Warning: Going concern opinions reach all-time high

After trending downward prior to the pandemic, going concern opinions increased substantially in fiscal year 2021, according to a recent report by Audit Analytics. Here’s an overview of the going concern assumption and the responsibility to identify “substantial doubt” about a company’s ability to operate as a going concern over the next year.

Evaluating future viability

The going concern assumption underlies all financial reporting under U.S. Generally Accepted Accounting Principles (GAAP). It presumes that a company will continue normal business operations into the future. However, when liquidation is imminent, the liquidation basis of accounting is used instead.

The final responsibility to decide whether there’s a going concern issue and provide related footnote disclosures shifted from external auditors to the company’s management, under Accounting Standards Update (ASU) 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.

Essentially, the going concern accounting standard requires management to decide 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. (Alternatively, this assumption may be assessed within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).

Defining substantial doubt

Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:

·??????Recurring operating losses,

·??????Working capital deficiencies,

·??????Loan defaults,

·??????Asset disposals, and

·??????Loss of a key franchise, customer or supplier.

Financial distress experienced during the pandemic could have caused these types of adverse conditions or events, leading to an uptick in going concern issues for the 2021 fiscal year.

After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.

Applying a consistent approach

The Auditing Standards Board’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, is intended to promote consistency between the auditing standards and accounting guidance under GAAP. The current standard requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. The standard also calls for auditors to conclude on the appropriateness of management’s assessment.

The evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level. So, the going concern auditing standard doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts or items of a financial statement.

Your auditor’s role

Management must provide appropriate documentation to prove to external auditors that its going concern assessment is reasonable and complete. Due to continued market volatility in 2022 and beyond, auditors are likely to scrutinize this assessment closely in the upcoming audit season.

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Sidebar: Going Concern: Audit Opinion Trends

Audit Analytics reviewed the population of audit opinions filed with the Securities and Exchange Commission (SEC) as of November 2022 to determine the number of opinions qualified by an uncertainty regarding the going concern assumption.

Prior to fiscal year 2021, going concern opinions had been declining after peaking during the Great Recession of 2008. In fiscal year 2008, there were 2,853 going concern opinions (28.3% of the total opinions). By fiscal year 2020, the number of going concern opinions had fallen to 1,320 (18.4% of the total opinions). However, the downward trend reversed in fiscal year 2021 with 1,674 companies receiving going concern opinions — an increase of 26.8% over fiscal year 2020. The number of going concern opinions in the current fiscal year is similar to fiscal year 2016.

Industries with significant growth in going concern opinions from fiscal year 2020 to fiscal year 2021 include:

·??????Finance,

·??????Wholesale trade,

·??????Manufacturing, and

·??????Construction.

In addition, fiscal year 2021 saw the highest number of new company going concern opinions since fiscal year 2008. These are companies that received a going concern opinion in their first annual report opinion. In fiscal year 2021, there were 395 new company going concern opinions issued, and 59% of going concern increases came from new companies with a going concern opinion in their first annual report.

In contrast, the number of new going concern opinions increased to 276 during fiscal year 2021— the highest number of new going concern opinions since fiscal year 2009. These are companies that received a clean opinion for the prior fiscal year and received a going concern opinion for the current fiscal year.?

Please contact DLA if you need assistance with the going concern assessment.