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Going Concern Assessment - Are You Prepared?
Great insight into the reporting responsibilities of charities as well as the advisor's role in analyzing the potential viability of a donor's gift.
By Dennis Walsh, CPA
Hometown Community Center is experiencing a chronic cash shortage due to loss of a key grant. Lease payments are three months behind and meeting payroll is a struggle. Other support is dropping off due to unfair media coverage about past overhead spending.
The development staff is doing everything possible to increase support and identify new mission-related revenue sources, but without prompt infusion of a major gift or new grant there is no reason to be optimistic that activities can continue much longer.
Does this sound familiar?
This scenario is not atypical. Financial challenges are a fact of life in the nonprofit sector, and keeping the doors open is especially challenging for many grassroots organizations.
Planned giving professionals play an important role on behalf of their clients in scrutinizing charitable organizations for such sustainability issues.
In 2014 the Financial Accounting Standards Board issued Accounting Standard Update (ASU) 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.”
The standard is effective for financial statements covering the annual period ending after December 15, 2016, including financial statements for the full calendar year 2016, and for all annual and interim periods ending after this date. It applies to all types of entities preparing financial statements under generally accepted accounting principles (GAAP) in the United States.
The “going concern” concept represents an assumption that and entity will continue to operate into the foreseeable future. Continuation as a going concern is presumed as the basis for preparing financial statements, unless an entity’s liquidation becomes imminent. In such case financial statements should be prepared on the liquidation basis of accounting.
But even if liquidation is not imminent, there may be situations that raise doubt about an entity’s ability to continue as a going concern, as in the earlier example. In these cases, management will continue to prepare financial statements on the going concern basis, but will also need to look to the new standard to determine whether to add prescribed information to the financial statement footnotes.
Prior to the ASU, requirements for going concern evaluation were present within auditing standards, but there was no guidance within GAAP about management’s responsibility to identify a going concern problem or to provide related disclosures. The going concern assessment has been, implicitly, a long standing part of GAAP, but the ASU provides explicit guidance as to what types of disclosures are required and when.
Each time an entity prepares financial statements under GAAP, management must now make an evaluation of whether there are relevant conditions or events, when taken together, that raise substantial doubt about its ability to continue as a going concern for a period of one year from the date that the financial statements are available to be issued, or the date issued if the entity is an SEC filer. This stands in contrast to one-year from the date of the financial statements (i.e. the last day of the reporting period) under prior auditing standards.
Substantial doubt exists when conditions or events indicate that it is probable that the entity will be unable to meet its obligations as they come due within the one-year period. While there is no quantitative test of probability for this purpose, a likelihood of 70% to 80% or higher that an entity will not meet its obligations might be regarded as a reasonable indication of substantial doubt.
Once substantial doubt has been identified, management will need to consider whether it is probable that its plans will be effectively implemented and, if so, that it is probable they will alleviate the conditions or events affecting the going concern assumption.
Consideration must be given to whether necessary plan approval, such as from the board of directors, will be obtained prior to issuance of the financial statements. The outcome of this assessment will then determine the nature and content of disclosures to be included in the financial statements.
If substantial doubt is not alleviated after consideration of management’s plans, then the financial statement footnotes should include a statement that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued or available to be issued, as applicable.
In all cases, the footnotes must include a narrative description of the following:
- Principal conditions or events that raise substantial doubt
- Management’s evaluation of the significance of these conditions or events in relation to the entity’s ability to meet its obligations
- Management’s plans that alleviated or are intended to alleviate substantial doubt about its ability to continue as a going concern
Omission of this information when required is a departure from GAAP that must be communicated within an independent accountant’s report on financial statements
All entities should remain mindful of the new standard, regardless of the strength of their financial position. Internal and external threats abound and no entity is immune. The loss of a major grant or donor, departure of key staff, bad publicity, a casualty loss, or failure to extend debt are among the type of perils that can strike quickly. Most nonprofits carry less than three months of cash reserve, and commercial financing is out of reach for many organizations.
Since donors, creditors, and other stakeholders frequently use financial statements in making decisions relative to their continuing support of an organization, it is important that management and those charged with governance are familiar with the new requirements and the implications that any going concern related disclosures may have on the entity’s ability to attract and maintain support and revenue streams or to obtain debt financing.
Advance communication among board members, management, and independent accountants is vital to provide opportunity to plan for mitigation of conditions or events giving rise to going concern doubt. This is important not only for entity survival, but can help ease the impact that a substantial doubt disclosure will likely have on ongoing development efforts.
In summary, independent accountants should inform management and those charged with governance when appropriate regarding the newly effective standard and advise them to assess financial and non-financial threats to sustainability as they arise. Plans for mitigation of conditions and events should be documented along with findings and revisions from follow up assessments. Taken together, these actions should help assure the entity satisfies reporting requirements while managing negative stakeholder reaction to a going concern disclosure.