By: Omid Mohebbi, CPA | Audit Supervisor
Auditors occasionally come across going concern issues in the course of performing their audit procedures. These issues essentially refer to the ability or inability, as the case may be, of the audited entity to continue operations beyond a certain timeframe, which the standards refer to as “a reasonable period of time”.
The New Standard from the AICPA
In February 2017, the AICPA issued AU-C 570, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern. The standard superseded the previous Statement of Auditing Standards (SAS) No. 126 and applies to financial statement audits for periods ending after December 15, 2017. Before diving into the more technical aspects of the latest standard, I would like to address the question of why those in management positions in the nonprofit industry should be aware of the key issues involved and the possible implications for your organization.
Why Does It Matter To Your Organization?
The most important implication is that if going concern issues are noted during the audit, there will be an additional responsibility placed on the auditee’s management to address these concerns and to evaluate plans designed to mitigate any concerns noted. The extent and adequacy of such plans could have important implications for the auditor’s opinion, which will in turn have further ramifications for the organization down the line.
Auditor and Management Responsibilities
Financial statements are normally prepared under the going concern basis of accounting with the underlying assumption that the entity will continue its day-to-day operations for a reasonable period of time. This is in contrast to the liquidation basis of accounting where the going concern basis is not deemed appropriate given the circumstances. The new standard focuses on a number of areas: the auditor’s responsibilities in assessing any conditions that affect the auditee’s ability to continue as a going concern for a reasonable period of time, if such conditions raise a substantial doubt in the auditee’s ability to do so, and if use of the going concern basis is appropriate. A reasonable period of time, in the absence of any specific requirements stipulated in the financial reporting framework used, refers to a period of one year after the financial statements are issued or are available to be issued.
The auditor is required to determine if the financial statements and disclosures include the information necessary to provide a true picture to users about the auditee’s ability to continue as a going concern, and any issues noted that raise a substantial doubt about its ability to do so. Furthermore, the auditor is required to determine if management has performed an evaluation of conditions that raise the substantial doubt referred to above, and its plans to mitigate the conditions identified. If management has not prepared such an evaluation, the auditor has to inquire of management as to its rationale for using the going concern basis and any conditions that exist that may raise substantial doubt.
At the conclusion of the audit, the auditor should determine if it is appropriate for the auditee to use the gong concern basis of accounting and if management’s disclosures in the financial statements are adequate and sufficient.
Examples of matters that may be included in the auditor’s consideration of substantial doubt include continued losses, negative operating cashflow, defaulting on loans, a continued and growing unrestricted deficit at year-end, litigation and substantial uninsured losses. Examples of management actions aimed at mitigating these factors are plans to dispose of assets, restructuring or consolidation of debt, plans to postpone or cut expenditures, and aggressive fundraising plans.
The standard above should be considered together with the guidance issued by the Financial Accounting Standards Board (FASB) Subtopic 205-40, that requires management to determine if there are conditions, ‘considered in the aggregate’, that lead to substantial doubt about an entity’s ability to continue as a going concern, and to disclose details of such conditions and any mitigating plans. The guidance is effective for annual periods ending after December 15, 2016.
Implications For the Auditor’s Opinion
The implications of the above for the auditor’s report are varied. If the auditor determines that the use of the going concern basis is not appropriate, this will invariably lead to an adverse opinion. If the use of the going concern basis is deemed appropriate but the auditor concludes that substantial doubt remains, an “emphasis of matter” paragraph is included in the audit opinion. The lack of adequate disclosures regarding the entity’s ability to continue as a going concern can lead to an adverse or qualified opinion. The auditor will also communicate its findings about going concern issues, management’s plans, and the implications for the audit opinion to those charged with the entity’s governance.
So What Should You Do For Your Next Audit?
Given the implications detailed above, what should nonprofits do to preempt and respond to the auditor’s concerns about going concern issues? At the very least, management should prepare (prior to the audit and ready for the auditor’s review) an evaluation of whether any going concern issues exist, its plans to address and mitigate any issues identified, and its justification for use of the going concern basis in the preparation of financial statements. This will save considerable time and effort during the audit when there are additional demands on the auditee’s management, and will allow management to put together a stronger evaluation of its plans should any going concern issues be identified. In summary, depending on the issues identified, prior preparation and evaluation could reduce the likelihood of an adverse opinion, qualified opinion, or an emphasis of matter paragraph, all of which would be unfavorable for the auditee compared to a clean unmodified opinion.
If your organization has questions regarding the new standard or going concern issues, please contact Omid Mohebbi, CPA, Audit Supervisor at 301-951-9090 or firstname.lastname@example.org.
AU-C Section 570, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern
FASB Accounting Standards Update 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