The Going Concern Assumption: Critical Issues for Auditors

By Tsay, Bor-Yi; Chen, Sean | The CPA Journal, December 2015 | Go to article overview

The Going Concern Assumption: Critical Issues for Auditors


Tsay, Bor-Yi, Chen, Sean, The CPA Journal


The managements of business entities must make some fundamental assumptions before they issue financial reports for external users. If these assumptions are not substantiated, all of their financial reports will become misleading. In the authors' view, the credibility of the financial reports relies heavily on the validity of these assumptions, which is in agreement with FASB's guidance (Accounting Standards Update 2014-15, BC9).

The going concern assumption has been under scrutiny in large part due to the economic upheavals of the past decade. Business failures, such as General Motors (GM) and Lehman Brothers, and accounting scandals including Enron and WorldCom have cast doubt in the minds of the general public and regulators on the trustworthiness of financial reports issued by management and audited by CPAs. The accounting profession has been reevaluating its practices in financial accounting and auditing in order to restore the confidence of the general public.

In August 2014, FASB released "Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern" (ASU, ASC subtopic 205-40). The preceding exposure drafts of the guidance generated heated debates in respondents' comments. The fact that FASB has repeatedly tried to work out a new standard on going concern reveals the complexity of the topic.

Auditors ere required to follow Statement on Auditing Standards (SAS) 59 on going concerns, as updated by SAS 126, which is codified as AU-C 570. For public companies, the PCAOB grandfathered SAS 59 into its standards, which is codified as AU 341. However, PCAOB's investor sub-advisory group, in its "Going Concern Considerations and Recommendations," published March 28, 2012, was critical of tiie existing rules in AU 341. Furthermore, going concern is listed on the PCAOB's future standards setting agenda.

Outside the United States, business entities preparing financial statements must follow International Accounting Standard (IAS) 1 of International Financial Reporting Standards (IFRS), which includes a section about going concern. International auditors must also comply with International Standard on Auditing (ISA) 570 regarding going concern.

The objective of this article is to present the relevant issues surrounding the topic of the going concern assumption in financial reporting and auditing.

Conceptual Issues

Management's implicit assertion. Business entities usually possess long-term assets and long-term liabilities. The measurement and classification of long-term items require the validity of the going concem assumption For example, consider a company that has invested $200 million in a new factory and intends to depreciate it for 20 years. If the going concern assumption cannot be upheld, the measurement of long-term items would revert to fair value measurement, as required in the liquidation basis of accounting in ASU 2013-07 (ASC 205-30). Based upon a fair value measurement, both depreciation and bond amortization would cease to exist, which, in tum, will affect the income statement.

Without the validity of the going concern assumption, financial statements prepared according to accrual-basis accounting become misleading. In other words, business entities issuing financial statements in compliance with GAAP make an implicit assertion that the going concern assumption is valid. It is particularly true when no footnote disclosure regarding the going concern is required. It is worth noting that an implicit assertion still is an assertion, which is still the responsibility of management.

Management's explicit disclosure. When business continuity becomes untenable and liquidation becomes imminent, businesses are required by ASC 205-30 to present financial statements on the liquidation basis of accounting. But there is a gray area: When business liquidation is not imminent, the risk of liquidation still exists. What should management do under the circumstances? …

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