Yesterday, FASB issued an Accounting Standards Update (ASU) regarding the disclosure of uncertainties about a company’s ability to continue as a going concern. ASU 2014-15 “provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes.”
As background, GAAP presumes that an entity will continue as a going concern until the entity’s “liquidation becomes imminent,” at which point preparation of the financial statements changes from a going-concern basis to a liquidation basis. In between those two states, there will be situations where there is “substantial doubt” about the entity’s ability to continue as going concern. Prior to issuance of the ASU, GAAP did not provide any guidance about the responsibility of management to evaluate or provide disclosures about this issue, and there was a distinct lack of uniformity in disclosures. (There is, however, some guidance under U.S. auditing standards and federal securities laws. For example, the SEC has specified disclosures that it expects to see when an auditor’s report includes a going-concern qualification.) The new ASU provides guidance to help determine whether to disclose additional information about the relevant conditions and events when there may be substantial doubt.
FASB indicates that it is providing this new guidance in response to concerns expressed about inconsistent approaches to the going-concern issue. And, as noted in these two articles from the WSJ, investors had become “frustrated with a lack of going concern opinions during the financial crisis that failed to warn them of impending bankruptcies.” According to a study reported in the article, only “about 40% of companies that filed for bankruptcy in the past two decades have explicitly disclosed the possibility that they could cease to operate before running into trouble….” One commentator observed in the article that a “going concern warning from an auditor is rarer than a hen’s teeth….You have to be dangling off a cliff, hanging on by your fingernails before the auditor blows the whistle….” Going-concern opinions from auditors are provided only once a year, and auditors “have varied significantly from year-to-year in their ability to use the going concern opinion as a warning to investors over the past few years. Market shifts have led to more rapid bankruptcies that are not as easy to detect 12 months in advance. Also, as auditors have grown more worried about their legal liability, they have been seen as less willing to give out negative going concern opinions that might make bankruptcy inevitable once they are issued.” The new ASU will impose obligations on management, and proponents of the ASU contend that management has “better information about a company’s ability to continue financing their operations than auditors.”
The ASU states that management should conduct an evaluation, based on known and reasonably knowable information, in connection with preparing its annual and interim financial statements to determine “whether there are conditions or events, considered in the aggregate, that raise 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.
The test for “substantial doubt” is based on probability (consistent with Topic 450, Contingencies): that is, do 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”? If so, “management should consider whether its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. 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.”
Disclosure will be required even if consideration of management’s plans does alleviate “substantial doubt.” In that event, the entity will be required to disclose the following:
- Principal conditions or events that raised “substantial doubt”;
- Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations; and
- Management’s plans that alleviated the substantial doubt.
If substantial doubt is not alleviated as a result of consideration of management’s plans, the entity will be required to state in the footnotes “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.” The entity will also need to disclose the same information as required above, except that, instead of discussing the plans that alleviatedthe substantial doubt, the response would be framed as a discussion of management’s plans intended to mitigate the conditions or events that raise substantial doubt.
The ASU will be effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.