Do you need to concern yourself with going concern in compilation and review engagements? Yes, if the financial statements are prepared in accordance with the FASB Codification. But is going concern relevant to special purpose frameworks such as the cash basis or tax basis financial statements. Yes, going concern is in play even with special purpose frameworks. This post provides an overview of what you need to know about going concern as it relates to compilation and review engagements.
A while back I wrote a post about ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which was effective for years ending after December 15, 2016. This standard requires companies to include certain disclosures when substantial doubt is present. So, we know that financial statements prepared in accordance with GAAP must include these disclosures. Otherwise, there is a GAAP departure. And in an audit, we modify our opinion when there is a departure.
Going Concern in Compilation Engagements
But what about financial statements subject to a compilation engagement, especially when substantially all disclosures are omitted? Is it permissible for the CPA to ignore the going concern standard since it just requires disclosures? Yes, but be careful. Ask yourself whether the financial statements would be misleading (without the going concern disclosure). If they are misleading, then include a selected disclosure regarding going concern. Also, consider adding an emphasis-of-matter paragraph (regarding going concern) to your compilation report.
Consider the following scenario. Your client (who has significant going concern issues) takes your compilation report (which has no emphasis of a matter paragraph) and their financial statements (that has no disclosures) to a local bank. It’s obvious that the company is not doing well. But the bank makes a large loan anyway, and later, the company defaults on the loan. Then the bank files suit against you (the CPA) asserting that you issued the compilation report without the emphasis-of-matter paragraph and that you knew the financial statements had no going concern disclosure. The bank says the financial statements were misleading.
While the emphasis-of-matter paragraph is not required, consider adding one anyway.
Going Concern in Review Engagements
Since review engagements require full disclosure, going concern disclosures are not optional when substantial doubt exists in GAAP financial statements. They must be provided. If they are not, a GAAP departure exists.
So what going concern procedures should you perform in a review engagement?
In regard to going concern when the financial reporting framework includes going concern requirements (e.g. GAAP), AR-C 90.65 states:
If the applicable financial reporting framework includes requirements for management to evaluate the entity’s ability to continue as a going concern for a reasonable period of time in preparing financial statements, the accountant should perform review procedures related to the following:
- Whether the going concern basis of accounting is appropriate
- Management’s evaluation of whether there are conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern
- If there are conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern, management’s plans to mitigate those matters
- The adequacy of the related disclosures in the financial statements
In regard to going concern when the applicable financial reporting framework does not address going concern (e.g., tax basis), AR-C 90.66 states:
If the applicable financial reporting framework does not include a requirement for management to evaluate the entity’s ability to continue as a going concern for a reasonable period of time in preparing financial statements and conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time existed at the date of the prior period financial statements (regardless of whether the substantial doubt was alleviated by the accountant’s consideration of management’s plans) or, in the course of performing review procedures on the current period financial statements, the accountant becomes aware of conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern, the accountant should do the following:
- Inquire of management whether the going concern basis of accounting is appropriate.
- Inquire of management about its plans for dealing with the adverse effects of the conditions and events.
- Consider the adequacy of the disclosure about such matters in the financial statements.
SSARS 24 does say that the nature and extent of procedures performed regarding going concern are a matter of professional judgment. If the audited entity has a history of profitable operations and access to financing, inquiry alone might be sufficient in a review engagement.
Going Concern Paragraph in a Review Report
If the accountant concludes that substantial doubt will remain for a reasonable period of time, an emphasis-of-matter paragraph is required in the review report. (Some reporting frameworks specify a “reasonable period of time.” For GAAP, it is one year from the date the financial statements are issued or are available to be issued.)
AR-C 90.A123 provides the following example of a going concern paragraph in a review engagement when (1) substantial doubt exists for a reasonable period of time, (2) management’s plans don’t alleviate the substantial doubt, and (3) the reporting framework requires a note disclosure.
Emphasis of Matter
- Management has disclosed to the accountant all information relevant to use of the going concern assumption in the financial statements.
Special Purpose Frameworks and Going Concern
While the cash, modified cash, or tax bases of accounting do not address going concern, accountants still need to consider the effects of negative financial conditions and trends. Why? When using a special purpose framework (like the tax basis), the accountant should follow the guidance in GAAP. No, that doesn’t mean your disclosures are just like GAAP, but it does mean they are similar to GAAP.
Since GAAP tells the financial statement preparer to consider whether substantial doubt exists, then persons creating cash basis, modified cash basis or tax basis financial statements should do the same. If substantial doubt is present, going concern disclosures are necessary.
So, what is substantial doubt? The FASB Codification defines it this way:
Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.
If substantial doubt is present and going concern disclosures are not included in full disclosure compilations or reviews, then modify your accountant’s report (for the departure).
[…] See my article titled Going Concern in Compilation and Review Engagements. […]
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Good question, Teresa. Yes, you do. While most special purpose frameworks don’t discuss going concern, the company should provide disclosures similar to GAAP. So the company would look at GAAP and ask, “how would I communicate going concern information in light of the special purpose framework?” For example, suppose your client uses the tax basis of accounting in a review engagement. The client and you would consider whether the client could meet its ongoing obligations for one year from the date the financial statements are issued. If the company can’t, then it would disclose this fact.
Does management still need to evaluate going concern under SPF like they do under GAAP?
Tom, I am going to start calling you eagle-eye.
Yes, you are right. We need to look to the special purpose framework first (if defined such as FRF-SME) before we look to GAAP.
And yes, I would only add the EOM if the client includes the going concern disclosure. EOMs can only highlight what is present in the financial statements.
Thanks for your feedback.
One point of clarification and a question:
I agree with everything you stated, however with a SPF it first looks to the framework for guidance does it not? So for income tax basis and the others you listed have no framework guidance so yes we would default to GAAP. However, if the FRF-SME was utilized, it contains guidance so that guidance would be utilized. FRF-SME retains one year from the balance sheet date as the evaluation period.
I seem to recall that prior to SSARS 21 the guidance I believe in an interpretation stated that we should not add going concern disclose to a nondisclosure compilation financial statement. That either disclosures ne added or we withdraw. Has that changed now that it is managements responsibility to perform the evaluation rather than the auditor / accountant?
Yes Jim. I think many CPAs preparing financial statements on a tax basis (for example) don’t think about going concern, but it’s still relevant.
Charles, this is indeed a confusing area, even before the recent changes. It’s easy to think of going concern as just an audit issue, but not that it is in GAAP, that really changes things.