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.
I recently wrote a post about ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which is 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.
But what about financial statements subject to a compilation engagement, especially when substantially all disclosures are omitted? Is it not 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 alternative. Your client (who has significant going concern issues) takes your compilation report and their financial statements (that has no disclosures) to a local bank. It’s obvious that the company is in poor shape. But the bank makes a large loan anyway, and later, the company defaults. Then the bank files suit against you (the CPA) asserting that you issued the compilation report without the emphasis of matter and financial statements without the going concern disclosure–knowing the statements were misleading.
An emphasis of a matter paragraph (concerning the going concern issue) is not required but may be necessary to ensure clarity. Below is a sample compilation report–with a going concern emphasis of matter–from the AICPA’s Preparation, Compilation and Review Audit Guide.
Management is responsible for the accompanying financial statements of XYZ Company, which comprise the balance sheets as of December 31, 20X2 and 20X1 and the related statements of income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements in accordance with accounting principles generally accepted in the United States of America. I (We) have performed compilation engagements in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. I (We) did not audit or review the financial statements nor was (were) I (we) required to perform any procedures to verify the accuracy or completeness of the information provided by management. Accordingly, I (we) do not express an opinion, a conclusion, nor provide any form of assurance on these financial statements.
As discussed in Note X, certain conditions indicate that the Company may be unable to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.
[Signature of accounting firm or accountant, as appropriate]
[Accountant’s city and state]
[Date of the accountant’s report]
Since review engagements require full disclosure, going concern disclosures–when substantial doubt exists in GAAP financial statements–are not optional. They must be provided. If not, then a GAAP departure exists.
AR-C 90.65 states “The accountant should consider whether, during the performance of review procedures, evidence or information came to the accountant’s attention indicating that there could be an uncertainty about the entity’s ability to continue as a going concern for a reasonable period of time.” So what’s a reasonable period of time? GAAP specifies the period as one year after the date the financial statements are available to be issued. If a financial reporting framework does not specify a period (such as the cash basis of accounting), then use one year from the date of the financial statements being reviewed.
The Accounting and Review Services Committee (ARSC) is presently reviewing AR-C 90 in light of FASB’s going concern standard, ASU 2014-15. ARSC is working to align the review standards with FASB’s going concern standards. Also, expect to see a requirement that an emphasis of matter paragraph be added to the review report when substantial doubt is present.
Here’s a sample emphasis of matter paragraph for a review report.
Emphasis of Matter
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raises an uncertainty about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our conclusion is not modified with respect to this matter.
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. Follow FASB’s guidance in my going concern post to create your special purpose framework disclosures.
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).
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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