While FASB is preparing to release an accounting standard clarifying management and auditor responsibilities for evaluating going concern issues, and as auditors begin to plan for calendar year 2010 audits, the effects of current economic events on the continued existence of reporting entities are increasingly important. Recent statistics released by the SEC indicated that 20% of issuer’s financial statements were accompanied by audit reports with going concern exceptions in 2009! 2010 could be worse for both the public and private sector.!
Here’s a chronology containing questions auditors may wish to ask regarding going concern issues:
1. Obtain interim financial information 60 to 90 days prior to the client’s reporting date. Consider annualizing the interim information and entering it in accounting or auditing software for comparison with trends of prior years. ASK: What caused significant variations? ASK: Are significant variations causes of potential threats to continued existence of the entity?
2. When the engagement leader delivers the engagement letter, ASK: What are the effects of the economic downturn on the entity’s business? ASK: What are the effects of the downturn on the entity’s major customers and major vendors?
3. At the audit team’s planning and brainstorming meeting, ASK: Are there increased risks of misstatements due to error or fraud because of going concern issues? ASK: What overall and/or specific audit responses are necessary to mitigate these risks?
4. If there are increased threats to continued existence, ASK: What are management’s plans to overcome these threats? ASK: Has, or can, management create formal plans? ASK: Should the CPA firm withdraw from this engagement?
5. If management doesn’t have the capability to complete plans on their own, ASK: Can they provide a person with suitable, skill knowledge or experience to oversee the performance of non-attest services by the auditors? ASK: Should the client hire other consultants to develop a formal plan for overcoming the threat to continued existence?
6. If a formal plan has been, or will be, developed by management or their representatives, ASK: What is the severity of the threat to continued existence and how will the audit team evaluate the appropriateness and reasonableness of management’s plans?
7. After management’s plans have been evaluated, ASK: Is there a remaining threat to continued existence and what will be the effects on footnotes disclosures and the auditor’s reports? ASK: What is the severity of any remaining threat? ASK: Will a disclaimer of opinion be necessary because of an imminent remaining threat, a departure from GAAP qualification because of a significant remaining threat, or an emphasis of a matter paragraph because of the possibility of the effects of threats on future operations?
8. After the nature of the auditor’s report has been determined, ASK: What affect will the report have on the entity’s relationship with financial statement users? ASK: Should the engagement leader accompany the entity’s management to present the report to financial statement users to discuss the appropriateness and reasonableness of management’s plans?
Because threats to continued existence can affect the entity’s reporting framework, i.e., can create departures from generally accepted accounting principles or other reporting frameworks, it may be necessary to ask these questions for audits, reviews and compilations to determine any necessary report modifications. One thing is for sure. Threats to continued existence of any entity can only be eliminated with prospective plans and actions. When an entity ceases to be a going concern, only finger pointing remains!
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