Growing ConcernPresented by:

Brad E. Muniz, CPA

Definition

What is going concern?

The going concern assumption is a basic underlying assumption of accounting. For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, objectives, and so on. In other words, the company will not have to liquidate or be forced out of business. If there is uncertainty as to a company's ability to meet the going concern assumption, the facts and conditions must be disclosed in its financial statements.

AU-C 570 – Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for a reasonable period of time.

Auditor

Accountant (Review/Compilation)

Management

Who is Responsible?

August 2014 – ASU 2014-15; Presentation of Financial Statements – Going Concern

• Applies to all entities

• Effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter

Management evaluation codified under ASC 205-40

Management

Management is required to evaluate for each annual and interim reporting period whether it is probable that the entity will not be able to meet its obligations as they become due within one year after the date that financial statements are issued (or are available to be issued, where applicable).

Management

When management identifies substantial doubt about the entity’s ability to continue asa going concern, management should consider whether its plans to mitigate conditionswill alleviate the substantial doubt.

Substantial Doubt about an Entity’s Ability to Continue as a Going Concern

Substantial doubt about an entity’s ability to continue as a going concern exists whenconditions and events, considered in the aggregate, indicate that it is probable (thefuture event or events are likely to occur) that the entity will be unable to meet itsobligations as they become due within one year after the date that the financialstatements are issued (or within one year after the date that the financial statementsare available to be issued when applicable).

Management

Examples of Adverse Conditions and Events (not all inclusive):

a. Negative financial trends, for example, recurring operating losses, working capitaldeficiencies, negative cash flows from operating activities, and other adverse keyfinancial ratios

b. Other indications of possible financial difficulties, for example, default on loans orsimilar agreements, arrearages in dividends, denial of usual trade credit fromsuppliers, a need to restructure debt to avoid default, noncompliance with statutorycapital requirements, and a need to seek new sources or methods of financing or todispose of substantial assets

c. Internal matters, for example, work stoppages or other labor difficulties, substantialdependence on the success of a particular project, uneconomic long-termcommitments, and a need to significantly revise operations

d. External matters, for example, legal proceedings, legislation, or similar matters thatmight jeopardize the entity’s ability to operate; loss of a key franchise, license, orpatent; loss of a principal customer or supplier; and an uninsured or underinsuredcatastrophe such as a hurricane, tornado, earthquake, or flood.

Management

When evaluating an entity’s ability to meet its obligations, management shallconsider quantitative and qualitative information about the followingconditions and events, among other relevant conditions and events knownand reasonably knowable at the date that the financial statements are issued:

a. The entity’s current financial condition, including its liquidity sources(for example, available liquid funds and available access to credit)

b. The entity’s conditional and unconditional obligations due or anticipatedwithin one year after the date that the financial statements are issued(regardless of whether those obligations are recognized in the entity’sfinancial statements)

c. The funds necessary to maintain the entity’s operations considering itscurrent financial condition, obligations, and other expected cash flows

d. The other conditions and events, when considered in conjunction with(a), (b), and (c) above, that may adversely affect the entity’s ability tomeet its obligations within one year after the date that the financialstatements are issued.

Management

Examples of plans that management may implement to mitigate conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern (not all inclusive):

a. Dispose of an asset or businessb. Borrow money or restructure debtc. Reduce or delay expendituresd. Increase ownership equity

The mitigating effect of management’s plans should be considered only to the extent that (1) it is probable that the plans will be effectively implemented and, if so, (2) it is probable that the plans will mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

Management

Management

Disclosures When Substantial Doubt Is Raised but Is Alleviated by Management’s Plans (Substantial Doubt Does Not Exist):

a. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)

b. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations

c. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

Management

Disclosures When Substantial Doubt Is Raised and Is Not Alleviated(Substantial Doubt Exists):

a. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern

b. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations

c. Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

ImportantInclude a statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued

Management

Sample Disclosure:

NOTE 2—GOING CONCERN MATTERSThese consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business. The terms of theCompany’s credit facility require, among other things, compliance withcertain financial ratios, including a funded debt ratio and a fixed chargecoverage ratio, on a quarterly basis. As a result of restructuring and assetimpairment charges incurred during fiscal 20X2, the Company was not incompliance with the fixed charge coverage ratio and minimum net incomecovenants under the credit facility as of and for the quarter endedSeptember 30, 20X2. As a result, in December 20X2, the Company’s lendersissued a notice of default, although no acceleration of outstanding debt wasrequested. At December 31, 20X2, the Company did not have sufficientfunds to pay all outstanding indebtedness, and the Company’s 20X2consolidated financial statements disclosed that this indicated substantialdoubt about the Company’s ability to continue as a going concern within oneyear from the date those financial statements were available to be issued.

Management

Sample Disclosure:

During April 20X3, the Company successfully negotiated an amendmentof its credit facility that limits its borrowing capacity to $2.5 million, callsfor interest rate increases periodically, retains the August 1, 20X6,maturity date of the credit facility, and waives all existing events ofdefault as of the amendment date.

A breach of any of the terms and conditions of the amended creditfacility agreement could result in acceleration of the Company’sindebtedness, in which case the debt would become immediately due andpayable. Although no assurances can be given, the Company expects thatit will be in compliance throughout the term of the amended creditfacility with respect to the financial and other covenants, including thoseregarding funded debt ratio, fixed charge coverage ratio, minimum year-to-date net income, tangible net worth, capital expenditure limits, andnew lease limits. The Company also believes that cash generated fromoperations will be sufficient to satisfy its currently budgeted capitalexpenditure and debt service requirements through 20X4 and that noadditional funding will be necessary.

Accordingly, the going concern doubts that existed at the end of theprior year have been alleviated as of December 31, 20X3.

Management

Both IFRS and GAAP emphasize that management is responsible for evaluating and disclosing uncertainties about an entity’s ability to continue as a going concern.

Under IFRS, financial statements are prepared on a going concern basis “unless management either intends to liquidate the entity or to cease trading [operations], or has no realistic alternative but to do so”.

Under IFRS, disclosures are required when management is aware of material uncertainties related to events and conditions that may cast significant doubt about an entity’s ability to continue as a going concern. Under the amendments to GAAP, disclosures are required when there is substantial doubt about an entity’s ability to continue as a going concern or when substantial doubt is alleviated as a result of consideration of management’s plans.

Under IFRS, the assessment period is at least one year from the financial statement date (balance sheet date) with no upper time limit. Under the amendments to GAAP, the assessment period is within one year after the date that the financial statements are issued (or available to be issued).

IFRS –v -GAAP

AU-C Section 570 – The Auditor's Consideration of an Entity's Abilityto Continue as a Going Concern

Source: SAS No. 132, of the same title

Effective for audits of financial statements for periods ending on or after December 15, 2017

AUDIT

The auditor's responsibilities to perform the following:

a. Conclude, based on the audit evidence obtained, whether substantial doubt exists about an entity's ability to continue as a going concern for a reasonable period of time

b. Evaluate the possible financial statement effects, including the adequacy of disclosure regarding the entity's ability to continue as a going concern for a reasonable period of time

Reasonable period of time. The period of time required by the applicable financial reporting framework or, if no such requirement exists, within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable).

AUDIT

When Management Is Required to Make a Specific Evaluation Under the Applicable Financial Reporting Framework (i.e. GAAP)

Management's evaluation of the entity's ability to continue as a going concern for a reasonable period of time involves making a judgment, at a particular point in time, about inherently uncertain future outcomes of conditions or events. The following factors are relevant to that judgment:

a. The degree of uncertainty associated with the outcome of a condition or event increases significantly the further into the future a condition or event or the outcome occurs. For that reason, most financial reporting frameworks that require an explicit management evaluation specify the period for which management is required to take into account all available information.

b. The size and complexity of the entity, the nature and condition of its business, and the degree to which it is affected by external factors affect the judgment regarding the outcome of conditions or events.

c. Any judgment about the future is based on conditions or events that are known and reasonably knowable at the date that the financial statements are issued (or at the date that the financial statements are available to be issued, when applicable). Subsequent events may result in outcomes that are inconsistent with judgments that were reasonable at the time they were made.

AUDIT

When Management Is Not Required to Make a Specific Evaluation Under the Applicable Financial Reporting Framework

In other financial reporting frameworks, there may be no explicit requirement for management to make a specific assessment of the entity's ability to continue as a going concern. Nevertheless, when the going concern basis of accounting is a fundamental principle in the preparation of financial statements, the preparation of the financial statements requires management to assess the entity's ability to continue as a going concern even if the financial reporting framework does not include an explicit requirement to do so.

AUDIT

Risk Assessment Procedures and Related Activities

In planning stage, in accordance with Section 315, the auditor should consider whether conditions/events raise substantial doubt, and the following regarding management’s evaluation:

a. If such an evaluation has been performed, the auditor should discuss the evaluation with management and determine whether management has identified conditions or events that raise substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time and, if so, understand management's plans to address them.

b. If such an evaluation has not yet been performed, the auditor should discuss with management the basis for the intended use of the going concern basis of accounting and inquire of management whether conditions or events exist that raise substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time.

AUDIT

Reviewing management’s plan:

a. Address management's evaluation of whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time.

b. Cover the same period as that used by management in its evaluation as required by the applicable financial reporting framework.

c. Include consideration of whether management's evaluation includes all relevant information of which the auditor is aware as a result of the audit

The auditor should inquire of management regarding its knowledge of conditions or events beyond the period of management's evaluation that may have an effect on the entity's ability to continue as a going concern

AUDIT

Additional audit procedures:

a. Requesting management to make an evaluation when management has not yet performed an evaluation

b. Evaluating management's plans in relation to its going concern evaluation, with regard to whether it is probable thati. management's plans can be effectively implemented andii. the plans would mitigate the relevant conditions or events that raise substantial

doubt about the entity's ability to continue as a going concern for a reasonable period of time

c. When the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in evaluating management's plans,i. evaluating the reliability of the underlying data generated to prepare the forecast

andii. determining whether there is adequate support for the assumptions underlying the

forecast, which includes considering contradictory audit evidenced. Considering whether any additional facts or information have become available since

the date on which management made its evaluation

AUDIT

Third party support letter:The purpose of the support letter from supporting parties is to provide sufficient appropriate audit evidence about the supporting parties' intent to provide financial support to the entity.

Example:

(Supporting party name) will, and has the ability to, fully support the operating, investing, and financing activities of (entity name) through at least one year and a day beyond [insert date] (the date the financial statements are issued or available for issuance, when applicable).

Note: the auditor must determine the accuracy of the statements made therein.

AUDIT

Management representations:

a. A description of management's plans that are intended to mitigate the adverse effects of conditions or events that indicate there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time and the probability that those plans can be effectively implemented

b. That the financial statements disclose all the matters of which management is aware that are relevant to the entity's ability to continue as a going concern for a reasonable period of time, including principal conditions or events and management's plans

AUDIT

Auditors responsibility:

Ultimately, the auditor is responsible to evaluate a) management’s plan and b) adequacy of disclosure.

Reporting:

If the financial statements have been prepared using the going concern basis of accounting but, in the auditor's judgment, management's use of the going concern basis of accounting in the preparation of the financial statements is inappropriate, the auditor should express an adverse opinion.

If, after considering identified conditions or events and management's plans, the auditor concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time remains, the auditor should include an emphasis-of-matter paragraph in the auditor's report

AUDIT

Reporting (continued):

If adequate disclosure about an entity's ability to continue as a going concern for a reasonable period of time is not made in the financial statements, the auditor should express a qualified opinion or adverse opinion, as appropriate.

If management is unwilling to perform or extend its evaluation to meet the period of time required by the applicable financial reporting framework when requested to do so by the auditor, the auditor should consider the implications for the auditor's report.

If substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time existed at the date of prior period financial statements that are presented on a comparative basis and that doubt has been removed in the current period, the going concern emphasis-of-matter paragraph included in the auditor's report on the financial statements of the prior period should not be repeated.

AUDIT

Reporting example:

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note X tothe financial statements, the Company has suffered recurring losses fromoperations, has a net capital deficiency, and has stated that substantial doubtexists about the Company's ability to continue as a going concern.Management's evaluation of the events and conditions and management'splans regarding these matters are also described in Note X. The financialstatements do not include any adjustments that might result from theoutcome of this uncertainty. Our opinion is not modified with respect tothis matter.___________________________________________________________

As discussed in Note X to the financial statements, the Company hassuffered recurring losses from operations and has a net capital deficiency.Management's evaluation of the events and conditions and management'splans to mitigate these matters are also described in Note X. Our opinion isnot modified with respect to this matter.

AUDIT

Communication with governance:

a. Whether the conditions or events, considered in the aggregate, that raise substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time constitute substantial doubt

b. The auditor's consideration of management's plans

c. Whether management's use of the going concern basis of accounting, when relevant, is appropriate in the preparation of the financial statements

d. The adequacy of related disclosures in the financial statements

e. The implications for the auditor's report

AUDIT

AR-C Section 90 – Review of Financial Statements

Source: SSARS No. 24, OMNIBUS STATEMENT ON STANDARDS FOR ACCOUNTING AND REVIEW SERVICES —2018

Generally, effective for reviews of financial statements for periods ending on or after June 15, 2019

REVIEW

The accountant should perform review procedures related to the following:

a. Whether the going concern basis of accounting is appropriate

b. Management's evaluation of whether there are conditions or events that raised substantial doubt about the entity's ability to continue as a going concern

c. If there are conditions or events that raised substantial doubt about the entity's ability to continue as a going concern, management's plans to mitigate those matters

d. The adequacy of the related disclosures in the financial statements

REVIEW

Requires the accountant to include an emphasis-of-matter paragraph in the accountant's review report if, after considering conditions or events and management's plans, the accountant concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time

If adequate disclosure about an entity's ability to continue as a going concern for a reasonable period of time is not made in the financial statements, the accountant should apply paragraphs .56-.60 regarding known departures from the applicable financial reporting framework

REVIEW

AR-C Section 80 – Compilation Engagements

Source: SSARS No. 23, OMNIBUS STATEMENT ON STANDARDS FOR ACCOUNTING AND REVIEW SERVICES —2016

Effective for compilations of financial statements for periods ending on or after December 15, 2015

COMPILATION

Financial statements may be misleading, for example, if the applicable financial reporting framework includes the premise that the financial statements are prepared on the going concern basis, and undisclosed uncertainties exist regarding the entity's ability to continue as a going concern. If the accountant becomes aware that uncertainties exist regarding the entity's ability to continue as a going concern, the accountant may suggest additional disclosures concerning the entity's ability to continue as a going concern in order to avoid the financial statements being misleading.

Disclosure of items, such as an uncertainty, is not required in financial statements in which substantially all the disclosures required by the applicable financial reporting framework are omitted.

COMPILATION

• March 1981 – SAS 34; The Auditor's Considerations When a Question Arises About an Entity's Continued Existence

• April 1988 – SAS 59; The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern

• July 2012 – SAS 126; The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern

• August 2014 – ASU 2014-15; Presentation of Financial Statements – Going Concern

• February 2017 – SAS 132; The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern

• May 2018 – SSARS 24; Omnibus Statement on Standards for Accounting and Review Services

BRIEF HISTORY

• Significant impact on operations, and possibility to recover

• Consider that cash flow and other projections may be volatile and difficult to calculate

• Delay in issuing financial statements• Reason• Affect on audit procedures• Significant delay (AU-C 570.31)

• Extend audit procedures• Perform additional audit procedures

• Effect on banking relationships

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brad.muniz@sobelcollc.com