-driven and higher risk requires more substantive evidence to reach a conclusion.
In the Chrysler case, risk at the financial statement level was very high due to imminent
threats to continued existence. Facing similar situations today, auditors may need to
perform procedures similar to those required for an examination of prospective financial
information to satisfy themselves as to the appropriateness and reasonableness of
management’s plans of corrective actions. Again, AU-C 570 specifies no required
procedures for the application of professional judgment.
On the other hand, when the risk of an entity not continuing in existence for a reasonable
period of time is lower, audit procedures performed to evaluate management’s plans may
be limited. At a minimum in such cases, this author suggests following the guidance for
compilations of prospective financial information in Section AT 301.12 and .13 as the
minimum procedures:
.12 A compilation of prospective financial statements is a professional service
that involves the following:
a. Assembling, to the extent necessary, the prospective financial
statements based on the responsible party's assumptions
b. Performing the required compilation procedures, including reading the
prospective financial statements with their summaries of significant
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assumptions and accounting policies, and considering whether they
appear to be presented in conformity with AICPA presentation guidelines
and not obviously inappropriate
c. Issuing a compilation report
.13 A compilation is not intended to provide assurance on the prospective
financial statements or the assumptions underlying such statements. Because of
the limited nature of the practitioner's procedures, a compilation does not provide
assurance that the practitioner will become aware of significant matters that
might be disclosed by more extensive procedures, for example, those performed in
an examination of prospective financial statements.
While compliance with the attestation standards is not required for auditors evaluating the
appropriateness and reasonableness of management’s plans designed to alleviate threats
to continued existence, the guidance in the standards offers a framework for auditors in
these cases. The severity of the threats to continued existence, among other things, is
indicative of the degree of risk at the financial statement level. As risk increases, so
should the extent of the auditors’ procedures applied when evaluating management’s
plans.
GOING CONCERN REPORTING OPTIONS FOR AUDITS
Following are illustrations of the reporting options for going concern issues in audit
engagements.
Emphasis of a Matter Paragraph
First, second and third paragraphs—standard.
Fourth paragraph:
The accompanying financial statements have been prepared on the basis of
generally accepted accounting principles with the assumption the Corporation
will continue to operate as a going concern. As discussed in Note X, the
Corporation has incurred recurring losses from operations and has a deficiency
in assets which raises substantial doubt about its ability to continue operations.
Management’s plans to overcome the threat to the Corporation’s continued
existence are also discussed in Note X. No adjustments have been made to the
financial statements which might result from the outcome of this uncertainty.
Qualified Opinion—Departure from Applicable Financial Reporting Framework
First and second paragraphs—standard.
Third paragraph—same as fourth paragraph for emphasis of a matter above.
Fourth paragraph:
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In our opinion, except for the matters discussed in the preceding paragraph, the
financial statements referred to in the first paragraph present fairly……
Adverse Opinion—Departure from Applicable Financial Reporting Framework
First and second paragraphs—standard.
Third paragraph—same as fourth paragraph for emphasis of a matter above.
Fourth paragraph:
In our opinion, because the threat to continued existence of the Corporation is
imminent, the financial statements referred to above do not present fairly, in
conformity with generally accepted accounting principles, the financial position
of XYZ Corporation as of December 31, 20XX, or the results of its operations or
its cash flows for the years then ended.
Auditor’s Reasoning: Distinguishing Between Emphasis of a Matter, Qualified
Opinion, Disclaimer of Opinion or Adverse Opinion for Going-Concern
Uncertainties
In the case of an uncertainty caused by a going concern problem, the reporting options
are an emphasis of a matter paragraph, a qualified opinion, a disclaimer of opinion or an
adverse opinion regarding generally accepted accounting principles. Other uncertainties
having material effects on the financial statements may require either a qualified opinion
or a disclaimer of opinion.
For going concern problems, management of a reporting entity has the responsibility to
develop plans for overcoming any substantial doubt about the continued existence of their
entity. Auditors have the responsibility for evaluating the adequacy of such plans. If the
auditor believes the plans are adequate and little doubt remains, an emphasis paragraph
may not be needed. If, after reviewing management’s plans, the auditor believes there is
doubt the plans may not overcome the substantial doubt about the continued existence of
the entity, or the auditor is not convinced the plans are feasible, a qualified opinion or a
disclaimer of opinion may be necessary due to the magnitude and imminence of the
threat. If the plans clearly are not feasible, or clearly do not overcome the substantial
doubt, an adverse opinion may be necessary. When plans are not feasible, the adverse
opinion would be necessary because the statements should be presented on the liquidation
basis of accounting instead of GAAP.
Other material uncertainties would require either a qualified opinion or disclaimer of
opinion depending on the likelihood of occurrence and the magnitude of the effects on
the financial statements.
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REPORTING ON THE GOING CONCERN ASSUMPTION FOR
COMPILATIONS AND REVIEWS
Going Concern Issues
When uncertainties exist about and entity’s ability to continue in existence for a year
from the date of the financial statements, management should be requested to consider
the possible impact of the uncertainties on the financial statements. If the accountant
believes management’s decisions are unreasonable or disclosures are inadequate, it may
be necessary to disclose a departure from the applicable reporting framework in the
accountant’s report. In circumstances where threats to continued existence have been
alleviated, the uncertainty may be emphasized in the accountant’s report if it is disclosed
in the financial statements.
Illustrative Review Report Wording—Departure from Applicable Financial
Reporting Framework Due to a Going Concern Exception
First three paragraphs—standard
Fourth paragraph:
Based on my (our) review, with the exception of the matter(s) described in the
following paragraph(s), I am (we are) not aware of any material modifications
that should be made to the accompanying financial statements in order for them
to be in conformity with accounting principles generally accepted in the United
States of America (or other applicable financial reporting framework).
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note X to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note X. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Illustrative Compilation Report Wording—Departure from GAAP Due to a Going
Concern Exception
First three paragraphs—standard
Fourth paragraph:
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note X to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability to
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continue as a going concern. Management's plans in regard to these matters are
also described in Note X. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
If management has elected to omit substantially all disclosures, a selected footnote
disclosure should be included and referenced in the fourth paragraph.
Emphasis of a Matter Paragraph for Going Concern Exception for Compilations
and Reviews
For both compilations and reviews, standard accountants’ reports would be used. A final
paragraph would be added to each report describing the emphasized matter. The matter
must also be discussed in a footnote. The emphasis of a matter paragraph may be used
when the risk associated with the severity of a going concern exception is not high.
When threats to continued existence of the entity are imminent, a departure from the
applicable reporting framework paragraph should be added to the report or, in extreme
cases, the accountant should withdraw and no report should be issued.
Particularly for compilations in connection with monthly accounting services,
emphasizing going concern issues may be the most common report disclosure. A
selected footnote would be necessary when management has elected to omit substantially
all disclosures. An emphasis of going concern matter paragraph for compilations and
reviews suggested by this author follows:
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note X (or a selected
footnote for compilations) to the financial statements, the Company has suffered
recurring losses from operations and has a net capital deficiency that raises
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note X (or the selected
footnote) or (Management has not developed plans to alleviate the substantial
doubt) .The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
An Illustrative Footnote—Going Concern Uncertainty
The Company has incurred net losses of $xxx,xxx and $xxx,xxx for the years
ended December 31, 2015 and 2014, respectively. As of December 31, 2015 and
2014, the Company also had retained deficits of $xxx,xxx and $xxx,xxx,
respectively. The Company’s line of credit at ABC Bank has been exhausted and
cannot be increased. These conditions have resulted from a catastrophic fire that
destroyed the Company’s production and office facilities. These conditions raise
substantial doubt about the ability of the Company to continue as a going concern
for a reasonable period of time.
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Management plans to sell 10,000 acres of its undeveloped, commercially-zoned
land to generate funding to rebuild facilities and sustain operations until
profitable operations can be achieved. A recent appraisal of the land indicates its
market value at $x,xxx,xxx, which amount would be sufficient to accomplish
management’s plans. No adjustments have been made to the accompanying
financial statements that might be necessary should the Company be unable to
sell the land to a qualified buyer, or be unable to sell the land for its full market
value.
Are You Asking the Right Questions?
While management’s responsibilities for evaluating going concern issues are identified in
ASU 2014-15, and as auditors begin to plan for future audits considering SAS No. 126,
the effects of current and future economic events on the continued existence of reporting
entities are increasingly important. Here’s a chronology of events for evaluating the
going concern assumption along with questions management and auditors may wish to
ask:
1. Obtain interim financial information 60 to 90 days prior to the entity’s reporting date.
Consider annualizing the interim information and entering it in accounting or auditing
software for comparison with trends of prior years.
 ASK: What caused significant variations?
 ASK: Are significant variations causes of potential threats to continued existence
of the entity?
2. When the engagement leader delivers and discusses the audit engagement letter,
 ASK: Are there any negative economic factors affecting the entity’s business?
 ASK: Are there any negative economic factors affecting the business of the
entity’s major customers and major vendors?
3. At the audit team’s planning and brainstorming meeting,
 ASK: Are there increased risks of misstatements due to error or fraud because of
going concern issues?
 ASK: What overall and/or specific audit responses are necessary to mitigate these
risks?
4. If there are increased threats to continued existence,
 ASK: What are management’s plans to overcome these threats?
 ASK: Has, or can, management create formal plans?
 ASK: Should the CPA firm withdraw from this engagement?
5. If management doesn’t have the capability to complete plans on their own,
 ASK: Can they provide a person with suitable, skill knowledge or experience to
oversee the performance of non-attest services by the auditors?
 ASK: Should the client hire other consultants to develop a formal plan for
overcoming the threat to continued existence?
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6. If a formal plan has been, or will be, developed by management or their
representatives,
 ASK: What is the severity of the threat to continued existence and how will the
audit team evaluate the appropriateness and reasonableness of management’s
plans?
7. After management’s plans have been formulated and evaluated,
 ASK: Is there a remaining threat to continued existence and what will be the
effects on footnotes disclosures and the auditor’s report?
 ASK: What is the severity of any remaining threat?
 ASK: Will an adverse opinion be necessary because of an imminent remaining
threat, a departure from GAAP qualification because of a significant remaining
threat, a qualified opinion or disclaimer of opinion due to the uncertainty or an
emphasis of a matter paragraph because of the possibility of the effects of threats
on future operations?
8. After the nature of the auditor’s report has been determined,
 ASK: What affect will the report have on the entity’s relationship with financial
statement users?
 ASK: Should the engagement leader accompany the entity’s management to
present the audit report to financial statement users to discuss the appropriateness
and reasonableness of management’s plans?
Because threats to continued existence can affect the entity’s reporting framework, i.e.,
can create departures from generally accepted accounting principles or other reporting
frameworks, it ordinarily will be necessary to ask these questions for audits, reviews and
compilations to determine any necessary report modifications. One thing is for sure.
Threats to continued existence of any entity can only be eliminated with prospective
plans and actions. When an entity ceases to be a going concern, only finger pointing
remains!
CONCLUSION
The going concern assumption is the foundation for all reporting frameworks. When
facts and circumstances indicate an entity is not likely to operate as a going concern for a
reasonable period of time, the only acceptable reporting framework is the liquidation
basis of accounting. Management is responsible for identifying and evaluating conditions
and events that threaten the continued existence of their entity. Management is also
responsible for developing plans to alleviate the threats. Auditors are responsible for
evaluating the appropriateness and reasonableness of management’s plan. Footnote
disclosure of the threats and management’s plans is required. Audit report modification
may be necessary when management’s plans to overcome threats are unreasonable or
insufficient.
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