Thousands of U.S. companies file for bankruptcy every year. Many of those businesses had previously hired a CPA firm to perform an audit, review, or compilation of the financial statements.
Did the financial statements include disclosure of the financial problems associated with the business? Did the CPA’s report include a separate paragraph highlighting the going-concern issue?
In an attempt to mitigate losses associated with a business failure, a client’s lenders, shareholders, and bankruptcy trustees may pursue a claim against a CPA firm. Indeed, approximately 30% of claims brought against CPAs in the AICPA Professional Liability Insurance Program are made by third parties. Moreover, nearly 60% of the program’s 2013 financial statement services claims related to the failure to detect a misstatement or a disclosure error, especially going-concern disclosures. These claims are found in all types of financial statement services, even reviews and compilations.
The CPA’s responsibilities
The auditor’s requirements related to going concern are defined in the AICPA Statements on Auditing Standards (see AU-C Section 570, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern). Professional standards for CPAs performing review and compilation services also include a requirement to assess an entity’s ability to continue as a going concern (see AR Section 90.47-50 and AR Section 80.40-43).
During the performance of review or compilation procedures, evidence or information may come to the accountant’s attention that indicates an uncertainty regarding the client’s ability to continue as a going concern for a reasonable period of time, generally not to exceed one year beyond the date of the reviewed or compiled financial statements. If such information is discovered, the professional standards outline the accountant’s responsibilities—including discussing the matter with management. Depending on management’s response, the CPA’s report may need to be modified.
Some CPAs may erroneously believe a going-concern assessment does not apply to a compilation engagement whereby a report is issued but the financial statements omit substantially all disclosures. However, AR Section 80.20 states that disclosures may be omitted only if the omission does not cause the financial statements to be misleading. It’s difficult to imagine that the omission of an applicable going-concern disclosure is not misleading.
When the accountant is aware of a going-concern matter, the CPA is required to address it, regardless of the level of service. Period.
Many clients fear that a going-concern disclosure and related modification to the CPA’s report will be the kiss of death for their company. They may pressure the CPA to either exclude the disclosure or delay issuance of the financial statements until management can rectify the matter. Nevertheless, if the company subsequently fails, the CPA may be sued under a developing legal theory called deepening insolvency. Under this theory, it is argued that the life of a troubled company was artificially prolonged through additional financing, resulting in increased losses to the company’s creditors and shareholders. A plaintiff attorney may assert that the company’s true financial condition was misrepresented and that, if the CPA had addressed the going-concern matter sooner, additional financing may not have been extended and losses could have been minimized.
While it may be difficult to issue this disclosure, the CPA is not doing the client, or the firm, any favors by failing to directly address a going-concern matter.
Risk management tips
These tips can help protect firms against going-concern claims:
- Remain up-to-date on professional standards and related responsibilities. Know that a going-concern evaluation does apply to compilations and reviews.
- Maintain effective quality controls, especially with respect to supervision and review. Assign senior, experienced team members to perform the going-concern evaluation. Consider assigning a quality-control reviewer to help support the team. Include thorough workpaper documentation that supports the ultimate conclusion reached.
- Be alert to changing economic conditions that can affect the client or its major customers or suppliers, including subsequent events arising after the balance sheet date but prior to the issuance of a report.
- Avoid communication with third parties regarding the client’s financial condition. Participating in discussions with third parties may permit the third party to bring a claim against the CPA.
- If a client refuses to include a going-concern disclosure in the notes or pressures the CPA to delay its issuance, consider walking away from the engagement.
Changes in professional standards
In 2014, two standards were issued with going-concern implications.
SSARS No. 21, Statement on Standards for Accounting and Review Services: Clarification and Recodification, was issued in October and is effective for annual and interim periods ending on or after Dec. 15, 2015. Early adoption is permitted. SSARS No. 21 supersedes AR Sections 80 and 90. There are two important issues related to going-concern matters and SSARS No. 21:
- Going concern is not expressly addressed in Section 80 of SSARS No. 21 for compilation services. However, Section 80.15 of SSARS No. 21 states that if the accountant becomes aware that the financial statements are misleading, he or she should propose appropriate revisions to management.
- SSARS No. 21 defines the period for which an entity will continue as a going concern to be the same period required to be used by management in its going-concern assessment or, in the absence of proscriptive guidance, one year after the balance sheet date.
FASB also issued Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern, in August. This standard is effective for annual periods ending after Dec. 15, 2016, and provides definition and guidance to management regarding its responsibilities related to going concern. In addition, ASU No. 2014-15 defines management’s time period as one year after the date of financial statement issuance, or within one year after the date the financial statements are available to be issued, not one year after the balance sheet date.
Sarah Beckett Ference is a risk control director at CNA.
Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. For more information, call Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, at 800-221-3023 or visit cpai.com.
This article provides information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.
Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured.