The following is a contributed article from Bob Dohrer, CPA, chief auditor at the American Institute of CPAs. Opinions expressed are author's own.
As the widespread impact of COVID-19 continues making headlines, we might start to see a new topic spread across the news of private and public companies alike: going concern.
Going concern refers to the concept that financial statements users – investors, employees, customers, lenders, etc. — can expect an entity to continue operating for a reasonable period of time, usually for the next year, given events that have occurred, and conditions that exist, at the time the financial statements are issued. The term sounds ominous, but it is an accounting concept used to help understand an entity's viability.
In a strong economy, entities can lose significant contracts, face cash flow problems, or be in danger of missing loan payments. They stand a good chance of addressing challenges like these by making important business decisions such as working with lending institutions to evaluate their debt obligations or postponing projects for another day. If an entity addresses such challenges, and is able to continue operations for a year or longer, it would still be considered a going concern.
This term has an additional meaning. When substantial doubt exists about the entity's ability to continue as a going concern, the auditor will modify the auditor's report on the financial statements to emphasize this matter to financial statement users. This is sometimes referred to as a "going concern opinion."
Financial statement users may have questions about whether a going concern report modification is a prediction of future failure. While it's difficult to predict the future, it can be reassuring to know that many variables go into a going-concern report modification, including the entity’s industry, sector, financial health, and its sources of liquidity and availability of funding.
Beyond the usual questions
Amid the COVID-19 pandemic, an important element of an entity's ongoing conversation with its auditor will be its ability to pivot during times of stress. The current economic climate, plus our new ways of doing business, will prompt auditors' curiosity about how an entity thrives. They will ask more questions, and seek information that might not have been needed in the past.
For example, auditors might need more details about cash flow projections, including weighted probabilities in uncertain unpredictable times, and balance sheet debt. This does not necessarily imply that a going concern modification will be issued.
Entities should be prepared to provide multiple scenarios and models about their future, if requested by the auditor. While this might require some more work, and possibly difficult conversations, auditors are committed to providing financial statements users with clear and accurate information.
Another important outcome of COVID-19 is a shift to going concern opinions as critical information. In many ways, auditors add credibility to information that provides insight on an entity’s operations and financial health.
Auditors' ability to communicate with boards of directors, audit committees, and other key stakeholders in ensuring the availability of transparent information can bring calm in the midst of great change, even if that includes a going concern opinion.
As chief auditor at the American Institute of CPAs, I speak with private company, non-profit and government auditors with questions about COVID-19, and the possibility a client might not be able to continue as a going concern. In a recent Journal of Accountancy article I co-authored, I provided this advice to auditors and those charged with governance:
- Assess whether COVID-19 created doubts about whether the entity can continue as a going concern.
- Review management’s evaluation, and determine whether it is complete and accurate.
- If management has substantial doubt that the entity can continue as a going concern, this should be disclosed in the financial statement notes – regardless of whether the doubt is alleviated by any recovery plans.
- Evaluate management’s plans to address the substantial doubt. Assess how this might impact the auditor’s report.
- Does management’s plan alleviate substantial doubt? If so, an unmodified opinion may be issued.
- If the going concern basis of accounting is appropriate but substantial doubt remains, an emphasis-of-matter paragraph is required.
- If the going concern basis of accounting is not appropriate, an adverse opinion should be issued.
We cannot predict — try as we might — what our economy will look like at the end of 2020. Auditors, boards and management are finding new ways of working together and independently, embracing new technology. As we move past the pandemic's peak, everyone must remain focused on financial statement users' needs, because they need transparency now more than ever.
End note: The AICPA Auditing and Attestation Standards, which apply to the audit reports of those organizations not required to undergo a Public Company Accounting Oversight Board (PCAOB) audit, address this from a variety of perspectives, including audit evidence, management estimates and materiality. Also, AICPA offers a COVID-19 Audit and Accounting Resources web page for those who wish to learn more about the topics discussed here, and key risks to consider in 2020 year-end audits.