Peter Bible CPA
Partner, Public companies group
 

Margaret Gallagher CPA
Director, Public Companies Group
 

FAST FACTS 

• Now an accounting requirement rather than an audit requirement (management needs to assess) 
• Increases the "forecast" period from not to exceed one year after the audit opinion date (for issuers) to at least a 12-month time frame
• Effective for interim or annual periods ending after June 15, 2009 (Q2 for calendar year entities)
• Aligns going concern guidance with international standards

Background 

In another sign of the influence of international accounting standards, U.S. accounting standard setters revised how auditors and company executives will assess a company's ability to continue in existence. The Financial Accounting Standards Board's (FASB) proposed standard on going concern evaluations goes into effect for periods ending after June 15, 2009. The overall essence is how far into the future management and auditors must forecast a company's ability to survive. The unintended timing of its effective date, as our economic downturn ensnares more businesses, will present above-normal challenges. Companies' management are leery - this change is expected to increase going concern opinions, which may unintentionally become a self-fulfilling prophecy…or nightmare. Auditors, already uneasy with this "crystal ball" side to their role, are gearing up for tough judgments.

Existing U.S. audit standards obligated auditors to evaluate a company's ability to continue as a going concern. If, in the auditor's professional judgment, they believed there was "substantial doubt" that a company would not continue in existence for a year beyond the audit opinion date (for issuers), they communicated it through an additional "going concern" paragraph in their audit opinion. This new accounting standard obligates management to conduct this evaluation. Faced with the increasing influence of the judgment-based international accounting standards, and a recognition of the limitations of this old, "bright line" 12 month approach, the FASB saw room for improvement. The critical differences: removing that "bright line" and making this standard management's responsibility.

This standard becomes effective in a tense economic environment. Approximately 20% more public companies were identified as a "going concern" during the fiscal years ended June 30 to December 31, 2008. Investor frauds, financial markets' volatility, government bail-outs, and Chapter 11 bankruptcies have heightened investors' expectations of transparency in financial reporting. These collective factors set the stage for a struggle between management and the auditors' professional obligation to properly identify a company as a "going concern," complicated by limited forecasting abilities, management's desire for clean audit opinions and the investing public's need to know. This new standard throws in an extension of how far out into the future management must consider a company's financial viability. This "extended" management assertion must then be audited by the auditor.

Summary 

Prior U.S. professional literature required auditors to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the audit opinion date (for issuers). International accounting standards require that the entity "consider all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period" in its going concern evaluation. FASB recognized that adopting the international standards' approach would also enhance convergence between U.S. and international accounting standards. This change in the forecast period also illustrates the contrast between international and U.S. accounting standards, the former relying on a heavy dose of professional judgment, and the latter more rule-based.

FASB believed this topic was primarily an accounting, not auditing, matter. Therefore, the related professional guidance should reside in the accounting (ie, FASB) not auditing realm. This aligns with their position that, since management is the preparer of the financial information and thereby subject to FASB's accounting standards, the going concern guidance should be located there, too. This location change emphasizes management's responsibilities for the going concern assessment. Prior to this FASB proposal, authoritative guidance on evaluating the entity's ability as a going concern was .established in U.S. auditing standards, thereby applicable only to auditors of U.S. companies.

The proposed standard would "require that management consider all available information about the future, which is at least, but not limited to, 12 months from the end of the reporting period, when assessing whether the going concern assumption is appropriate." This should avoid the "blinders" effect when a significant event occurs just beyond the previous one year "bright line" created by the former standard. For example, assume a public biopharma company has recurring losses, an accumulated deficit and negative cash flow from operating activities. It has sufficient investor and lenders' financial support to survive exactly one year after the audit opinion date. However, 14 months after such date, the patent protection on its only significant product will expire. The entity had previously sold the generic production rights to this product, and there are no new products in its pipeline to take its place. Under the new FASB standard, management must address the impact of this patent expiration in its going concern assessment.

Other changes in the new standard impact the type of information to be considered when making the going concern assessment (all available information about the future must be evaluated) and requiring an accompanying disclosure when auditors cite a going concern consideration. However, these do not deviate from current practice and we believe these will have little to no impact. See www.fasb.org/draft/ed_going_concern.pdf for the full text of the proposed standard. 

Implementation 

This standard is effective for interim or annual statements ending after June 15, 2009. Q2 filers will be required to adopt this standard.

Alignment with PCAOB 

The PCAOB tasked its Standing Advisory Group (SAG) for input on digesting this new standard. Specifically, auditors of public companies will need guidance on how to apply the new going concern standard to their clients. In April, the PCAOB directed SAG to specifically address:

How would the extension of the time period that an auditor would use to evaluate an entity's ability to continue as a going concern affect the overall audit of an issuer?

Should the PCAOB standard on going concern require the auditor to perform procedures specifically designed to identify conditions and events that indicate that there is substantial doubt about a company's ability to continue as a going concern for a reasonable period of time? If so, what types of specific procedures should the auditor perform in this regard?

What should the auditor's responsibilities be for evaluating an entity's assumptions, such as projected cash flows underlying a forecast, when mitigation of the adverse effects of events or conditions is based on management's forecast?

What, if any, changes should be made to the explanatory paragraph in the auditor's report relating to going concern? For example, should the explanatory paragraph be retained substantially in its current form? Should additional information be added to the explanatory paragraph and, if so, what information? Or should the explanatory paragraph refer only to management's disclosures and conclusions as described in the notes to the financial statements?

What additional changes to the auditing standard on going concern should be considered to assist auditors in conducting an audit of an issuer?

The answers to these questions will shape the PCAOB official guidance. Watch EisnerAmper.com for updates on this issue.

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