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Evaluating a business as a going concern

going concern, audit, accountingDuring an audit, one thing that will be evaluated is your company’s ability to continue as a going concern. In layman’s terms, this means: will your company be able to stay in business in the near future? Making this determination is oftentimes not black and white, and there are several factors that both management and the auditor should consider when making this assessment.

What would indicate that your company can’t continue as a going concern? Examples of things to look for are

  • Negative trends in operating results
  • Cashflow issues
  • Loan defaults and covenant failures
  • Maturing debt with a balloon payment due
  • Changes to the industry or macroeconomic environment
  • Legal troubles

It’s management’s responsibility to evaluate if there is “substantial doubt” that the entity will be able to meet its obligations as they become due within one year of the financial statements’ issue date. If substantial doubt exists, management then must consider if they have a plan in place intended to mitigate these conditions, and if the plan’s success is probable. Whenever substantial doubt exists, both it and management’s plan to remedy the situation are disclosed in the financial statements, regardless if the management’s plan alleviates that substantial doubt.

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Once management has completed their assessment, the auditor will separately conclude on the management’s evaluation and will document the auditor’s own assessment of your company’s ability to continue as a going concern. This may involve gathering additional audit evidence. For example, if financial support from a third party or the company’s owner-manager is the mitigating factor to a company’s substantial doubt, management must provide the auditor evidence showing the supporting party’s intent and ability to provide the necessary support.

If it is determined that an entity will continue as a going concern, the financial statements will continue to use their standard basis of accounting in preparation. If not, however, accounting changes may be necessary. For example, if liquidation appears imminent, the liquidation basis of accounting should be used, which involves a handful of accounting differences.

While we all hopefully won’t progress to this point, the going concern analysis is something that every company’s management should be knowledgeable on.

Brad Sinko