Management's evaluation of an entity's ability to ­continue as a going concern

For many years, the only financial statement guidance relating to the evaluation of an entity's ability to continue as a going concern, that is, to continue operating for the foreseeable future, was included in U.S. auditing standards and federal securities laws. Interestingly, although financial statements are prepared by management, until recently there was no requirement for management to evaluate going concern when preparing the statements. Instead, U.S. Generally Accepted Auditing Standards (GAAS) required an auditor to consider if there was substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. If substantial doubt existed, or existed but was mitigated by management's plans, certain financial statement disclosures were required. Due to the fact that there was little guidance on what constituted "substantial doubt" and on differing interpretations, in practice, footnote disclosures were often very diverse. In August 2014, FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern to provide guidance on management's requirement to evaluate going concern and provide guidance for consistency in footnote disclosures, as well as define the term "substantial doubt". ASU 2014-15 is effective for fiscal years ending on or after December 15, 2016 (for many organizations this is effective for upcoming December 31, 2016 year-ends), although earlier application is permitted for entities desiring to do so. With issuance of this ASU, responsibility for evaluating going concern is now included in U.S. GAAP and therefore rests with management in connection with preparation of financial statements. The evaluation of an entity's ability to continue as a going concern must be considered for at least one year after the date the financial statements are issued (or available to be issued) for audited financial statements, this is generally one year from the auditor's opinion date. Factors management must consider when making their assessment include: - Negative trends in operating results, such as a series of losses - Liquidity concerns - Loan defaults by the entity - Denial of trade credit to the entity by suppliers - Conditional and unconditional obligations due or anticipated to become due - Legal proceedings against the entity Management must evaluate whether or not substantial doubt about the entity's ability to continue as a going concern exists. Substantial doubt is defined as "when conditions or events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date the financial statements are issued". In the initial assessment of substantial doubt, potential mitigating plans, such as a capital raise, refinance of debt, or sale of assets, should not be considered. If management's evaluation determines it is probable that substantial doubt exists, without regard to mitigating factors, management must then consider whether or not any mitigating factors alleviate the substantial doubt. Mitigating factors can be considered only when it is probable that those factors will be effectively implemented within one year of the date of the financial statements. Also, actual implementation of any specific mitigating plans of management must be feasible within the one year timeframe in order to be included in the evaluation. Should substantial doubt exist but be deemed adequately mitigated through management's plans, the entity must disclose in the financial statement footnotes information which allows the reader to understand the following items: - Significant conditions or events which raised the substantial doubt; - Management's evaluation of those conditions or events as they relate to the ability of the entity to meet its obligations; and - Management's plans which alleviate the substantial doubt. If management's plans are not able to mitigate the substantial doubt, the entity must include all of the above disclosures as well as a statement that there is substantial doubt about the ability of the entity to continue as a going concern within one year after the date the financial statements are issued. In extreme situations, where the entity's liquidation becomes imminent, the going concern threshold is no longer met and the liquidation basis of accounting must be used instead. Although with issuance of ASU 2014-15 management became responsible for evaluating going concern, the ASU did not change existing auditing standards. Auditors must still evaluate management's plans to determine if a going concern explanatory paragraph is necessary in the auditor's opinion. Due to the changes from ASU 2014-15, management should consider developing internal procedures relating to the evaluation of the entity's ability to continue as a going concern and the development of any required footnotes. ----- Jackie Lee, CPA, is a principal with Mengel, Metzger, Barr & Co. LLP. She may be reached at Jlee@mmb-co.com. Published: Wed, Jul 27, 2016