Under US GAAP (generally accepted accounting principles) a company’s continuation as a going concern is presumed when preparing the financial statements. As part of their review of the financial statements, auditors are required to evaluate whether there is a substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time (often 12 months) after the date of the financial statements.
Until recently GAAP did not provide guidance to management regarding management’s responsibility to evaluate whether there exists a substantial doubt about the company’s ability to continue as a going concern. As a result, there have been significant inconsistencies between companies in their evaluation of this issue as well as the related disclosures. Also, without the benefit of guidance, management was often left to rely on the assessment performed by the auditors.
Companies may face unintended negative implications on their business resulting from the auditor’s determination of “substantial doubt” and the inclusion of a going concern qualification in the audit letter. For example, inclusion of a going concern qualification may result in a significant reduction in a company’s D&B Supplier Evaluation Risk Rating (SER). The SER, which predicts the likelihood that a business will seek legal relief from creditors or cease operations in the next 12 months, is relied on by many large retailers to evaluate their vendors. A significant reduction in a company’s SER could result in that company being dropped from the approved vendor list and losing a significant customer.
In August, FASB issued guidance to management in making this evaluation. Based on this guidance, management is required to evaluate on a quarterly basis whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern in the next 12 months. In its guidance FASB defined substantial doubt as: “Substantial doubt about an entity’s ability to continue as a going concern exists when relevant 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 that the financial statements are issued . . . .”
Careful review of the roadmap provided by FASB and analysis by management may help standardize the evaluation and disclosures provided by companies and avoid negative business implications associated with a going concern qualification.
For more information on this topic, please contact Daniele.