At its May 17, 2012 meeting, the PCAOB’s Standing Advisory Group discussed possible revisions to the current auditing standard regarding the auditor’s evaluation of whether there is substantial doubt about a company’s ability to continue as a going concern. Financial statements are prepared on the assumption that the company will continue as a going concern. Under the federal securities laws and PCAOB standards, the auditor has a responsibility to evaluate whether there is substantial doubt about a company's ability to continue as a going concern during the ensuing fiscal year. In the wake of the recent financial crisis, the PCAOB, as well as certain other standard-setters and regulatory bodies, has been considering the auditor's responsibilities regarding the going concern evaluation.
A key going concern term is "substantial doubt," which is not defined in either FASB accounting standards or PCAOB auditing standards. One possible approach to defining "substantial doubt" would be to use one of the likelihood thresholds in existing accounting standards. The PCAOB asked the SAG to examine if a proposed standard on going concern should define the term "substantial doubt" using a likelihood threshold such as reasonably possible, probable, or more likely than not.
SAG Member Gaylen Hansen, Director of Accounting and Auditing Quality Assurance, Ehrhardt Keefe Steiner & Hottman, favors a reasonably possible standard. He said that going concern should fall into that basket. He also urged the Board to look at including debt covenants as part of a going concern conclusion. In addition, he said that the time horizon should be flexible, with known issues beyond the horizon disclosed. It is not a precise science, he advised, it is judgmental.
Former SEC Chief Accountant Lynn Turner said that there is evidence of a problem in the going concern area. Investors are getting surprised, he noted, adding that this is an issue that should be driven by investors. Substantial doubt may not be working for investors. He noted that reasonably possible, in practice, is a fairly high standard. Investors are looking for an early warning signal, he said, which could be management disclosures in the footnotes. Mr. Turner mentioned that the 2000 report of the O’Malley Panel on Audit Effectiveness determined that there is problem with going concern and urged FASB to develop a standard.
The O’Malley Panel, which contained former SEC Commissioners Aulana Peters and Bevis Longstreth, urged FASB to promulgate explicit going concern disclosure requirements to fit various circumstances, including disclosures about the company’s reliance on the financial support of related or third parties to mitigate the adverse effects of conditions and events that create substantial doubt about the entity’s ability
to continue as a going concern. The panel also asked FASB to define going concern and clarify that management, not the auditor, has the primary responsibility to assess whether the entity has the ability to remain a going concern. The O’Malley Panel also recommended that audit firms incorporate into their methodologies specific guidance on considering management’s plans for mitigating the adverse effects of conditions and events that created the auditor’s substantial doubt about the entity’s ability to continue as a going concern.
Sam Ranzilla, National Managing Partner, Audit Quality and Professional Practice, KPMG, noted that the fundamental problem with going concern is that it is binary, either you are a going concern or you are not. The focus must be on disclosures around material uncertainties, and auditor opinion on the disclosures. Boilerplate language around going concern should be avoided. FASB Member Larry Smith said that it is important to get these types of disclosures into the footnotes. He noted that some FASB members are concerned about redundancies in relation to liquidity and other management disclosure that are currently required.
Former FASB Chair and current SAG Member Dennis Beresford said that the PCAOB must work hand-in-hand with FASB on this issue, and the Board may even be premature. Going concern is a company representation, he noted. There should be two stages: first, what is FASB going to determine as far as company representations and, secondly, what the PCAOB will determine what the auditor needs to do to be satisfied with management’s representation. It may be premature to do the auditor piece first, he noted.
SAG Chair and PCAOB Chief Auditor Marty Baumann said the Board’s initial approach was to defer to FASB, but FASB took going concern off its agenda. He also noted that the PCAOB is getting pressure that this is an important disclosure issue. Investors are saying that they need information on going concern. A PCAOB proposal is slated for the 3rd quarter. PCAOB staff pledged to work closely with FASB in developing going concern standards.
FASB Member Larry Smith emphasized the importance of FASB and the PCAOB being in agreement on going concern so that auditors and preparers are making the same assessments. He said that the history of the FASB project on going concern has been like a ``slow tennis match’’. Going concern was added originally as part of the codification project. At the same time, FASB was working on the convergence project with the IASB and began to incorporate some IFRS principles into the deliberations on going concern. FASB began deliberating in 2009-2010 on the importance of early warning disclosures that surround a company as it is experiencing difficulties. The project was thus recast as a project on disclosures about risks and uncertainties. FASB also decided it would not make management do a going concern assessment and would instead address disclosures that are necessary. In April, going concern was put into the liquidity and interest rate risk disclosure project. FASB is also again looking at management making a going concern assessment, surrounded by disclosures. Speaking for himself, Mr. Smith said that it is important for management to make specific disclosures that the auditor can attest to.
Jamie Miller, Controller and Chief Accounting Officer, General Electric Co., urged the PCAOB, as it broadens the definition to, for example, reasonably possible, to provide guidance and specificity in the standard on key auditor assumptions. Mike Gallagher, Assurance Partner and U.S. Assurance National Office Leader, PwC, in addition to urging the Board to coordinate with FASB, said one challenge in dealing with going concern opinions is that if you get it wrong on either side, there can be bad consequences. Under a binary model of going concern, he reiterated, you have to get it right. He also urged the PCAOB to examine how going concern intersects with enhanced disclosure and the auditor reporting model.
There is a growing consensus in the SAG that going concern must focus beyond the traditional liquidity risk to other risks, such as litigation and legislative risks. This dovetails with a recent report of the UK Financial Reporting Council’s Sharman Inquiry, which urged the UK oversight authority to ensure that the going concern guidance for directors reflects the right focus on solvency risks, not only on liquidity risks, including identifying risks to the company’s business model or capital adequacy.
The SAG members are also concerned about the current binary nature of the going concern report. The Sharman Report noted that, although the outcome of a going concern assessment is a binary decision, the considerations that make up this assessment are not binary and additional disclosure can provide investors with relevant information about the risks.