Going Concern Disclosures (#185)
/In this podcast episode, we discuss having to disclose whether your business is a going concern. Key points made are noted below.
The Going Concern Requirement
The requirement to disclose whether a business is a going concern is a GAAP requirement. The disclosure is needed if there is a substantial doubt about the ability of the company to continue as a going concern within the next year. This is a major issue, since a going concern problem can result in loans being pulled, credit requests being declined, and investors selling off their shares. This is a common issue with startup companies in particular, given their initial financial situations.
Going Concern Evaluation Criteria
Management’s determination of this matter is based on its evaluation of relevant conditions and events that are known and reasonably knowable as of the date when the financial statements are issued. Those conditions and events would mean that the business could probably not meet its obligations during the next year.
Mitigating Events
The disclosure is reduced if management’s plans for the future will mitigate these conditions or events. Examples of these plans are selling off assets to raise cash, selling shares, borrowing money, reducing expenses, or restructuring debt. This option is only available if it is probable that the plans will actually be implemented, and it is probable that the plans will mitigate the issues that have been raised.
Information to Disclose
The disclosure includes the main issues that raised a concern, as well as management’s evaluation of those conditions. Also describe the nature of any plans to alleviate the going concern issue. If there is no way to improve the situation, then the disclosure also has to state that there is a substantial doubt about the entity’s ability to continue as a going concern. If this issue keeps coming up in later periods, then you have to keep on making the same disclosure.
This analysis needs to be done in every interim period, not just at the end of the year. From a practical perspective, it will probably only be addressed as part of the year-end audit for privately-held businesses. A publicly-held company will need to do a quarterly review, since the auditors are on-site to conduct a review every quarter.
Adverse Conditions and Events
Examples of adverse conditions and events are negative financial trends, ongoing losses, declines in working capital, and negative cash flows. Other indications of financial difficulties are loan defaults, being unable to pay declared dividends, having to restructure debt, and being denied trade credit by suppliers. Another area of concern is internal matters, which includes work stoppages, long-term commitments that are not profitable, and being substantially dependent on the success of a specific project. A final area of concern is external matters, which include lawsuits, legislation, loss of a patent, loss of a major customer, and an uninsured catastrophe.