Auditors reconsider the ‘going concern’ assumption every time they audit your financial statements. When your company’s long-term viability is doubtful, it may cause the auditor to issue a qualified audit opinion. Depending on the level of uncertainty and the underlying reasons, a qualified opinion could raise a red flag that your company is under financial distress and might need to file for bankruptcy in the near future.
Going concern assumption
Financial statements are generally prepared under the assumption that the business will remain a going concern. That is, the entity is expected to continue to generate a positive return on its assets and meet its obligations in the ordinary course of business.
Sometimes adverse conditions and events — such as negative operating cash flow or pending lawsuits — cast ‘substantial doubt’ on the entity’s ability to continue as a going concern over the next year.
Levels of opinion
Audit opinions vary depending on available information, financial viability, errors discovered during audit procedures, and other limiting factors. When an auditor issues an unqualified opinion, he or she is saying that the company’s financial condition, position, and operations are fairly presented in the financial statements.
When uncertainties exist regarding the going concern assumption, the auditor will typically issue a qualified opinion. A qualified opinion also may be issued if your financial statements appear to contain a small deviation from U.S. Generally Accepted Accounting Principles (GAAP) or if management limits the scope of audit procedures.
Much less desirable are adverse opinions. They indicate material exceptions to GAAP that affect the financial statements as a whole.
By far the most alarming opinion is a disclaimer, which occurs when the auditor gives up mid-audit. Reasons for a disclaimer may include significant scope limitations and uncertainties within the subject company itself.
Management’s role
Guidance that shifts the responsibility for identifying going concern issues from external auditors to internal managers was issued by the Financial Accounting Standards Board in 2014. This change is intended to inform stakeholders about financial problems sooner.
If you identify a going concern issue, ask yourself, “Can we fix it?” Then, assemble a team of internal and external advisors to brainstorm remedies. If it is not fixable, expect a downgraded audit opinion and prepare to address inquiries from your lenders and investors when your financial statements are issued.
If you’re looking for an external team of advisors, contact KPM today to see how we can help you.