Pandemic still complicates going concern disclosures

By Joseph Radigan

The COVID-19 pandemic caused an unprecedented amount of financial pressure for many businesses, and auditors will still be sorting out the risks clients face during this year’s audit engagements.

Some of the economic data released in the spring of 2021 suggests that some pressure can be expected to ease in certain industries. But that may add to the challenges in this year’s audit engagements because practitioners may have to use more care in determining which companies are truly on the rebound and which clients are still mired in the recession brought on by the pandemic.

“Not everybody is out of the figurative woods yet,” said Steven Morrison, CPA/CFF, partner-in-charge, Audit Quality Group for CohnReznick LLP in New York. In addition to the economic problems caused by the recession, financial reporting challenges caused by the pandemic are arguably somewhat more complex than the reporting challenges businesses faced during the 2008–2009 economic crisis. For example, the requirements in FASB 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, extended the period a going concern assessment has to cover.

During the 2008 recession, an entity’s determination of its ability to continue as a going concern was based on an entity’s expectations about its performance for a one-year period from the date of the balance sheet. Before FASB updated its guidance, some companies with a December fiscal year end that issued their financial statements the following June took the position that they only had to make a forecast based upon their expectations for the next six months after June. Now with the updated U.S. GAAP and U.S. generally accepted auditing standards requirements, entities have to make a going concern assessment based upon whether it’s probable that they will be unable to meet their obligations within one year from the issuance of the financial statements, not the balance sheet date.

The increased difficulty caused by the longer period is compounded by the uncertainty arising from the unprecedented nature of the pandemic and its recession.

Conditions or events may raise substantial doubt about an entity’s ability to continue as a going concern. Various considerations may come into play when considering management’s plans and (1) whether those plans can be effectively implemented and (2) whether the plans would mitigate the relevant conditions or events. For example:

  • A phone company with a warehouse of 10-year-old smartphones may find its plan to increase revenues difficult because the 10-year-old smartphones are likely selling at a deep discount, if at all. In such a case, management’s plans may not be able to be effectively implemented and thus not alleviate substantial doubt.
  • Another entity may be projecting a shortfall of cash over the next year but plans to obtain the necessary support from a supporting party, such as an owner-manager or related party. If the entity obtains sufficient appropriate audit evidence as to the intent of the supporting party to provide sufficient support in a timely manner, and the ability to do so, the entity may be able to conclude that its plans alleviate substantial doubt.

“A number of entities may find it difficult to perform projections and support their assumptions if they base the projections on pre-pandemic results. This is because pre-pandemic results and assumptions may not be as appropriate going forward,” Morrison said. “It’s not like people can always automatically just say, ‘The company has always been able to perform at X level in the past, so it definitely will in the future.’ With a changing dynamic and changing industries, some entities are having difficulties looking forward and accurately predicting.”

Morrison is scheduled to co-lead a July 26 session at ENGAGE 2021 titled “Malpractice Risks and Going Concern,” with Thomas Falkenberg, the managing partner of the Chicago law firm Falkenberg Ives LLP.

Falkenberg said the pandemic’s economic fallout means auditors have to be especially selective when acquiring new clients or evaluating the retention of existing clients. His law firm advises auditors on how to minimize their exposures to litigation with clients that are struggling financially.

“What do you do if they’re a marginal client, and they’re struggling — maybe having going concern issues?” Falkenberg said. “Do you walk away from the client? Do you continue to engage and continue to do the work?”

Falkenberg added that the recession is forcing auditors to be realistic about clients’ financial viability and review and update their client acceptance and retention policies where appropriate.

“There are more opportunities for the company to fail, and when a company fails, litigation ensues,” he said. “You’ve got to be more careful because the risk associated with taking on clients that may fail or incur substantial losses is going to greatly outweigh the fees you get from taking on that client.”

Auditors should address their concerns about a client’s financial viability at an engagement’s outset as they draft the engagement letter, Falkenberg said.

In preparing the financial statements, management is required to use the guidance in FASB ASC Subtopic 205-30 to determine whether it’s necessary to apply the liquidation basis of accounting. If the liquidation basis is not required, management evaluates whether there is substantial doubt that the entity can continue as a going concern.

If substantial doubt is raised, the going concern assessment requires an entity to determine whether management’s plans will alleviate substantial doubt about the entity’s ability to continue as a going concern. This is yet another area where an auditor applies skepticism, Morrison said.

“We take a look and ask, ‘Are those plans probable of being implemented? And if they’re implemented, will they be effective?’” Morrison said. “If it’s a soft plan that basically says, ‘Well I’m going to go ahead and try and sell some more, and I’ll try and talk to my lender,’ well, that by itself may not sound very compelling.”

If it is probable that management’s plan will mitigate relevant conditions and events that have caused substantial doubt, the entity is required to disclose this. An entity with sound plans supported by sufficient appropriate evidence, perhaps such as detailed cash flow projections, or a specific commitment from a supporting party to fully support the cash flows of the entity, may be able to disclose that the plans have alleviated the substantial doubt.

“It gets so much into the facts and circumstances,” Morrison said.

If it’s not probable that management’s plan will alleviate the substantial doubt, the entity is required to disclose this as well as providing a statement that indicates there is substantial doubt about its ability to continue as a going concern.

The auditor’s responsibilities related to going concern follow a similar process to that taken by management. An auditor is required to:

  • Evaluate whether it’s necessary to use the liquidation basis of accounting;
  • Consider whether substantial doubt exists;
  • Consider whether management’s plans alleviate substantial doubt;
  • Evaluate the adequacy of management’s disclosures; and
  • Consider the implications for the auditor’s report.

Morrison added that the going concern guidance is written in such a way that it helps guide the auditor in conversations with clients about the appropriate disclosures.

A number of businesses, including a number that are privately held, are often susceptible to financial problems even when the economy is growing. Now with the pandemic into its second year, they may be less concerned about providing an auditor with a sufficiently detailed plan so that the auditor can evaluate it and make the conclusions necessary. Paragraph A20 of AU-C 570, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, states that if management does not perform a sufficient evaluation, this may be a significant deficiency or a material weakness.

But Morrison said the auditing standards and the accounting guidance are designed in such a way that they help practitioners resolve difficult issues that can arise during engagements.

“Going concern is not necessarily something anecdotal,” he said. “It’s not something you think off the top of your head and only go with instinct.” The terms associated with going concern disclosures are clearly defined, and the standards are written in a way that helps auditors apply them.

AICPA & CIMA ENGAGE 2021, the premier event for accounting and finance professionals, will be a hybrid event this year. Join us at the Aria Resort and Casino in Las Vegas or online, July 26–29, for keynotes and sessions on accounting and auditing, tax, technology, leadership, personal financial planning, diversity, equity, inclusion, and more. Keynotes with Sir Richard Branson and NASA’s Adam Steltzner will be held online on June 8.

Joseph Radigan is a financial writer based in New York. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA’s editorial director, at

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