Why Your Auditor Seems More Interested in Your Organization’s Ability to Continue as a Going Concern

Four years ago, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-15 (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, which rewrote the rules for an organization’s requirement to consider its ability to continue as a going concern. These new rules were effective for reporting periods ending after December 15, 2016. Organizations with December 31 year ends have now implemented this guidance for one year.

What is Going Concern?

Going concern is not a new concept in accounting. In fact, it is a key principle in the preparation of financial statement in accordance with accounting principles generally accepted in the United States (U.S. GAAP). Going concern implies the organization will be able to continue as “a going concern” for a reasonable period of time. A reasonable period of time is defined as one year from the date the financial statements were issued.

If there is substantial doubt about an organization’s ability to continue as a going concern for a reasonable period of time, the organization would be required to disclose to its auditors the events or conditions that raise substantial doubt, develop a plan to alleviate the conditions or events, and adequately disclose the conditions or events and management’s plans to alleviate them.

How is “Substantial Doubt” Defined?

The FASB defines “substantial doubt” exists when conditions and 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 that the financial statements were issued. This standard puts explicit responsibility on the organization’s management to make its own assessment about its ability to continue as a going concern.

However, these rules did not change the requirements for auditors. Auditors continued to follow Statement on Auditing Standards No. 126 (SAS 126), The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern. Under this standard, auditors were required to consider an organization’s ability to continue as a going concern for a reasonable period of time, which was defined as one year from the reporting date, not the date the financial statements were issued. This resulted in a mismatch in the going concern considerations that management was required to make under Financial Accounting Standards and the going concern considerations auditors were required to make under Auditing Standards.

In 2017, the AICPA Auditing Standards Board (ASB) issued Statement on Auditing Standards No. 132 (SAS 132), The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern. The purpose of this new SAS was to bring auditor requirements up-to-date with ASU 2014-15.

Below is a summary of key provisions of SAS 132:

• Effective Date: For audits of financial statements for periods ending on or after December 31, 2017.
• The auditor is required to perform a separate analysis and independently conclude whether there is substantial doubt about an organization’s ability to continue as a going concern.
• The auditor is required to determine whether management used the appropriate basis of accounting if there is substantial doubt about the organization’s ability to continue as a going concern.
• The auditor is required to obtain sufficient appropriate audit evidence necessary to support the assertion made by management (management’s assertion under ASU 2014-15) about the organization’s ability to continue as a going concern for a reasonable period of time.
• The auditor is required to inquire with management about conditions or events beyond the period of management’s evaluation that may have an effect on the organization’s ability to continue as a going concern.
• The auditor needs to evaluate management’s disclosures for accuracy.
• The auditor must determine the effect on the financial statements and auditor’s report.
• The auditor must communicate the evaluation with those charged with governance.

To meet this requirement, beginning with years ending on or after December 31, 2017, your auditors are likely going to be digging deeper than usual when it comes to their going concern analysis. Previously, if there was substantial doubt about an organization’s ability to continue as a going concern, auditors could wait to issue the audit until after one year had passed since the financial reporting date. Now, auditors have to consider the organization’s ability to continue as a going concern for one year from the date the financial statements were issued.

For example, your organization’s year end is December 31, 2017 and your audit is issued on March 24, 2018. Under the old standard, SAS 126, the auditors would be required to assess your organization’s ability to continue as a going concern through December 31, 2018. Under SAS 132, the auditors are required to assess your organization’s ability to continue as a going concern through March 24, 2019.

This update increases the risk for auditors and therefore, to mitigate that risk, auditors will be paying much closer attention to your organization’s performance and any liquidity issues. Your auditors may request written evidence from third parties who have made commitments to your organization (donors, lenders, guarantors, etc.). Similar to auditing other balances or transactions, auditors may also request sending confirmations to those third parties to verify independently that those commitments are bona fide.

At the end of the day, this newly effective standard brings the auditors in line with the requirements already implemented by organizations. There will be more consistency between the responsibilities of management and external auditors. Most importantly, however, there will be more clarity and transparency to the users of the financial statements.

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