COVID-19 tests going concern assessment rules
Published December 1, 2020
When preparing financial statements under U.S. Generally Accepted Accounting Principles (GAAP), management must assess a company’s ability to make enough money to stay afloat and avoid bankruptcy. These so-called “going concern” assessments have become a hot topic during the COVID-19 pandemic. Here’s an overview of how managers assess this issue and how the accounting guidance is holding up under current market conditions.
A basic accounting assumption
The going concern assumption underlies all GAAP financial reporting. It presumes that a company will continue normal business operations into the future. When liquidation is imminent, the liquidation basis of accounting is used to report financial results instead. The Financial Accounting Standards Board (FASB) modified the going concern rules in 2014, because some stakeholders felt that external auditors often made this call too late, when struggling businesses were well on the way to collapse.
Accounting Standards Update No. (ASU) 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, applies to public and private companies that follow GAAP, not just those that are audited. It charges management, not auditors, with assessing if there’s a going concern issue and requires disclosure when there’s substantial doubt about business continuity or about whether substantial doubt has been alleviated by management’s mitigating plans. This assessment is subject to external review and audit procedures.
Under the updated standard, management must decide whether conditions or events exist that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).
Conditions that raise doubt
Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:
- Negative financial trends, such as recurring operating losses or working capital deficiencies,
- An uninsured or underinsured catastrophe, such as a hurricane or wildfire,
- Denial of credit from suppliers,
- Dividend arrearages,
- Disposals of substantial assets,
- Work stoppages and other labor difficulties,
- Legal proceedings or legislation that jeopardizes ongoing operations,
- Loss of a key franchise, license or patent,
- Loss of a principal customer or supplier, and
- Loan defaults and debt restructuring.
The existence of one or more of these conditions or events doesn’t automatically mean that there’s a going concern issue. Similarly, the absence of these conditions or events isn’t a guarantee that the company will meet its obligations over the next year.
Instead, management should base its assessment on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued (or available to be issued). Management should consider the timing, likelihood and magnitude of the potential effects of these conditions and events when making its determination.
Current market conditions
The current economic turmoil is the first time since the updated standard was issued that the going concern rules are being broadly put into play. And the FASB has received questions about how temporary declines in the value of some nonfinancial assets affect the assessment.
“Given the current environment, as the quarters continue, as the COVID-19 pandemic continues to affect businesses and plans become more clear, we continue to pay attention and monitor the disclosures and how the standard is working,” said FASB member Marsha Hunt. “One reminder about the standard is that the period of assessment goes through one year from the date that the financial statements are actually issued. So, management needs to understand conditions that are known or knowable and how they may affect that period of time.”
It’s also important to remember that, if management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate that doubt. In other words, management should ask, “Can we fix it?” The mitigating effect of management’s plans should be considered only if it’s probable that the plans will be implemented and will alleviate the adverse conditions or events. That determination may be subjective in today’s uncertain market conditions.
Eye on nonprofits
The going concern issue was also raised during recent FASB advisory meetings with its Not-for-Profit Advisory Committee (NAC) and the Financial Accounting Standards Advisory Council (FASAC). NAC members suggested that there should be more disclosures than they’re seeing related to subsequent events or some of the assessments that management may be doing.
Moreover, during FASAC discussions, some council members talked about the disclosures that they find helpful, specifically those related to liquidity, debt covenants and defaults. FASAC members said those could serve as indicators for investors or users of the financial statements and could identify areas to address to help predict what could become a going concern issue in the future.
Going, going, gone
For many businesses and not-for-profits, the COVID-19 crisis remains an ongoing threat to organizational continuity. Predicting how much longer this situation will persist and continue to have adverse financial effects on your organization is a challenging endeavor. The appropriate time frame is one year from now — and, as we’ve learned in 2020, a lot can change in a year. If you have concerns about how long your organization can stay afloat, contact your CPA to discuss possible solutions.
Sidebar: New guidance on debt modifications and restructurings
Unfortunately, many companies have restructured or modified their outstanding debt arrangements during the COVID-19 pandemic — many for the first time ever. In recent months, the Financial Accounting Standards Board (FASB) has received many questions about how to apply the accounting guidance on debt restructurings and modifications. So, it recently published an educational staff paper to help financially distressed borrowers work through the details.
“The nature and extent of a debt modification will determine the accounting effects on an entity’s statement of operations and statement of financial condition,” FASB staff wrote. “Consequently, entities will need to evaluate all facts and circumstances to ensure that the debt modification is appropriately accounted for.” The FASB recommends that borrowers review two sections of the debt guidance:
- Accounting Standards Codification (ASC) Subtopic 470-60, Debt — Troubled Debt Restructurings by Debtors. A troubled debt restructuring (TDR) occurs when a borrower is experiencing financial troubles and a lender makes concessions that it wouldn’t consider under normal circumstances. The staff paper explains accounting for TDRs and provides help in determining whether a TDR has or hasn’t occurred, including by explaining what constitutes financial difficulties on the part of a borrower.
- ASC Subtopic 470-50, Debt — Modifications and Extinguishments. This section helps determine if a nontroubled modification or exchange of debt with the same creditor should be accounted for as either an extinguishment or a modification.
If your company has modified or restructured loans in 2020, contact your CPA firm to discuss how to report these transactions in your year-end financial statements. These professionals are on top of the latest developments in this nuanced accounting topic.