Going Concern Assessment: AU-C 570 and ASC 205-40 for Private Companies

Going concern is the basic assumption behind almost every set of financial statements: the entity will keep operating and meet its obligations in the normal course of business. When that assumption is in doubt, both management and the auditor have work to do. For US private companies the accounting side sits in ASC 205-40, Presentation of Financial Statements: Going Concern, and the auditing side sits in AU-C 570, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern (as issued by SAS No. 132 and amended by SAS No. 134).

This guide walks through how the two fit together: what management must evaluate, the conditions that point to trouble, what the auditor does, and how the outcome shows up in the disclosures and the report. It paraphrases the standards.

Why going concern sits with both management and the auditor

Before ASC 205-40 took effect, US GAAP did not tell management to assess going concern. The auditor did the evaluation and the disclosure decision often followed the auditor's conclusion. ASC 205-40 changed that. Management now has its own responsibility, for every reporting period, including interim periods, to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern.

AU-C 570 was then rewritten so the auditor evaluates management's assessment instead of replacing it. In practice that means two separate files of thinking: management's evaluation, which the client should be able to show you, and your evaluation of it, which goes in the audit file under AU-C 230.

Management's evaluation under ASC 205-40

The look-forward period

Under ASC 205-40, management looks forward one year from the date the financial statements are issued, or available to be issued for entities that are not SEC filers. It is not one year from the balance sheet date. If the December 31 statements are released in late April, the window runs to late April of the following year.

This detail matters for small-company audits where fieldwork drifts. Every extra month between year-end and release pushes the window further out, and the cash flow forecast has to cover it.

The substantial doubt threshold

ASC 205-40 says substantial doubt exists when conditions and events, considered in the aggregate, indicate that it is probable the entity will be unable to meet its obligations as they become due within the look-forward period. "Probable" has the same meaning as in ASC 450 on contingencies: the future event is likely to occur.

Management first evaluates conditions and events without considering its plans. If substantial doubt exists on that basis, management then considers whether its plans alleviate it.

Management's plans

Plans can alleviate substantial doubt only if both of these hold:

1. It is probable the plans will be effectively implemented within the look-forward period.
2. It is probable the plans, once implemented, will mitigate the relevant conditions or events.

Typical plans include disposing of assets, borrowing or restructuring debt, reducing or delaying expenditures, and raising equity. A plan that depends on a lender or investor who has not committed is harder to call probable. A plan approved by the board with a signed term sheet is easier.

Disclosures

The disclosure outcome depends on where the evaluation lands.

Going concern disclosures are not the same as the liquidation basis of accounting. Liquidation basis under ASC 205-30 applies only when liquidation is imminent, which is a different and higher bar.

Indicators of substantial doubt

Neither ASC 205-40 nor AU-C 570 gives a checklist that decides the question, but both list examples. The common ones group like this.

Financial indicators

• Recurring operating losses or negative cash flows from operations
• Working capital deficiency
• Negative trends such as declining revenue or gross margin
• Default on loan agreements or similar obligations
• Arrearages in dividends
• Denial of usual trade credit from suppliers
• Need to restructure debt to avoid default
• Need to seek new sources or methods of financing, or to dispose of substantial assets

Operating and external indicators

• Work stoppages or other labor difficulties
• Substantial dependence on the success of a particular project
• Uneconomic long-term commitments
• Loss of a key franchise, license, patent, principal customer or supplier
• Legal proceedings, legislation or similar matters that could jeopardize the ability to operate
• An uninsured or underinsured catastrophe such as a fire or flood

Look at them together. One indicator alone, such as a single loss year for a company with a large cash balance, usually does not create substantial doubt. Several indicators pointing the same way often do.

The auditor's procedures under AU-C 570

Objectives

AU-C 570 sets out the auditor's objectives as obtaining sufficient appropriate audit evidence about, and concluding on, whether substantial doubt exists for a reasonable period of time; evaluating the possible effects on the financial statements, including the adequacy of disclosure; and reporting in accordance with the standard. Where the framework (here ASC 205-40) defines the reasonable period, the auditor uses that period.

Risk assessment

Going concern starts at planning, not at completion. When performing risk assessment procedures under AU-C 315, the auditor considers whether conditions or events exist that raise substantial doubt. That includes asking whether management has already performed a preliminary evaluation, discussing the basis of it, and asking about plans.

Practical sources at this stage:

• the prior-year file and any going concern memo
• interim financial information and the current-year budget
• debt agreements and the latest covenant compliance certificates
• board and committee minutes
• inquiries of management and, where relevant, those charged with governance

Evaluating management's assessment

The auditor evaluates management's assessment. If management has not made one and the framework requires it, the auditor asks management to do so. The auditor's evaluation covers the same period management used. If management's period is shorter than the framework requires, the auditor asks management to extend it.

The auditor also stays alert throughout the audit for conditions that management did not identify. A covenant breach found during the debt testwork, a customer that stopped paying, or a large post-year-end loss all feed back into the evaluation.

Additional procedures when conditions are identified

When conditions or events raise substantial doubt, AU-C 570 requires additional procedures. These include:

1. Evaluating management's plans. Ask management to describe its plans, assess whether it is probable they will be effectively implemented and mitigate the conditions, and obtain evidence for the plans that matter most.
2. Evaluating forecasts. Where management's plans rely on a cash flow forecast, evaluate the reliability of the data used and whether there is adequate support for the significant assumptions. Compare prior forecasts to actual results to judge the track record.
3. Considering new information. Consider whether additional facts or information have become available since management made its assessment.
4. Obtaining written representations. Request representations from management about its plans and their feasibility, and that all relevant information has been disclosed. See AU-C 580.

Good evidence for plans is external where possible: a signed loan commitment, a lender waiver, executed asset sale agreements, committed investor funding, or minutes approving cost reductions.

Forecast weaknesses to look for

Problems to look for in a management forecast:

• revenue growth far above recent history with no support
• collections assumed faster than the current receivables aging shows
• debt maturities, balloon payments or covenant step-ups left out
• the window ending at a calendar year-end instead of one year after issuance
• no sensitivity analysis, so the auditor cannot see how much headroom exists

Ask for a monthly cash forecast, not just an annual one. A company can be fine on an annual basis and still run out of cash in month four.

Concluding and reporting

Use of the going concern basis

The auditor concludes on whether substantial doubt exists after considering management's plans, and evaluates the adequacy of the related disclosures. The conclusion drives the report.

Substantial doubt alleviated

If substantial doubt existed but management's plans alleviate it, the auditor evaluates whether the disclosures describe the conditions and the plans adequately. An emphasis-of-matter paragraph is permitted but not required. See types of audit opinions for how emphasis-of-matter paragraphs work.

Substantial doubt remains

If substantial doubt remains, the auditor includes a separate section in the report with the heading "Substantial Doubt About the Entity's Ability to Continue as a Going Concern" (see the illustrative reports in AU-C 570). It draws attention to the note that discloses the matter and states the auditor's conclusion that substantial doubt exists. The opinion itself remains unmodified if the disclosures are adequate.

The section must not use conditional language about the auditor's conclusion. Phrases that suggest the auditor is unsure whether doubt exists are not allowed.

Inadequate disclosure

If the auditor concludes that substantial doubt exists and the disclosure is not adequate, that is a misstatement of the financial statements. The result is a qualified or adverse opinion under AU-C 705, depending on whether the effect is pervasive.

Disclaimer in rare cases

AU-C 705 allows a disclaimer of opinion in rare situations, for example where there are multiple uncertainties that are significant to the financial statements as a whole. This is an exception, not a default for difficult cases.

Management unwilling to make or extend its assessment

If management will not perform or extend its evaluation when asked, the auditor considers the effect on the report. A limitation on scope can lead to a qualified opinion or a disclaimer.

Communication with those charged with governance

Unless all of them are involved in managing the entity, the auditor communicates with those charged with governance about conditions or events identified, including whether they constitute substantial doubt, whether the going concern basis is appropriate, and the adequacy of disclosures. AU-C 260 governs the broader communication.

Interaction with other standards

• Subsequent events. Going concern evidence often arrives after year-end. Events between the balance sheet date and the report date belong in both the going concern evaluation and the subsequent events review. See subsequent events: Type 1 vs Type 2.
• Materiality and misstatements. An uncorrected misstatement that would push the entity into breach of a debt covenant can be material for qualitative reasons even when it is small in amount. See AU-C 320 and AU-C 450.
• Prior-year reports. If a going concern section appeared last year and the doubt has been resolved, the current report does not repeat it. Where comparative statements are reported on, consider the effect on the prior-period report.

What the going concern workpaper should show

A reviewer or successor auditor should be able to read the going concern paper and see:

1. The conditions and events identified, and where each came from.
2. Management's assessment, the period it covers, and how that period was derived from the issuance date.
3. Management's plans and the evidence obtained for each significant plan.
4. Evaluation of the forecast: data reliability, key assumptions, sensitivity, and comparison with past accuracy.
5. The auditor's conclusion and the reasoning behind it.
6. Evaluation of the disclosure against ASC 205-40.
7. The effect on the report, and the related written representations and governance communications.

A weak file shows a one-line conclusion such as "no going concern issues noted" next to a balance sheet with a working capital deficit and a covenant waiver. That is the pattern to avoid.

FAQ

Is the going concern period measured from the balance sheet date?

No. Under ASC 205-40 the period runs one year from the date the financial statements are issued, or available to be issued for entities that are not SEC filers.

Does a going concern section mean the opinion is qualified?

No. If the disclosures are adequate, the opinion is unmodified and the going concern matter appears in a separate section of the report. A qualified or adverse opinion results only if the related disclosure is inadequate.

Can management's plans include raising money from the owners?

Yes, but the auditor needs evidence that the funding is probable, such as a written commitment and evidence that the owner has the ability to provide it. A verbal intention is weak evidence on its own.

Does ASC 205-40 apply to interim financial statements?

Yes. ASC 205-40 requires management to perform the evaluation for each annual and interim reporting period.

What if substantial doubt existed but management's plans resolved it?

The disclosures still need to describe the conditions and the plans that alleviated the doubt. The auditor may add an emphasis-of-matter paragraph but is not required to.

Sources

• AICPA, AU-C Section 570, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern (SAS No. 132, as amended by SAS No. 134)
• FASB ASC 205-40, Presentation of Financial Statements - Going Concern (ASU 2014-15)
• FASB ASC 450-20, Loss Contingencies (meaning of probable), and ASC 205-30, Liquidation Basis of Accounting
• AICPA, AU-C Section 705, Modifications to the Opinion in the Independent Auditor's Report
• AICPA, AU-C Sections 230, 260, 315 and 580

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error