CPA Exam AUD: Going Concern Assessment and Reporting

Going Concern Assessment: CPA Exam AUD Essentials

Going concern is a fundamental assumption underlying the preparation of financial statements. Under AU-C Section 570, the auditor has a responsibility to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time (generally not to exceed one year beyond the date of the financial statements being audited, or, for entities following ASU 2014-15, one year from the date the financial statements are issued or available to be issued). This topic is heavily tested on the CPA AUD exam.

The Going Concern Assumption

The going concern assumption means that the entity is expected to continue its operations for the foreseeable future without the need to liquidate or significantly curtail its activities. Financial statements are prepared on a going concern basis unless management intends to liquidate or cease operations, or has no realistic alternative but to do so. When the going concern assumption is no longer appropriate, the entity must prepare its financial statements on a liquidation basis under ASC 205-30.

Conditions and Events Indicating Substantial Doubt

The auditor should remain alert throughout the audit for conditions or events that may cast substantial doubt on the entity's ability to continue as a going concern. Common indicators include negative financial trends such as recurring operating losses, working capital deficiencies, negative cash flows from operating activities, and adverse key financial ratios. Other indicators include default on loan agreements, denial of usual trade credit from suppliers, arrearages in dividends, restructuring of debt, noncompliance with statutory capital requirements, and the need to seek new sources of financing or dispose of substantial assets.

Internal matters such as work stoppages, substantial dependence on a single customer or supplier, loss of key management, and loss of a principal customer or supplier also serve as indicators. External matters such as legal proceedings, legislation, or regulatory actions that could jeopardize the entity's operations may also raise going concern issues.

Auditor Evaluation Process

When conditions or events are identified that may indicate substantial doubt, the auditor evaluates management's plans for dealing with the adverse effects of these conditions or events. Management's plans may include plans to dispose of assets, plans to borrow money or restructure debt, plans to reduce or delay expenditures, and plans to increase ownership equity. The auditor must evaluate the feasibility of management's plans and whether implementation of those plans is likely to mitigate the conditions or events that raised the going concern doubt.

The auditor considers whether management's plans are sufficiently detailed, whether the assumptions underlying the plans are reasonable, whether the entity has the ability to carry out the plans, and whether the plans are likely to be effective in removing the substantial doubt. The auditor should also obtain written representations from management regarding their plans and the feasibility of those plans.

Reporting When Going Concern Doubt Exists

If, after evaluating management's plans, the auditor concludes that substantial doubt remains about the entity's ability to continue as a going concern, the auditor should include an emphasis-of-matter paragraph in the auditor's report (under AICPA standards). This paragraph is placed after the opinion paragraph and uses the heading "Going Concern" or a similar heading. The inclusion of this emphasis-of-matter paragraph does not affect the opinion itself. The auditor may still issue an unmodified opinion with a going concern emphasis-of-matter paragraph.

If substantial doubt is alleviated by management's plans, the auditor may consider including an emphasis-of-matter paragraph regarding the conditions, but is not required to do so. If the entity fails to include required going concern disclosures in the financial statements when conditions exist, the auditor evaluates whether this omission represents a departure from the applicable framework, which could result in a qualified or adverse opinion.

PCAOB Considerations

Under PCAOB standards (AS 2415, substantially the same as AU-C 570 in principle), the going concern assessment and reporting requirements are largely similar. The auditor includes an explanatory paragraph in the report when substantial doubt exists. For integrated audits, going concern considerations also affect the auditor's assessment of internal control, particularly regarding management's financial reporting process and disclosure controls.

Management's Responsibility Under GAAP

Under ASU 2014-15 (ASC 205-40), management is required to evaluate whether conditions or events raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued (or available to be issued). Management must provide certain disclosures if either substantial doubt exists and is alleviated by management's plans, or if substantial doubt is not alleviated.

Exam Tips for Going Concern

• A going concern emphasis-of-matter paragraph does not modify the audit opinion; the opinion remains unmodified.
• The evaluation period is generally one year from the financial statement date or issuance date, depending on the framework.
• If management refuses to make required going concern disclosures, the auditor considers whether a departure from GAAP exists, potentially leading to a qualified or adverse opinion.
• The auditor is not required to design procedures specifically to identify going concern issues, but must evaluate conditions identified during the audit.
• The auditor evaluates the feasibility of management's plans, not just whether plans exist.