Going Concern

Companies that have recurring losses, negative cash flow from operations, and a significant accumulated deficit are all at risk of being deemed a going concern risk. Going concern is a fundamental accounting concept that a company will continue to operate for the foreseeable future. If it will not be able to operate or meet its obligations for the foreseeable future, it may be required to make adjustments in its financial statements (i.e., liquidation basis accounting) and provide significant disclosures. Companies must perform a going concern analysis as part of their financial statements each reporting period.

Accounting Guidance

ASC 205-40, Presentation of Financial Statements – Going Concern, provides management with guidance on going concern assessments and disclosures.  The guidance in ASC 205-40 details the following:

• Management must assess going concern each reporting period with a look-forward period of one year from the date the financial statements are issued
• Defines substantial doubt
• Requires disclosures when there is substantial doubt about the Company’s ability to continue as a going concern, even when management’s plans alleviate the substantial doubt

Assessing Going Concern

Step 1: Are there conditions or events that raise substantial doubt about the Company’s ability to continue as a going concern?

The first step in the going concern analysis is to determine whether there is substantial doubt about the Company’s ability to continue as a going concern. Substantial doubt can arise when conditions and events indicate it is probable that the Company will be unable to meet its obligations as they become due within one year after the issuance date of the financial statements.

The first step is based on conditions that are known, or reasonably knowable, at the financial statement issuance date.  This is initially done without regard to management’s plans to mitigate the substantial doubt. In other words, the Company cannot factor in potential sources of cash from financing activities that aren’t yet implemented.

When evaluating an entity’s ability to meet its obligations, management shall consider both quantitative and qualitative information. 

1. Assessment of Current Financial Condition

As part of its assessment of financial condition, management should look at the Company’s liquid assets, including cash and cash equivalents, ST investments, and accounts receivable. The Company should also assess its access to credit (line of credit or other revolving credit facility) that it can readily draw on.

2. Assessment of Conditional and Unconditional Obligations

Management must consider the Company’s conditional and unconditional obligations that are due during the look-forward period. This should include accounts payable, accrued liabilities, lease payments, and debt payments.

3. Assessment of Funds Necessary to Maintain the Entity’s Operations

To determine the funds necessary to maintain the Company’s operations, Management will typically prepare a cash flow forecast for the look-forward period. The cash flow forecast should include forecasted cash flows from operations, investing, and financing. After taking into consideration the cash flows during the look-forward period, the Company will need to determine whether it will end with a positive or negative cash balance.

4. Assessment of other adverse conditions and events

In addition to the above, Management must also consider other conditions and events that may adversely affect the Company’s ability to meet its obligations during the look-forward period.

• Negative financial trends (e.g., recurring operating losses, negative cash flows from operating activities, working capital deficiencies, and other adverse key financial ratios)
• Other possible financial difficulties (e.g., default on loans, a need to restructure debt to avoid default, denial of trade credit from suppliers, a need to seek financing or dispose of assets, or noncompliance with statutory capital requirements)
• Internal matters (e.g., management turnover, substantial dependence on the success of a particular project, labor difficulties, a need to significantly revise operations, or uneconomic long-term commitments)
• External matters (e.g., legal proceedings, legislation, loss of a key franchise, license, or patent, loss of a key supplier or customer, or an uninsured catastrophe)

Step 2: Consider management’s plan if substantial doubt exists about the Company’s ability to continue as a going concern

If the conclusion in Step 1 is that there is substantial doubt about the Company’s ability to continue as a going concern, then the Company must evaluate whether its plans to mitigate those conditions will alleviate the substantial doubt.

Management’s plan can only be considered if:

• Management’s plans will be effectively implemented within one year after the issuance date of the financial statements
• Management’s plans, when implemented, will mitigate the conditions or events that raised substantial doubt within one year after the issuance date of the financial statements.

To be considered effectively implemented, management (or the board of directors) must have approved the plan as of the date the financial statements are issued. Management should also consider its history of successfully implementing these plans.

Some examples of management’s plans to mitigate substantial doubt include the following:

• Issuance of stock or debt (additional financing)
• Restructuring existing debt
• Disposal or sale of an asset or business
• Reduction in discretionary spending
• Delay of projects or R&D

Going Concern Disclosures

If management concludes that the substantial doubt is alleviated by its plans, ASC 205-40 still requires certain disclosures. However, these disclosures would not explicitly say there is substantial doubt. Only if substantial doubt remains despite management’s plans does ASC 205-40 require an explicit statement that there is substantial doubt about the reporting entity’s ability to continue as a going concern. The Company must be transparent about its going concern assessment and status. The auditors will also add language to their opinion if there is substantial doubt about a company’s ability to continue as a going concern.

If management’s plan alleviates the substantial doubt, ASC 205-40 requires the following disclosures:

1. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
2. Management’s evaluation of the significance of those conditions or events about the entity’s ability to meet its obligations
3. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern.

If substantial doubt is raised and not alleviated by management’s plan, ASC 205-40 requires the following disclosures:

1. A statement in the notes to financial statements indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the issuance date of the financial statements
2. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
3. Management’s evaluation of the significance of those conditions or events about the entity’s ability to meet its obligations
4. Management’s plans to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

In subsequent reporting periods, the Company should continue to provide disclosures if conditions continue to give rise to substantial doubt. Disclosures may become more extensive as additional information becomes available. Companies will also need to disclose significant changes in conditions between reporting periods. If substantial doubt no longer exists, the Company should disclose how the relevant conditions were resolved.