The going concern principle is that you assume a business will continue in the future, unless there is evidence to the contrary. When an auditor conducts an examination of the accounting records of a company, he or she has an obligation to review its ability to continue as a going concern; if the assessment is that there is a substantial doubt regarding the company's ability to continue in the future (which is defined as the following year), a going concern qualification must be included in his or her opinion of the company's financial statements. This statement is typically presented in a separate explanatory paragraph that follows the auditor's opinion paragraph.
There are no specific procedures that an auditor must follow to arrive at a going concern opinion. Instead, he derives this information from the sum total of all other audit procedures performed. Indicators of a potential going concern problem are:
- Negative trends. Can include declining sales, increasing costs, recurring losses, adverse financial ratios, and so forth.
- Employees. Loss of key managers or skilled employees, as well as labor difficulties of various types, such as strikes.
- Systems. Inadequate accounting record keeping.
- Legal. Legal proceedings against the company, which may include pending liabilities and penalties related to the violation of environmental or other laws.
- Intellectual property. The loss or expiration of a key license or patent.
- Business structure. The company has lost and been unable to replace a major customer or key supplier.
- Financing. The company has defaulted on a loan or is unable to locate new financing.
The auditor's going concern qualification can be mitigated by management if it has a plan to counteract the problem. If such a plan exists, the auditor must assess its likelihood of implementation and obtain evidential matter about the most significant elements of the plan. For example, if the CEO has declared that he will extend a loan to the company to cover a projected cash shortfall, evidential matter might be considered a promissory note in which the CEO is obligated to provide a stated amount of funds to the company.
The going concern qualification is of great concern to lenders, since it is a major indicator of the inability of a company to pay back its debts. Some lenders specify in their loan documents that a going concern qualification will trigger the acceleration of all remaining loan payments. A lender is typically only interested in lending to a business that has received an unqualified opinion from its auditors regarding its financial statements.
An auditor who is considering issuing a going concern qualification will discuss the issue with management in advance, so that management can create a recovery plan that may be sufficient to keep the auditor from issuing the qualification. Thus, the going concern qualification is a major issue, but you will have a chance to find a way around the problem and potentially keep the auditor from issuing it.