Month: January 2022

Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. A financial auditor is hired by a business to evaluate whether its assessment of going concern is accurate. After conducting a thorough review (audit) of the business’s financials, the auditor will provide a report with their assessment. It is possible for a company to mitigate an auditor’s view of its going concern status by having a third party guarantee the debts of the business or agree to provide additional funds as needed. By doing so, the auditor is reasonably assured that the business will remain functional during the one-year period stipulated by GAAS. This makes it easy for a parent company to ensure that its subsidiaries are always classified as going concerns.

Conditions that lead to substantial doubt about a going concern include negative trends in operating results, continuous losses from one period to the next, loan defaults, lawsuits against a company, and denial of credit by suppliers. An adverse opinion states that the financial statements do not present fairly (or give a true and fair view). This opinion will be expressed regardless of whether or not the financial statements include disclosure of the inappropriateness of management’s use of the going concern basis of accounting. The auditor will consider the adequacy of the disclosures made in the financial statements by management.

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Impact on your credit may vary, as credit scores are independently determined by credit bureaus based on a number of factors including the financial decisions you make with other financial services organizations. When an auditor issues a going concern qualification, the way their opinion is disclosed depends on the structure of the business. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value.

• However, in our view, there is no general dispensation from the measurement, recognition and disclosure requirements of the Standards in this case, and these requirements are applied in a manner appropriate to the circumstances.
• The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value.
• This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research.
• The concept of going concern is particularly relevant in times of economic difficulties and in some situations management may determine that a profitable company may not be a going concern, for example because of significant cash flow difficulties.
• A negative judgment may also result in the breach of bank loan covenants or lead a debt rating firm to lower the rating on the company’s debt, making the cost of existing debt increase and/or preventing the company from obtaining additional debt financing.
• For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

Understanding whether an entity is a going concern is a key concern for management, investors and auditors. Stakeholders want to understand how viable and resilient an entity is to current and future stresses. If there are any material uncertainties relating to the going concern assumption, then management must make adequate going concern disclosures in the financial statements. At the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company. An entity is assumed to be a going concern in the absence of significant information to the contrary.

What is the Liquidation Valuation Method? (Fire Sale)

Going concern is not included in the generally accepted accounting principles (GAAP) but is included in the generally accepted auditing standards (GAAS). Although US GAAP is more prescriptive than IFRS Standards, we do not expect significant differences in the types of events or conditions management would consider when assessing going concern under both GAAPs. This includes information known or reasonably knowable at the date the financial statements are issued (or going concern meaning available to be issued). In both cases a paragraph explaining the basis for the qualified or adverse opinion will be included after the opinion paragraph and the opinion paragraph will be qualified ‘except for’ or express an adverse opinion. If a company’s liquidation value – how much its assets can be sold for and converted into cash – exceeds its going concern value, it’s in the best interests of its stakeholders for the company to proceed with the liquidation.

• At the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company.
• No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.
• The directors have no realistic alternative but to liquidate in order to raise funds to pay back the bank and the bank have already confirmed that they will commence legal proceedings to force the entity into selling off assets to raise finance to repay their borrowings.
• If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board.
• A going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due.

The entity is already in breach of its agreed overdraft and the bank has refused to renew the borrowings. The entity has also been unsuccessful in applying to other financial institutions for re-financing. It is highly unlikely that the entity will be successful in renewing or re-financing the $10m borrowings and, in such an event, the directors will have no alternative but to cease to trade.

How a going concern qualification affects a business

Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis. If there’s significant evidence that a privately held business might not be viable under the going concern assumption, the auditor must disclose it in the audit report. Even if the business’s financials aren’t audited, an accountant who has concerns about the business’s viability should disclose those concerns to the business owner.

If the auditor concludes that the disclosures are inadequate, or if management have not made any disclosure at all and management refuse to remedy the situation, the opinion will be qualified or adverse. Many candidates fall into the trap of relying on ‘discussions with management/directors’ and ‘obtaining a written representation’. Candidates must appreciate that while discussion/inquiry is a valid audit procedure under ISA 500, Audit Evidence, such a procedure is always used in addition to other procedures – in other words, inquiry on its own will not generate sufficient appropriate audit evidence. Similarly ISA 580, Written Representations recognises that while written representations do provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal.