Financial statements are generally prepared under the assumption that the business will remain a ‘going concern.’ In accounting, a ‘going concern’ is defined as the expectation that a business will continue to generate a positive return on its assets and meet its obligations in the ordinary course of business. However, sometimes conditions put that assertion into question.
Recently, the responsibility for making going concern assessments shifted from auditors to management. So, it is important for you to identify the red flags that going concern issues exist.
Who is Responsible for ‘Going Concern’ Assessments’?
Under Accounting Standards Update No. 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, management is responsible for assessing whether there are conditions or events that raise ‘substantial doubt’ about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued or available to be issued. (The alternate date prevents financial statements from being held for several months after year end to see if the company survives).
When going concern issues arise, auditors may adjust balance sheet values to liquidation values, rather than historic costs. Footnotes also may report going concern issues, and the auditor’s opinion letter, which serves as a cover letter to the financial statements, may be downgraded to a qualified or adverse opinion. All of these changes forewarn lenders and investors that the company is experiencing financial distress.
Signs of ‘Going Concern’ Issues
When evaluating the going concern assumption, look for signs that your company’s long-term viability may be questionable, such as:
- Recurring operating losses or working capital deficiencies
- Loan defaults & debt restructuring
- Denial of credit from suppliers
- Dividend arrearages
- Disposals of substantial assets
- Work stoppages & other labor difficulties
- Legal proceedings or legislation that jeopardizes ongoing operations
- Loss of a key franchise, license, or patent
- Loss of a principal customer or supplier
- An uninsured or underinsured catastrophe
The existence of one or more of these conditions or events does not automatically mean that there is a going concern issue. Similarly, the absence of these conditions or events is not a guarantee that your company will meet its obligations over the next year.
Comply with the new guidance
Compliance with the new accounting standard starts with annual periods ending after December 15, 2016. So, managers of calendar-year entities will need to make the going concern assessment starting with their 2016 year-end financial statements. At KPM, we provide audit and assurance services that provide the information you need about making going concern assessments and how it will affect your financial reporting. Contact us today to see how we can help you.