No. US2014-07 September 23, 2014 What s inside: Background... 1 Key provisions... 2 Disclosure threshold: Substantial doubt... 2 Consideration of management s plans... 4 Required disclosures... 6 What s next... 7 Appendices Appendix A: Decision flowchart... 8 Appendix B: Example application... 9 Going concern FASB defines management s going concern assessment and disclosure responsibilities At a glance On August 27, 2014, the FASB (the board ) issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity s Ability to Continue as a Going Concern, which requires management to assess a company s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. Before this new standard, there was minimal guidance in U.S. GAAP specific to going concern. Under the new standard, disclosures are required when conditions give rise to substantial doubt about a company s ability to continue as a going concern within one year from the financial statement issuance date. The new standard applies to all companies and is effective for the annual period ending after December 15, 2016, and all annual and interim periods thereafter. Background.1 Financial reporting under U.S. GAAP assumes that a company will continue to operate as a going concern until its liquidation becomes imminent 1. This is commonly referred to as the going concern basis of accounting..2 If a company faces conditions that give rise to uncertainties about its ability to continue to operate (for example, recurring operating losses), it may be necessary to make adjustments in the company s financial statements and provide related disclosures (for example, asset impairment losses). Nevertheless, financial statements would continue to be prepared under the going concern basis of accounting even when there are significant going concern uncertainties. Although the basis of accounting generally would not change no matter how significant the going concern uncertainty, disclosures may be appropriate to alert investors about the underlying conditions and management s plans..3 Disclosures regarding going concern uncertainties are common in financial reporting today, but before the new standard, there was minimal guidance in U.S. GAAP about when management should start providing such disclosures (that is, how significant must the uncertainty become to trigger disclosures) or about what information to disclose. The lack of management-specific guidance led to diversity in practice. The new standard 1 When a company s liquidation becomes imminent, financial statements should no longer be prepared under the going concern basis of accounting, but rather under the liquidation basis of accounting in accordance with ASC 205-30, Presentation of Financial Statements-Liquidation. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 1
provides management with direct guidance on going concern assessments and disclosures..4 Presently, U.S. auditing standards and federal securities law require auditors to evaluate a company s ability to continue as a going concern, and auditing standards require auditors to consider management s footnote disclosures..5 The new standard incorporates some of the principles of the current auditing standards and builds upon them, as follows: Requires an assessment each annual and interim reporting period. Audits are generally conducted annually; thus, auditing standards do not apply to interim periods. Defines substantial doubt. Auditing standards do not explicitly define substantial doubt. Sets a look-forward period of one year from the financial statement issuance date. Auditing standards provide a shorter look-forward period of one year from the balance sheet date. Requires disclosures even when an initially-identified substantial doubt is alleviated by management s plans. The auditing standards indicate that auditors should consider the adequacy of disclosures in these situations, but there are no specific disclosure requirements. Key provisions Disclosure threshold: Substantial doubt.6 Under the new standard, the emergence of substantial doubt about a company s ability to continue as a going concern is the trigger for providing footnote disclosure. For each annual and interim reporting period, management should evaluate whether there are conditions that give rise to substantial doubt within one year from the financial statement issuance date, and if so, provide related disclosures. The board adopted the auditing standard s substantial-doubt concept and defined it in the new standard to reduce the diversity in its interpretation under current practice..7 The assessment is required to be performed for each reporting period including interim periods. Accordingly, SEC registrants with interim reporting requirements should assess going concern uncertainties quarterly. Nonpublic entities should assess going concern uncertainties annually, or more frequently if they issue interim financial statements that are prepared under U.S. GAAP. Companies will need to implement processes and controls (or formalize existing ones) to assess risk, to determine the level of analysis necessary, and to perform the going concern assessment. Companies may be able to leverage their existing processes and controls that are used in assessing risks and developing forecasts..8 The new standard indicates that conditions that give rise to substantial doubt ordinarily relate to a company s ability to meet its obligations as they become due. It also provides a definition of substantial doubt that is principally based on likelihood. Substantial doubt exists when conditions and events, considered in the aggregate, indicate it is probable that a company will be unable to meet its obligations as they National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 2
become due within one year after the financial statement issuance date 2. The likelihood threshold of probable is defined as the future event or events are likely to occur, which is consistent with its current use in U.S. GAAP applicable to loss contingencies. During its deliberations, the FASB made it clear that probable represents a higher likelihood threshold than its initially-proposed more-likely-than-not threshold. Discussions at public meetings of the FASB attributed a likelihood range of approximately 70 to 80 percent when describing how practice in the U.S. generally interprets probable with respect to loss contingencies. However, the assessment is not intended to rely on a formula-based likelihood calculation. Management will have to consider all relevant qualitative and quantitative information and exercise judgment..9 Management s assessment should be based on the relevant conditions that are known and reasonably knowable at the issuance date, rather than at the balance sheet date. This means that the assessment should consider the most current information available before the financial statements are issued, requiring companies to consider all relevant subsequent events after the balance sheet date. The term reasonably knowable was introduced to emphasize that a company should make a reasonable effort to identify conditions that it may not readily know, but that could be identified without undue cost and effort. Illustration: Look-forward period 3 The assessment date Assess conditions known (or reasonably knowable) at the FS issuance date The assessment...to determine if it is probable that entity will not meet... The look-forward period one year from FS issuance date. 12/31/X1 3/1/X2 12/31/X2 3/1/X3 Balance sheet date Financial statement issuance date One year from the balance sheet date One year from the FS issuance date.10 The substantial doubt definition is principally based on likelihood, but the standard indicates that both quantitative and qualitative information should be considered in the assessment. Management should consider information about the following conditions, among others, as of the financial statement issuance date: 2 For companies that are not SEC filers, the assessment period is one year from the date the financial statements are available to be issued, which is defined in ASC 855, Subsequent Events. 3 Adapted from Appendix A of the FASB s May 7, 2014 Board Meeting Handout. The FASB material is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and is reproduced with permission. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 3
The company s current financial condition including its current liquid resources (for example, available cash or available access to credit) Conditional and unconditional obligations due or anticipated in the next year (whether or not they are recognized in the financial statements) Funds necessary to maintain operations considering the company s current financial condition, obligations, and other expected cash flows in the next year Other conditions that could adversely affect the company s ability to meet its obligations in the next year (when considered in conjunction with the above). For example: - Negative financial trends (e.g., recurring operating losses, working capital deficiencies, or negative operating cash flows) - Other indications of financial difficulties (e.g., default on loans, denial of supplier credit, a need to restructure debt or seek new debt, noncompliance with statutory capital requirements, or a need to dispose of substantial assets) - Internal matters (e.g., labor difficulties, substantial dependence on the success of a project, uneconomic long-term commitments, or a need to significantly revise operations) - External matters (e.g., significant litigation, loss of a key customer, franchise, license, patent or supplier, or an uninsured natural disaster).11 The assessment of a company s ability to meet its obligations is inherently judgmental. The standard indicates that a company should assess relevant conditions in the aggregate, and weigh the likelihood and magnitude of their potential impact on the company s ability to meet the assessment period. The FASB acknowledged that the level of analysis necessary for management s assessment will vary depending on a company s specific facts and circumstances. We anticipate that a detailed analysis will generally not be necessary when a company has a history of profitable operations, positive cash flows, substantial liquidity, and no other significant adverse conditions exist. A more robust analysis will occasionally be necessary for companies that are otherwise financially healthy. This may be the case, for example, because of external factors (such as an economic recession) or because of known events that may risk a company s ability to meet its obligations (such as an upcoming debt maturity that requires refinancing). In some cases, detailed prospective financial information (for example, forecasted cash flows or covenant calculations) will have to be prepared to adequately assess whether a company can meet its the next year. Consideration of management s plans.12 If conditions give rise to substantial doubt in the initial assessment, the standard requires management to consider its plans and their mitigating impact. In doing so, management should assess whether its plans to mitigate the adverse conditions, when implemented, will alleviate substantial doubt. Whether an initially-identified substantial doubt is alleviated or not will determine the nature of required disclosures. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 4
.13 The new standard sets a high bar for a company to be able to take credit in its assessment for the mitigating impact of its management s plans. Management s plans should be considered only to the extent that information available as of the issuance date indicates both of the following: It is probable that the plans will be effectively implemented within the assessment period It is probable that management s plans, when implemented, will mitigate the conditions that give rise to substantial doubt within the assessment period.14 In assessing effective implementation, management should evaluate the feasibility of the plans in light of the company s specific facts and circumstances. Management s ability to successfully implement the plans is important in this evaluation. Generally, to be considered probable of being effectively implemented, the standard indicates that management (or others with the appropriate authority, such as the board of directors) must have approved the plan before the issuance date..15 Management should further assess its plans (that are probable of effective implementation) to determine whether it is probable that those plans will mitigate the conditions that give rise to substantial doubt. In this assessment, management should consider the expected magnitude and timing of the mitigating effect of its plans (for example, the amount and timing of cash proceeds from the planned sale of a building) in relation to the magnitude and timing of the relevant conditions or events that those plans intend to mitigate (for example, the amount and timing of additional cash necessary to pay down anticipated obligations)..16 If management concludes that the initially-identified substantial doubt is alleviated by its plans, the standard still requires certain disclosures about the underlying conditions and management s plans. However, such disclosures would not express that there is substantial doubt. Only if substantial doubt remains despite management s plans does the standard require an express statement that there is substantial doubt about the company s ability to continue as a concern..17 The standard provides examples of plans that management may implement to mitigate the conditions that give rise to substantial doubt and identifies the types of information that management should consider in evaluating their feasibility. The examples are not intended to be all inclusive. Plans to dispose of an asset or business: consider the restrictions on such disposal, such as covenants that limit disposal, or encumbrances against the asset. Also consider marketability of the asset Plans to borrow money or restructure debt: consider the availability and terms of new or existing debt, existing guarantees, commitments, and subordination clauses Plans to reduce or delay expenditure: consider the feasibility of plans to reduce overhead or expenditures, to postpone research or maintenance, or to lease rather than purchase Plans to increase ownership equity: consider the feasibility of raising additional capital from affiliates or other investors, or arrangements to reduce current dividends National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 5
.18 The standard also clarifies that any mitigating effect resulting from a plan to liquidate the company (for example, cash infusions through liquidation of a business) should not be considered in the assessment, even if the liquidation is probable of occurring. Consideration of management s plans is another area requiring significant judgment. Generally, management should consider the mitigating effect of its plans that have already been implemented as of the issuance date (for example, proceeds from debt refinanced prior to the issuance date, cash savings from successful cost-cutting efforts that are underway, or revenue expected from a back-log of existing customer orders). However, management should not consider its plans that have not yet been fully implemented as of the issuance date (for example, debt that has not yet been refinanced, cost-cutting efforts that have not been initiated, or marketing efforts that have not yet resulted in customer orders) unless it is probable those plans will be successfully implemented, and if implemented, probable that the plans will mitigate the adverse conditions giving rise to substantial doubt. Required disclosures.19 Disclosures are only required if conditions give rise to substantial doubt, whether or not the substantial doubt is alleviated by management s plans. No disclosures are required specific to going concern uncertainties if an assessment of the conditions does not give rise to substantial doubt..20 If substantial doubt is alleviated as a result of the consideration of management s plans, a company should disclose information that enables users of financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes): Principal conditions that initially gave rise to substantial doubt Management s evaluation of the significance of those conditions in relation to the company s ability to meet its obligations Management s plans that alleviated substantial doubt The standard specifically allows an entity to refer to information elsewhere in the footnotes (for example, the debt footnote) when substantial doubt is alleviated by management s plans. This may be appropriate, for example, when the only significant adverse condition is an upcoming debt maturity (within the next year), and while the company does not have enough cash to pay down the entire debt, it is otherwise financially healthy; accordingly, management determines that is probable the company will refinance the debt before its maturity date. In most other cases, we believe that the disclosures should be in a single location in the footnotes to provide appropriate background and context about the conditions present and about management s plans that alleviated substantial doubt. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 6
.21 If substantial doubt is not alleviated after considering management s plans, disclosures should enable investors to understand the underlying conditions, and include the following: A statement indicating that there is substantial doubt about the company s ability to continue as a going concern within one year after the issuance date The principal conditions that give rise to substantial doubt Management s evaluation of the significance of those conditions in relation to the company s ability to meet its obligations Management plans that are intended to mitigate the adverse conditions Whether or not substantial doubt is alleviated, footnote disclosures should focus on pertinent information about significant conditions that are specific to going concern uncertainties, management s evaluation of those conditions, and management s plans. SEC registrants may use MD&A to complement and expand upon footnote disclosures by providing additional context about the potential causes and effects of going concern uncertainties..22 In subsequent annual and interim periods, a company should continue to provide the disclosures if conditions continue to give rise to substantial doubt in those periods. Disclosures should become more extensive as additional information becomes available about the company s financial condition and about management s plans. Companies should provide appropriate context and continuity in explaining how conditions have changed between reporting periods. In the period substantial doubt no longer exists (before or after consideration of management s plans), the standard indicates that companies should disclose how the relevant conditions were resolved. What s next.23 The new standard will be effective for all companies in the first annual period ending after December 15, 2016 (December 31, 2016 for calendar year-end companies). Earlier application is permitted..24 The PCAOB and the AICPA s Auditing Standards Board both have projects on their agendas to review and potentially modify existing auditing standards related to going concern. The PCAOB has indicated in a recent staff audit practice alert that the auditor's evaluation of whether substantial doubt exists is qualitative, based on the relevant events and conditions and other considerations set forth in the auditing standards. Accordingly, a determination that no disclosure is required under the new standard is not conclusive as to whether an explanatory paragraph is required in the auditor s report. Before initial adoption, companies and their auditors should discuss the interaction of the new accounting standards with the auditing standards. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 7
Appendix A: Decision flowchart 4 Start Are the criteria met for the liquidation basis of accounting? (ASC 205-30) Apply the liquidation basis of accounting. (ASC 205-30) No Are there conditions or events, considered in the aggregate, that raise substantial doubt about an 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)? (ASC 205-40-50-01 through 50-5) No No disclosures are required specific to going concern uncertainties under ASC 205-40. See ASC 275 and ASC 450 for other disclosures about risks, uncertainties, and contingencies, as applicable. Consider management s plans intended to mitigate the adverse conditions or events. (paragraphs 205-40-50-6 through 50-11) Is it probable that management s plans will be effectively implemented? (ASC 205-40-50-7 through 50-8) Is it probable that management s plans will mitigate the relevant conditions or events that raise substantial doubt? (ASC 205-40-50-10) An entity shall disclose information to help users understand the following when substantial doubt is alleviated by management s plans: 1. Principal conditions or events that raised substantial doubt, before consideration of management s plans 2. Management s evaluation of the significance of those conditions or events 3. Management s plans that alleviated substantial doubt. (ASC 205-40-50-12) No No An entity shall disclose information to help users understand the following when substantial doubt is not alleviated: 1. Principal conditions or events that raise substantial doubt 2. Management s evaluation of the significance of those conditions or events 3. Management s plans that are intended to mitigate the conditions or events that raise substantial doubt. The entity also should include in the footnotes a statement indicating that there is substantial doubt about the entity s ability to continue as a going concern within one year after the date that the financial statements are issued (or available to be issued). (ASC 205-40-50-13) 4 Reproduced from ASC 205-40-55-1. The FASB material is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and is reproduced with permission. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 8
Appendix B: Example application Relevant conditions Management s assessment results Management's plans to mitigate adverse conditions Do conditions raise substantial doubt? Is substantial doubt alleviated by management s plans? Disclosures Negative financial trends No significant debt coming due within the assessment period Substantial liquid resources (cash & line of credit) Cash flow forecasts demonstrate the company will meet its the assessment period Cost cutting measures No, because it is not probable that the entity will be unable to meet the next year N/A No disclosures specific to going concern required Negative financial trends No significant debt coming due within the assessment period Limited liquid resources (cash & line of credit) Cash flow forecasts demonstrate the company will run out of cash (and available line of credit) within the assessment period Sell Division A Plan approved by the board before the issuance date and it is probable within the assessment period that the plan: - will be effectively implemented, and, because it is probable that the entity will not meet obligations within the next year unless it sells Division A Disclose conditions, management s evaluation, and management s plans that alleviated substantial doubt - will mitigate the conditions (that is, sufficient cash will be generated from the transaction) Positive financial trends and positive working capital Significant debt is coming due within the next year The company does not have the ability to repay all debt at maturity The company has a history of refinancing debt and nothing indicates it cannot refinance again Absent a refinancing, the company would not be able to meet its the next year With refinancing, it would meet its obligations Refinance debt The plan is deemed to be probable of being implemented and probable of mitigating adverse conditions, because it is probable that the entity will not meet its the next year unless it refinances Limited incremental disclosures: refer to debt footnote, mention the plan to refinance Negative financial trends and limited liquidity Significant debt is coming due within the next year The company does not have the ability to repay all debt at maturity The company does not have a history of refinancing debt Absent a refinancing, the company will not meet its the next year With refinancing, it would meet its obligations Refinance debt Plan is not probable of being implemented due to negative financial trends and lack of refinancing history, because it is probable that the entity will not meet its the next year unless it refinances No Express that there is substantial doubt. Also disclose conditions, management s evaluation, and management s plans. National Professional Services Group CFOdirect Network www.cfodirect.pwc.com In depth 9
Questions? PwC clients who have questions about this In depth should contact their engagement partner. Engagement teams who have questions should contact the Risk Management team in the National Professional Services Group. Authored by: Daghan Or Partner Phone: 1-973-236-4966 Email: daghan.or@us.pwc.com Guy Raymaker Partner Phone: 1-973-236-4180 Email: guy.raymaker@us.pwc.com Toni Lockett Senior Manager Phone: 1-973-236-5483 Email: antonette.l.lockett@us.pwc.com 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. To access additional content on financial reporting issues, visit www.cfodirect.pwc.com, PwC s online resource for financial executives.