The FASB’s latest proposal on going concern uncertainties introduces a new layer of accounting guidance that adds to the existing requirements set by auditing standards and SEC regulations. The added guidance provides a more systematic approach that is designed to promote more consistency in the nature and timing of disclosures about an entity’s ability to continue as a going concern.
The proposed approach
The FASB’s proposed approach describes how management should evaluate going concern uncertainties and what information should be provided in the footnotes to the financial statements. The proposal introduces new definitions and disclosure thresholds, along with scalable reporting requirements that would allow the disclosures to evolve as the level of financial stress increases. These requirements generally would apply to all entities that use US GAAP, though some disclosures would apply only to SEC filers that use US GAAP.
Five steps required under the proposed approach:
- Determine if the entity is required to use the liquidation basis of accounting. There is an inherent presumption under US GAAP that the reporting entity will be able to continue as a going concern. The proposed guidance would define a “going concern” as an entity that will continue to operate by realizing its assets and meeting its liabilities in the ordinary course of business. If this is not the case and liquidation is considered imminent, then the entity would use the liquidation basis of accounting instead, starting when certain events occur. Our Substance of the Standard on “FASB Finalizes Standard on Liquidation Basis of Accounting” provides more details on when and how this basis should be applied.
- Determine whether going concern disclosures are necessary. At each annual and interim reporting date, management would assess the risk that the entity may not be able to meet its obligations as they come due within 24 months after the financial statement date. This assessment would consider all the information about conditions and events that exist at the date the financial statements are issued (or for a nonpublic entity the date the financial statements are available to be issued). Examples of relevant information are provided in the Appendix to this MHM Messenger (pdf). For purposes of this step, the guidance would not permit consideration of the mitigating effects of any of management’s plans that are outside the ordinary course of business.Disclosures would be required if the answer is yes to either of the following two questions.
- Is it more likely than not that the entity will be unable to meet its obligations within 12 months after the financial statement date without taking actions outside the ordinary course of business?
- Is it known or probable that the entity will be unable to meet its obligations within 24 months after the financial statement date without taking actions outside the ordinary course of business?
- Provide the required going concern disclosures. If Step 2 indicates that disclosures are necessary, the disclosures would need to provide information that enables users of the financial statements to understand all of the following:
- The principal conditions and events that give rise to the entity’s potential inability to meet its obligations.
- The possible effects that those conditions and events could have on the entity.
- Management’s evaluation of the significance of those conditions and events.
- Mitigating conditions and events.
- Management’s plans that are intended to address the entity’s potential inability to meet its obligations.
- For SEC filers, determine if there is substantial doubt about the going concern presumption. The determination of substantial doubt would be similar in scope to the determination in step 2 in that it would encompass events and conditions of the types listed in Tables 1 and 2 of the Appendix to this MHM Messenger (pdf). But this step would differ from step 2 in that it would permit consideration of the effects of all of management’s plans that are likely to be effectively implemented and that are likely to mitigate the adverse conditions and events, including the mitigating effect of management’s plans that are outside the ordinary course of business.
- If there is substantial doubt, provide the required disclosures for the SEC filer. When Step 4 indicates that disclosures about substantial doubt are necessary for an SEC filer, the disclosures would need to specifically state that there is substantial doubt through the use of the phrase “there is substantial doubt about the entity’s ability to continue as a going concern within 24 months after the financial statement date” or similar wording that includes the terms “substantial doubt” and “ability to continue as a going concern” or “ability to prepare financial statements under the going concern presumption.”
Some of these steps introduce inconsistencies with the existing US auditing standards and with IFRS. Other standard-setters may consider changes in this area in the future. Currently, the PCAOB is considering a proposal that would expand the audit report for public companies to include a section on “critical audit matters” where the auditor can provide additional insights into the most challenging audit issues, including the auditor’s conclusions regarding going concern matters. See MHM Messenger 17-13 for more details of the PCAOB’s proposal. The PCAOB has indicated it may consider other changes related to going concern after the FASB completes its project.
For more information
MHM Messenger 18-13 provides additional information about the FASB’s proposal — including questions, suggestions and concerns cited in comment letters.