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.
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