With its issuance of Accounting Standards Update (ASU) 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, FASB has altered the focus of the going concern assessment from the auditor to management. Previously, AICPA AU-C section 570 and PCAOB AU section 341, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern,” provided guidance for the auditor’s consideration and disclosure of going concern in audit reports for auditors of nonpublic and public entities, respectively. Despite some overlap between FASB’s new standard and existing auditing standards, some significant differences arose, causing the AICPA to issue AU-C section 9570, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern: Auditing Interpretations of AU-C section 570.” The AICPA’s resolution of these differences and the attendant implications for practicing auditors are summarized in the Exhibit. The authors also highlight the differences between the U.S. and international accounting and auditing standards.
Going Concern: Comparison of Prior and New Guidance
Overview and Time Frame
ASU 2014-15 requires management to “evaluate whether there are conditions or events … that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued,” (p. 2, emphasis added). AU-C section 570 and AU section 341.02 require auditors to assess whether substantial doubt exists about an entity’s ability to continue as a going concern for a period not to exceed one year beyond the date of the audited financial statements. The AICPA resolved this difference by requiring the auditor to opine on the fair presentation of the financial statements in “accordance with the applicable financial reporting framework” (AU-C section 9570.04), thus extending the auditor’s time frame to match management’s. International accounting and auditing standards require considering going concern for at least one year beyond the financial statements’ balance sheet date (IAS 1, Presentation of Financial Statements, para. 26, and ISA 570, Going Concern, para. 13, respectively). While using the term “at least” allows extending the international period of going concern consideration to one year beyond the issuance date as the U.S. standard now requires, the extension is not required, resulting in potential inconsistencies between U.S. and international standards.
Explicitly requiring management to assess going concern, followed by the auditor’s consideration of the assessment, parallels other management assertions (e.g., valuation). Going concern assessments, like many other judgments relating to valuation, are forward looking, requiring first management and then the auditor to evaluate future events. Will customers pay their accounts receivable? Will inventory sell for at least cost? Going concern considerations add a new twist on the already complex management judgments relating to valuation.
For many valuation decisions, management can delay issuing the financial statements and auditors can delay issuing the opinion for some period of time to reduce their uncertainty. For example, issuance can be delayed for weeks or months to see whether a customer pays its balances or the inventory sells over its cost price. The auditors must now assess going concern evidence through one year after financial statement issuance—rather than the balance sheet—date. Although delays could resolve some going concern conditions, no amount of delay will reduce both management’s and the auditor’s responsibility for a full one-year prediction.
Substantial Doubt Alleviated—Auditor’s Responsibilities
ASU 2014-15 requires management to make specific going concern disclosures when its own plan alleviates substantial doubt, such as disclosing the conditions and events that led to these doubts and specific plans to mitigate them. Previously, if management disclosed a going concern issue, auditors considered adding a going concern emphasis of matter paragraph in the auditor’s report. If management failed to disclose a going concern issue, auditors would issue an “except for” qualification for inadequate GAAP disclosure. Although the reporting requirement for auditors did not change, under AU-C section 9570, they should obtain appropriate audit evidence regarding the sufficiency of disclosures.
Extending the time frame for going concern consideration could increase the risk of inadequately reporting on going concern issues, thereby increasing the potential for lawsuits against auditors; however, improved management processes and increased management disclosure requirements could reduce auditors’ risk because management now assumes greater responsibility for the going concern assessment. Moreover, analyzing management’s assessment should help support the auditor’s own assessment, especially if management performs its task competently. Prior research indicates that going concern emphasis of matter paragraphs reduce the likelihood of auditors facing class action lawsuits and the severity of settlements (Kaplan and Williams, “Do Going Concern Audit Reports Protect Auditors from Litigation: A Simultaneous Equation Approach,” Accounting Review, 2013, vol. 88 no. 1, pp. 199–232); increased management disclosure could act similarly.
Explicitly requiring management to assess going concern, followed by the auditor’s consideration of the assessment, parallels other management assertions.
Interim Financial Statements
ASU 2014-15 requires management to evaluate going concern for both annual and interim financial statements. The prior guidance regulating the review of public companies’ interim financial statements, AU section 722 and AU-C section 930, required auditors to inquire of management and consider the adequacy of going concern disclosures if substantial doubt existed in the prior period, or the auditor became aware of conditions during normal interim review procedures. Under AU-C section 9570, auditors should now actively assess going concern at each interim date.
This change will expand audit procedures for interim financial statement reviews. While previously auditors’ consideration of going concern was secondary (if the auditor became aware of conditions), auditors should now add explicit procedures related to management’s going concern assessment as part of their interim reviews, likely increasing the cost and time required to complete these reviews, especially when the going concern assessment is more difficult.
ASU 2014-15 moves the primary responsibility for the going concern assessment from the auditor to management. It provides principles and definitions that should reduce diversity in the timing and content of commonly provided financial statement disclosures. Management should develop processes and controls to identify and evaluate whether conditions or events exist that raise substantial doubt about the entity’s ability to continue as a going concern and consider whether its plans that seek to mitigate those relevant conditions or events will alleviate the substantial doubt. Given the complexity involved in these assessments, management might need to hire outside consultants for assistance.
This standard, and the AICPA’s resulting AU-C section 9570 that conforms the auditor’s responsibility and time frame to ASU 2014-15, will change current audit practices. Auditors should consider requesting going concern information in management’s representation letter. Moreover, extending the time frame of going concern consideration requires auditors to expand their current predictions, and no amount of delay in issuing financial statements can reduce the time frame of uncertainty. The new standards extend the reach of the going concern assessment beyond annual audits to reviews. The added management disclosure requirements related to going concern, even when management plans appear to mitigate those issues, increase an auditor’s duties to assess management’s process related to going concern assessment and the adequacy of disclosure. This enhanced management process and increased disclosure could reduce the auditor’s legal liability if a company fails without the auditor having issued a going concern emphasis of matter paragraph.
Extending the time frame of going concern consideration requires auditors to expand their current predictions, and no amount of delay in issuing financial statements can reduce the time frame of uncertainty.
The authors wish to thank Abe Akresh (Government Accountability Office, retired), Dave Dupree (Comerica), John Fleming (Loscalzo Associates), Gerald Hepp (Gnosis Praxis), Greg Trompeter (University of Central Florida), and Leah Woodall (Google) for their helpful comments.