Management’s Role in Going Concern Doubts

by James Rebenar, Audit Manager 

Posted on July 7, 2015

Going concern; it’s a discussion that management hopes to never have, and one of the more difficult subjects to broach as an auditor. Prior to FASB’s issuance of Accounting Standards Update No. 2014-15 in August 2014, there was no clear guidance on the going concern concept in Generally Accepted Accounting Principles. However, as a result of the new issuance, we know now that FASB defines substantial doubt about an entity’s ability to continue as a going concern to exist 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 the financial statements are issued.

So what does this mean for management? For each annual reporting period, management and the auditors are required to evaluate whether conditions and events exist that raise substantial doubt about the organization’s ability to continue as a going concern. Some examples of these conditions and events could include:

  • Defaulting on debt
  • Negative trends in operating results, such as reoccurring losses or negative cash flows
  • Significant legal proceeding against the organization

These conditions are considered in the aggregate. Once it is determined they give rise to substantial doubt management must provide the auditors with a plan to mitigate the effect of such conditions. Common strategies included in management’s plan are:

  • Debt restructuring or other plans to borrow money
  • Delaying or reducing expenditures
  • Disposing of assets

The auditor’s responsibility after receiving management’s plan is to assess the likelihood that the plan can be effectively implemented and if it will mitigate the conditions or events which raise the substantial doubt. Whether or not the auditor believes the plan is adequate to aleve substantial doubt, the financials must include disclosures to inform readers of:

  1. the principal conditions or events that raised substantial doubt
  2. management’s evaluation of the significance of those conditions or events, and
  3. management’s plans that either alleviated the substantial doubt or were intended to mitigate the conditions which raised the substantial doubt.

Although not a death sentence, management should prepare for an adverse response to receiving an explanatory paragraph in the auditor’s report describing an uncertainty about their ability to continue as a going concern. Beyond the expected reaction from the organization’s board, it is not uncommon to see a subsequent decrease in contributions, particularly in funding through government grants. On the other hand, studies have shown that there is little correlation between a going concern audit report and an organization’s receipt of public support. In all likeliness this may be due to the small number of donors who actually take the time to read the audited financials of the NPOs that they support.

In any case, the best response by management in a going concern situation is to remain calm and work with their auditors to ensure they provide them with as much evidence as they can to alleviate the substantial doubt. If management feels a going concern discussion is forthcoming, the best idea is to be proactive and develop a plan prior to the start of the audit. The more prepared that management is both physically and mentally, the less stress it will cause during the audit and the better chance of avoiding a modified audit opinion.