Investor Win: FASB Proposes Enhanced “Going Concern” Warnings for U.S. Firms
The winds may be shifting in favor of investors frustrated with the “going concern” opinions from external auditors that failed to provide sufficient advance warnings about a company’s failing financial health. It seems investors now may benefit from more timely notice from those who are in the best position to know — company management.
The big names bring the headlines (think Lehman Brothers, AIG, and Washington Mutual), but as reported by the Wall Street Journal’s Emily Chasan, Duff and Phelps found in 2008 that 63% of medium and large companies filing for bankruptcy that year had not received a going concern warning ahead of their bankruptcy filing. Furthermore, 50% of the companies that received going concern opinions in 2007 were still operating 18 months later. It is clear that going concern reporting needs more teeth.
A basic tenet of financial reporting for any business entity, whether public or private, is that its financial statements are prepared based on the presumption that the entity will continue to operate as a going concern. In other words, will the entity meet its financial obligations as they come due and does it possess sufficient liquidity and capital resources to continue operating for at least the next 12 months or so? When these conditions are not met, users of financial reports — including investors — should be informed of the facts and circumstances surrounding that entity’s ability to continue as a viable operation. From severe liquidity and capital resource constraints that would interfere with making good on major debt repayment to changes in a major customer or vendor supply agreement, investors should know about it. In fact, the sooner, the better.
It seems that improvements may be on the horizon because the Financial Accounting Standards Board (FASB) recently issued a proposal that would require a firm’s management to regularly evaluate and disclose any risks that the company will not continue in the ordinary course of business. Currently, only the external auditors are required to express an opinion on whether the company will continue to operate for the next 12 months. Management, on the other hand, has not been required to disclose its own assessment. The FASB wants to change this.
For its part, CFA Institute agrees that the primary responsibility for reporting going concern matters rests with the company’s management because it is best positioned to make an early assessment of the financial health of the company by reporting this in the company’s financial statements and MD&A. In a March 2012 survey of CFA Institute members, 81% of respondents said it is the responsibility of management to report whether a company will continue as a going concern.
That’s not all. Investors also stand to benefit from enhanced going concern reporting in an improved auditor’s reporting model under consideration by both the Public Company Accounting Oversight Board (PCAOB) and the International Auditing and Assurance Standards Board (IAASB). These audit standard setters are due to issue separate proposals as early as this summer to enhance the independent auditor’s report. Under consideration is more expansive reporting by the auditor of the company’s ability to continue to operate as a going concern.
Will investors finally benefit from expanded disclosure of a company’s financial health from those in the best position to know? Let’s hope so.
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