Going Concern Opinion: 5 Essential Rules for CPA Firms

Going Concern Opinion: The Evaluation Framework Your Firm Needs Before Fieldwork Ends

A going concern opinion is one of the highest-stakes deliverables in small and mid-size company auditing, and one of the most uncomfortable conversations a CPA firm has with a private-company client. At BusAcTa Advisors, we support audit documentation and workpaper preparation for US CPA partners across private-company engagements.

The going concern evaluation is the area where we see the most process inconsistency in your firm's files, the most last-minute scrambling in your team's workflow, and the most client communication that happens too late to be useful. This going concern audit guide walks through the five rules your firm needs to handle the going concern evaluation correctly, from the initial doubt assessment through the client conversation before the report goes out.

Rule 1: Know When Substantial Doubt Exists, Not Just When It's Obvious

The AU-C 570 going concern standard (as revised by SAS 134) requires the auditor to evaluate whether substantial doubt about the entity's ability to continue as a going concern for a reasonable period exists, where that reasonable period is not less than 12 months from the date of the financial statements. The substantial doubt going concern test is triggered when conditions and events, taken together, indicate it is probable that the entity will be unable to meet its obligations as they become due within the evaluation period.

The triggering conditions AU-C 570 identifies are worth reviewing at the planning stage of every audit, not just for clients who appear distressed at first glance:

• Financial indicators: Recurring operating losses, working capital deficiency, negative cash flows from operations, adverse key financial ratios, and defaults on existing loan agreements or covenants.

• Operating indicators: Loss of a principal customer, supplier, or key employee without realistic prospect of replacement; labor difficulties such as work stoppages; loss of a major franchise, license, or patent; denial of usual trade credit from suppliers.

• Other indicators: Legal or regulatory actions that, if determined adversely, could result in obligations that cannot be met; uninsured or underinsured catastrophe losses; pending legislation or regulatory changes that could jeopardize operations.

Your firm should evaluate these conditions as part of your risk assessment, before fieldwork is complete. Waiting until your client's trial balance is clean to consider whether going concern applies is too late. Substantial doubt can exist at a company with positive net income in the current year if a debt covenant was breached mid-year, a large customer did not renew, or the credit line was not extended. Does your firm's engagement planning checklist require your team to perform an explicit going concern indicator review at the beginning of audit fieldwork, not just at the end?

Rule 2: Evaluate Management's Plans with Appropriate Skepticism

When triggering conditions exist, the substantial doubt management plans evaluation under AU-C 570 requires the auditor to assess management's plans for dealing with the adverse conditions. This evaluation is not passive. The auditor must assess whether management's plans are both feasible and, if successfully implemented, sufficient to alleviate substantial doubt within the evaluation period.

The most common going concern documentation weakness we see in small firm workpapers is insufficient evaluation of management's plans. "Management has stated it intends to renegotiate its credit line" is not an evaluation of that plan. Your workpapers need to address whether the renegotiation is in process, whether the lender has expressed willingness, what terms are being discussed, and whether those terms, if achieved, would provide sufficient liquidity. Your client's management assertion is the starting point. Your auditor's analysis of its likelihood and sufficiency is the required conclusion.

Common management mitigation plans your team will encounter, and what your evaluation should cover for each:

• Obtaining additional financing or restructuring existing debt: Is there evidence of your client's lender discussions? Term sheets? Prior communication from the lender indicating willingness? If the credit line has already been denied once, a stated plan to renegotiate requires more than management's assertion to be evaluated as feasible.

• Reducing or delaying capital expenditures: Is there a written capital budget amendment? Which projects are deferred and by how long? Is the reduction sufficient to close your client's liquidity gap within the evaluation period?

• Disposing of assets: Which assets? At what expected proceeds? Is there a buyer identified or a listing agreement? Fair value estimates based on management's optimistic assumptions without market support are not a sufficient basis for plan feasibility.

• Increasing ownership equity: Is new investment committed to your client? From whom? On what terms? A family member's informal promise to invest is not the same as a signed term sheet from an institutional investor.

Your team's evaluation conclusion must be documented for every going concern engagement. It is not sufficient to list management's plans and move on. The workpapers must reach a documented auditor conclusion: either that management's plans, if successfully implemented, adequately alleviate substantial doubt, or that they do not.

Rule 3: Know Which Audit Report Outcome Applies to Which Situation

AU-C 570 creates a decision path with distinct outcomes depending on the auditor's conclusion after evaluating management's plans. Your team should know this path cold before the report is drafted:

Two points your team should internalize. First, the emphasis-of-matter paragraph is not a modified opinion. An unmodified opinion with a going concern emphasis paragraph is still an unmodified opinion on the financial statements. The going concern paragraph explains a matter but does not modify the opinion on the statements themselves. Clients who believe a going concern paragraph means their financial statements were rejected have misunderstood what the paragraph does.

Second, the client's disclosure obligation under FASB ASC 205-40 is separate from the auditor's report obligation under AU-C 570. Management is required under FASB ASC 205-40 to disclose, in the notes to the financial statements, the conditions that raised substantial doubt and the plans adopted to address those conditions. The adequacy of those disclosures is what determines whether the auditor can issue an unmodified opinion with the going concern paragraph or must issue a qualified or adverse opinion.

Rule 4: FASB ASC 205-40 Going Concern , Management's Separate Reporting Obligation

FASB ASC 205-40, effective for annual periods ending after December 15, 2016, requires management to evaluate at each annual and interim reporting period whether conditions or events raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued or are available to be issued. This is management's own assessment obligation, separate from the auditor's.

The practical implication for your audit engagement is that management should be performing this assessment every reporting period as part of their financial reporting process, not waiting for the auditor to raise it. In practice, most of your small private company clients do not perform a documented going concern assessment unless your team prompts them. Your engagement planning process should include a going concern inquiry of your client's management at the start of fieldwork: has management considered whether conditions exist that raise substantial doubt? What is their conclusion and what is it based on?

The going concern financial statement disclosure required under FASB ASC 205-40 when substantial doubt exists must include:

• The principal conditions or events that raised substantial doubt

• Management's evaluation of the significance of those conditions and events in relation to the entity's ability to meet its obligations

• Management's plans that are intended to mitigate the conditions or events that raised substantial doubt

The FASB ASC 205-40 disclosure is the management-authored narrative. The going concern paragraph in the auditor's report is the auditor's independent conclusion about the same conditions. Both must exist when your auditor concludes that substantial doubt exists and is not adequately alleviated for your client. An audit report with a going concern emphasis paragraph attached to financial statements with no note disclosure about going concern conditions is an inadequate disclosure situation that requires a qualified or adverse opinion, not a clean opinion with the paragraph added.

Rule 5: Going Concern Communication Clients Receive Before the Report Is Drafted

The most damaging version of the going concern conversation is the one that happens when the client sees the draft audit report for the first time. Your client who learns about the going concern paragraph from a draft report has not had the opportunity to correct disclosures, gather evidence of management's plans, consult their lender, or prepare their board. Your firm should be having the going concern conversation with your client's management as soon as your evaluation indicates substantial doubt may exist, which is during fieldwork, not after.

Three communication disciplines your firm should build into every engagement where going concern indicators are present:

1. Preliminary assessment communication, in writing, during fieldwork. When your evaluation identifies triggering conditions, communicate the preliminary assessment to management in writing before fieldwork is complete. This gives your client's management the opportunity to provide additional information about their plans, gather supporting documentation (lender letters, commitment letters, revised projections), and begin drafting note disclosure. The preliminary communication is not the audit report, it is the working conversation that produces a better report.

2. Management representation letter specificity. The management representation letter for any engagement with going concern conditions should include specific representations about management's knowledge of conditions that raise substantial doubt, management's plans to address those conditions, and whether those plans have been properly disclosed in the financial statements. A generic going concern representation that simply says "management is not aware of any conditions that raise substantial doubt" is insufficient when triggering conditions were identified during the audit.

3. Communicate what the paragraph means and what it does not mean. Many of your private-company clients, their lenders, and their investors misunderstand what a going concern opinion means. Your firm should explain to them, directly and clearly, that a going concern emphasis paragraph in an otherwise unmodified opinion is not a finding that the company is insolvent, not a prediction that the company will fail, and not a qualified opinion on the financial statements. It is an auditor's disclosure of conditions that raise uncertainty about the 12-month outlook. That explanation, delivered before the report goes out, prevents the client from being blindsided by a creditor or investor reaction they weren't prepared for.

You can see how we support going concern documentation and audit workpaper preparation on the how it works page. Our offshore accounting service covers going concern evaluation workpapers, management plan feasibility documentation, and the going concern emphasis-of-matter paragraph drafting process. Our quality control framework includes going concern indicator review as a standard planning-stage step on every engagement. For firms building or updating their going concern evaluation process, our advisory service can review your current audit programs against the AU-C 570 requirements.

For the full AU-C 570 standard and FASB ASC 205-40 guidance, see the AICPA AU-C 570 standard document, which is the authoritative source for the auditor's going concern evaluation requirements under US GAAS.

Handling Going Concern Correctly Protects Both Sides of the Engagement

Going concern opinions are uncomfortable for auditors and difficult for clients. The discomfort doesn't change the obligation. When substantial doubt exists, the going concern evaluation must be performed, management's plans must be assessed with skepticism, the appropriate disclosure must be included in the financial statements, and the audit report must reflect the auditor's conclusion. Getting the communication right, early and in writing, is what separates an engagement that handles this correctly from one that creates unnecessary disruption at report delivery.

If you'd like to discuss how we support going concern evaluation workpapers and client communication documentation for CPA partners' private-company audit engagements, book a scoping call with BusAcTa Advisors, and we'll walk your team through the planning workflow before you commit to anything.