GAAP vs. Non-GAAP

GAAP is a set of rules and procedures that accountants typically follow to record and summarize business transactions. These guidelines provide the foundation for consistent, fair and accurate financial reporting. Private companies generally aren’t required to follow GAAP, but many do. Public companies don’t have a choice; they’re required by the Securities and Exchange Commission to follow GAAP.

Over the years, the use of non-GAAP measures has grown. Some investors and executives argue that certain unaudited figures provide a more meaningful proxy of financial performance than customary earnings figures reported under GAAP. Before relying on non-GAAP metrics, however, it’s important to understand what’s included and excluded to avoid making misinformed investment decisions.

Spotlight on EBITDA

One popular example of a non-GAAP metric is earnings before interest, taxes, depreciation and amortization (EBITDA). It was developed in the 1970s to help investors project a company’s long-term profitability and cash flow. The figure is said to be one of the most valuable yardsticks that investors consider when a company is being bought or sold. However, some companies manipulate EBITDA figures by excluding certain costs, such as stock- or options-based compensation, that are plainly a cost of doing business. This trend has made it difficult for investors and lenders to make fair comparisons and understand the items taken out.

Last year, the Financial Accounting Standards Board added a project to its research agenda to consider the interaction with standardizing key performance indicators (KPIs) within the current regulatory framework, including whether to develop a standard definition of EBITDA. During a March meeting of the Financial Accounting Standards Advisory Council, senior accountants evaluated whether it makes sense to have a GAAP definition of EBITDA, to use either as a one-size-fits-all formula or as a starting point from which companies could make adjustments based on their business needs. For example, a company might tailor its EBITDA calculation to sync with the definition found in its loan agreements. Adjustments to EBITDA would then need to be clearly disclosed in the company’s footnotes.

Adopt a balanced approach

Many organizations decide to report EBITDA and other non-GAAP metrics to help investors and other stakeholders make better-informed decisions. However, these entities should also avoid making claims that could potentially mislead investors and lenders. Contact us to responsibly and transparently report non-GAAP figures for your company.

What are deferred taxes?

Companies pay income tax on IRS-defined taxable income. On their Generally Accepted Accounting Principles (GAAP) financial statements, however, companies record income tax expense based on accounting “pretax net income.” In a given year, taxable income (for federal income tax purposes) and pretax income (as reported on your GAAP income statement) may substantially differ. A common reason for this temporary difference is depreciation expense.

For income taxes, the IRS allows companies to use accelerated depreciation methods to lower the taxes paid in the early years of an asset’s useful life. Some companies also may elect to claim Section 179 deductions and bonus depreciation in the year an asset is placed in service. Alternatively, for GAAP reporting purposes, companies frequently use straight-line depreciation. Early in an asset’s useful life, this divergent treatment usually causes taxable income to be significantly lower than GAAP pretax income. However, as the asset ages, the temporary difference in depreciation expense reverses itself.

The use of different depreciation methods for book and tax purposes causes a company to report deferred tax liabilities. That is, by claiming higher depreciation expense for tax purposes than for accounting purposes, the company has temporarily lowered its tax bill — but it will make up the difference in future tax years. Deferred tax assets may come from other sources, such as capital loss carryforwards, operating loss carryforwards and tax credit carryforwards.

How are deferred taxes reported on the financials?

If a company’s pretax income and its taxable income differ, it must record deferred taxes on its balance sheet. The company records a deferred tax asset for the future benefit it will receive if it pays the IRS more tax than an income statement reflects. If the opposite is true, the company records a deferred tax liability for the additional future amount it will owe.

Like other assets and liabilities, deferred taxes are classified as either current or long-term. Regardless of their classification, deferred taxes are recorded at their cash value (that is, no consideration of the time value of money). Deferred taxes are also based on current income tax rates. If tax rates change, the company may revise its balance sheet and the change flows through to the income statement.

While deferred tax liabilities are recorded at their full amount, deferred tax assets are offset by a valuation allowance that reflects the possibility the asset will expire before the company can use it. Deciding how much deferred tax valuation allowance to book is highly subjective and left to management’s discretion. Any changes to the allowance flow through to the company’s income statement.

Now or later?

Financial statement users can’t afford to lose sight of deferred taxes. All else being equal, a company with significant deferred tax assets may be able to lower its future tax bill and preserve its cash on hand by claiming deferred tax breaks. Conversely, a company with significant deferred tax liabilities has already tapped into tax breaks and may need additional cash on hand to pay Uncle Sam in future tax years. Contact us for more information.

1. Targeted improvements for long-term insurance contracts

Accounting Standards Update (ASU) No. 2018-12, Financial Services — Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, was issued in 2018, but its effective date was deferred twice. It requires insurers to 1) review annually the assumptions they make about their policyholders, and 2) update the liabilities on their balance sheets if the assumptions change. Updated liabilities will be measured using a standardized, market-observable discount interest rate based on the yield from an upper-medium-grade, fixed-income instrument. This is a more conservative approach than the method used for insurance policies under previous guidance.

Large public insurance companies must implement these changes in 2023. This may initially require significant, expensive software changes. Private insurers have until 2025 to make the changes.

2. Expanded disclosures for supplier finance programs

With a supplier finance program, the buyer arranges for a third-party finance provider or intermediary to pay approved invoices before the due date at a discount from the stated amount. Meanwhile the buyer receives an extended payment date, say, 90 to 120 days, in exchange for a fee. This enables the buyer to keep more cash on hand. ASU No. 2022-04, Liabilities — Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations, will require buyers to disclose the key terms of supplier finance programs and where any obligations owed to finance companies have been presented in the financial statements.

3. Changes to M&A accounting

ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, requires companies to measure contract assets and liabilities acquired in a business combination as if they originated the contract. Under previous rules, buyers were required to report acquired customer contracts at fair value.

The updated guidance generally requires buyers to report acquired contracts consistent with how they were reported on the sellers’ financial statements, if the amounts were accurately reported in accordance with the revenue recognition rules under U.S. Generally Accepted Accounting Principles. This update goes into effect in 2023 for public companies and 2024 for private ones.

4. New model for reporting credit losses

ASU No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, requires banks and other entities that extend credit to forecast into the foreseeable future to predict losses over the life of a loan and then immediately book those losses. The updated guidance is designed to provide more-timely reporting of credit losses, but measuring losses is challenging in today’s uncertain, inflationary marketplace. It primarily affects banks and other financial institutions. However, any company that has trade receivables, notes receivable, investments in held-to-maturity debt securities or contract assets will be affected.

Large public companies have already transitioned from the incurred loss model to the current expected credit losses (CECL) model. This year, small public companies, private companies and not-for-profits must adopt the new CECL model.

5. Hedge accounting changes

ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging — Portfolio Layer Method, clarifies the updated guidance from 2017 on hedging transactions. It expands the current last-of-layer method (now called the “portfolio layer” method) that permits only one hedged layer to allow multiple hedged layers of a single closed portfolio.

The updated guidance bridges the gap between hedge accounting and the CECL standard to clarify that an entity is prohibited from including hedge accounting impact in the credit loss calculations. It also specifies how to consider hedge basis adjustments when determining credit losses for the assets included in a closed portfolio. The changes go into effect in 2023 for public entities and 2024 for private ones.

Are you ready?

In addition to educating your staff about accounting rule changes in the pipeline, you also should consider letting investors and lenders know about any changes that could have a major effect on your financial statements in 2023. Contact us for more information or help adopting these new rules.

Here’s an update on the FASB’s project to revamp the rules for recognizing, measuring, presenting and disclosing software costs. The project is based on feedback from companies that find the current rules complex and costly.

Applying the existing guidance

There are two main areas of U.S. Generally Accepted Accounting Principles (GAAP) that provide accounting guidance for software costs. To determine how to account for software costs, a company first must evaluate which area of GAAP applies. The guidance that a company must follow is largely dependent on how a company plans to use the software.

Specifically, when a company determines that it has a substantive plan to sell, lease or otherwise market software externally (including licensing), it’s required to account for the software costs as external use. In this situation, Accounting Standards Codification Subtopic 985-20, Software — Costs of Software to Be Sold, Leased, or Marketed, would be applied.

Conversely, if a company doesn’t have such a substantive plan in place when software is under development, it’s required to account for the software costs incurred to develop or purchase software as internal use. In this situation Subtopic 350-40, Intangibles — Goodwill and Other — Internal-Use Software, would be applied.

The guidance for internal-use software is generally applied to hosting arrangements by both the vendor that’s incurring costs to develop the hosting arrangement for customers (such as software-as-a-service) and the customer incurring costs to implement the hosting arrangement. However, Subtopic 985-20 applies to hosting arrangements in which 1) a customer has a contractual right to take possession of the software at any time during the hosting period without significant penalty, and 2) it’s feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

Designing a one-size-fits-all approach

The ultimate goal of the FASB’s project on reporting software is to align the differing accounting models for external and internal use. If the project takes shape as planned, companies will no longer have to distinguish between two sets of guidance. Instead, they’ll apply a single model for all software. That means everyone would follow the same model, regardless of whether they purchased software as a license, entered into a cloud computing arrangement, or developed internal software, licenses or cloud solutions.

However, there’s little consensus now on how that model would work. Approaches currently being researched by FASB staff include:

• Requiring software costs to be capitalized based on a principle such as when there’s a present right to the economic benefit as a result of incurring the software costs,
• Requiring software costs to be capitalized if they’re undertaken during certain development activities, and
• Expensing all software costs, including cloud computing.

Members of the Private Company Council gave mixed views on which approach they favored, reflecting the difficulty the FASB could ultimately face on the topic. Some financial statement preparers prefer a principles-based approach, while others said they like the idea of expensing software costs as there’s no true prediction of its future useful life.

Stay tuned

This project is currently in the deliberation phase. No proposals have yet been issued, but the FASB plans to discuss this topic in the coming months.

Planning tips

Though physical counts may be seen as time consuming and disruptive, a well-executed count of what’s on-hand can provide valuable insight into operational efficiency. Here are five tips on how to prepare for your count to maximize the benefits and minimize the hassle.

1. Order (or create) prenumbered inventory tags. Most companies use two-part tags to count inventory. One tag stays with the item on the shelf; the other is returned to the manager at the end of the count. Tags are numbered sequentially to ensure the manager can account for every tag issued. Using a tagging system prevents items from being counted twice or omitted. Each tag should identify the part number, location, quantity and person who performed the count. To avoid scrambling around last minute, assign someone in your accounting department to get this task done at least a month before your count is scheduled to start.

2. Preview inventory. Most companies do a dry run a few days before the count to identify any potential roadblocks and determine how many workers to schedule. This makes the count more efficient and gives warehouse personnel the opportunity to correct any foreseeable problems, such as missing part numbers, unbagged supplies and an insufficient amount of inventory tags.

3. Assign workers to count inventory. Assemble two-person teams to prevent fraudulent counts. Assign each team a specific area of the warehouse to count. (A map often helps workers identify count zones.) Never give employees inventory listings to reference during the count — otherwise, they may be tempted to duplicate the amount from the listing, rather than bring attention to a possible discrepancy.

4. Write off any unsalable items. All defective or obsolete items should be thrown away or recycled before the inventory count begins. There’s no sense counting items that will be written off.

5. Pre-count and bag slow-moving items. To make the physical count faster, some items that aren’t expected to be used before year end can be counted a few days in advance. Pre-counted items should be tagged and placed in sealed containers. If a broken seal is noticed on the day of the actual physical count, the items in the container should be recounted.

Inventory values

Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at the lower of cost or market value. However, estimating the market value of inventory may involve subjective judgment calls, particularly if your company converts the goods from raw materials into finished goods available for sale. The value of work-in-progress inventory can be especially hard to objectively assess, because it includes overhead allocations and, in some cases, may require percentage of completion assessments.

The value of inventory is always in flux as work is performed and items are delivered or shipped. To capture a static value at year end, it’s essential that business operations “freeze” while the count takes place. Usually, it makes sense to count inventory during off-hours to minimize the disruption to business operations. For larger organizations with multiple locations, it may not be possible to count everything at once. So, larger companies often break down their counts by physical location.

Your auditor’s role

If your company issues audited financial statements, one or more members of your external audit team will be present during your physical inventory count. Auditors aren’t there to help you count inventory. Instead, they’ll observe the procedures (including any statistical sampling methods), review written inventory processes, evaluate internal controls over inventory, and perform independent counts to compare to your inventory listing and counts made by your employees.

They’ll also look for obsolete, broken or slow-moving items that need to be written off. Be ready to provide them with invoices and shipping/receiving reports. Auditors review these documents to evaluate cutoff procedures for year-end deliveries and confirm the values reported on your inventory listing.

For more information

Contact us to discuss physical inventory counting procedures. We can help you get it right and investigate any discrepancies between your count and the amount reported in your company’s perpetual inventory system.

Gap in GAAP

Supplier finance programs — sometimes called “structured payables” and “reverse factoring” — are popular because they offer a flexible structure for paying for goods and services. In a traditional supplier arrangement, the buyer agrees to pay the supplier directly within, say, 30 to 45 days.

Conversely, with a supplier finance program, the buyer arranges for a third-party finance provider or intermediary to pay approved invoices before the due date at a discount from the stated amount. Meanwhile the buyer receives an extended payment date, say, 90 to 120 days, in exchange for a fee. This enables the buyer to keep more cash on hand. However, many organizations haven’t been transparent in disclosing in their financial statements the effects those programs have on working capital, liquidity and cash flows.

That’s the reason the Financial Accounting Standards Board recently issued Accounting Standard Update (ASU) No. 2022-04, Liabilities — Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. It will require buyers to disclose the key terms of supplier finance programs and where any obligations owed to finance companies have been presented in the financial statements.

More details

Supplier finance programs are a relatively new form of arrangement that continues to evolve and grow in popularity. Even after this ASU becomes effective, GAAP doesn’t provide any specific guidance on where to present the amounts owed by the buyers to finance companies. It’s up to the buyer to decide whether these obligations should be presented as accounts payable or short-term debt.

However, the updated guidance does require that in each annual reporting period, a buyer must disclose:

• The key terms of the program, including a description of the payment terms and assets pledged as security or other forms of guarantees provided for the committed payment to the finance provider or intermediary, and
• For the obligations that the buyer has confirmed as valid to the finance provider or intermediary 1) the amount outstanding that remains unpaid by the buyer as of the end of the annual period, 2) a description of where those obligations are presented in the balance sheet, and 3) a roll-forward of those obligations during the annual period, including the amounts of obligations confirmed and obligations subsequently paid.

In each interim reporting period, the buyer must disclose the amount of obligations outstanding that the buyer has confirmed as valid to the finance provider or intermediary as of the end of the period.

Ready, set, go

The new rules take effect for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on roll-forward information. That provision is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. Contact us for more information or help implementing the changes.

Know the rules

Under the accrual method of accounting, your company will report accounts receivable on its balance sheet if it extends credit to customers. This asset represents invoices that have been sent to customers but are yet unpaid. Receivables are classified under current assets if a company expects to collect them within a year or the operating cycle, whichever is longer.

Realistically, however, some customers won’t pay their invoices. Companies report bad debts using one of these two methods:

1. Direct write-off method. Companies that don’t follow U.S. Generally Accepted Accounting Principles (GAAP) record write-offs only when a specific account has been deemed uncollectible. This method is prescribed by the federal tax code, plus it’s relatively easy and convenient. However, it fails to match bad debt expense to the period’s sales. It may also overstate the value of accounts receivable on the balance sheet.

2. Allowance method. Companies turn to the allowance method to properly report revenues and the related expenses in the periods that they were earned and incurred. This method conforms to the matching principle under GAAP. The allowance shows up as a contra-asset to offset receivables on the balance sheet and as bad debt expense to offset sales on the income statement.

Review your estimate

Under the allowance method, a company usually estimates uncollectible accounts as a percentage of sales or total outstanding receivables. Some companies also include allowances for returns, unearned discounts and finance charges.

Companies typically base the allowance on such factors as the age of receivables and bad debt write-offs in prior periods. But it’s also critical to consider general economic conditions. Given the current economic stress you may be experiencing, your business might have to update its historical strategies for assessing the collectability of its receivables.

Monitoring changes in your customers’ credit risk can help prevent your business from being blindsided by economic distress in your supply chain. If a customer’s credit rating falls to an unacceptable level, you might decide to stop extending credit and accept only cash payments. This can help minimize write-offs from a particular customer before they spiral out of control.

Think like an auditor

Bad debt allowances are subjective and can be difficult to audit, especially during economic downturns. Auditors use several techniques to assess whether the allowance for doubtful accounts appears reasonable. Management can use similar techniques to self-audit the company’s allowance.

An obvious place to begin is the company’s aging schedule. The older a receivable is, the harder it is to collect. In general, once a receivable is four months overdue, collectability is doubtful. However, that benchmark varies based on the industry, the economy, the company’s credit policy and other risk factors.

If your customers have requested extended payment terms, it could cause an increase in older receivables on your company’s aging schedule. In this situation, if your company’s allowance is based on aging, you may need to consider adjusting your assumptions based on current conditions.

Consider outside assistance

Businesses are facing unprecedented uncertainty as the end of the calendar year approaches. In fact, a recent survey of audit partners published by the Center for Audit Quality, an affiliate of the AICPA, found that 40% were uncertain about the outlook for their primary industries.

Contact us if you’re unsure whether your bad debts allowance is sufficient in today’s uncertain marketplace. We can help evaluate your estimate and, if necessary, adjust it based on your company’s current circumstances. We’ll also explain the tax implications.

Book minimum tax provision

A company’s book income as reported on its income statement may differ significantly from its taxable income for federal income tax purposes. The IRA — a $740 billion package with provisions on health care, climate and tax — will require companies that report over $1 billion in adjusted financial statement income (AFSI) to pay a 15% minimum tax rate on that income. Some of these companies may already be satisfying this requirement. But others with over $1 billion in book income, which may have taken certain credits or deductions that lower their tax rate below 15% of their AFSI, may be subject to additional tax liability under the new law.

Unlike previous calculations of corporate alternative minimum tax that started in taxable income, the minimum tax under the IRA starts with book income. In addition to allowing for the use of net operating losses and foreign tax credits, the calculation of AFSI allows exemptions for such items as general business credits and defined pension benefits. A late modification also allows for the reduction of AFSI by accelerated depreciation under the federal tax code.

FASB mission

The FASB develops U.S. Generally Accepted Accounting Principles (GAAP) for public and private companies and not-for-profit organizations in the United States. This rulemaking body is designed to be independent from influence by corporations and Congress. However, the book minimum tax rule could potentially give the FASB significant influence over some of the revenue the federal government collects — with potentially significant financial implications for U.S. companies.

This provision is effective for tax years beginning after December 31, 2022. It applies to any corporation (other than an S corporation, regulated investment company, or a real estate investment trust) that meets an average annual AFSI test for one or more earlier tax years that end after December 31, 2021. The Joint Committee on Taxation estimates that about 150 corporate taxpayers would be subject to this tax annually.

“Even though [the IRA] doesn’t directly involve FASB, it does have implications for FASB because it is asking major companies to pay a tax based on financial statement income which is based on GAAP standards set by FASB,” said Andrew Lautz, director of federal policy at National Taxpayers Union.

Changes made to financial accounting rules could have a direct impact on federal tax revenue. As a result, Congress may take more interest in the FASB’s work in the future and lobby for or against certain changes. Accounting standards could become targets for special interests and lobbyists. Any resulting rule changes could extend to all entities that follow GAAP, not just large corporations with more than $1 billion in AFSI.

Accounting industry pushback

“What is concerning at this point is that tying the new minimum tax to financial statement income creates incentives for companies to report lower book income, which may be at odds with the overall purpose of financial statements (and the goal of the FASB) to be a source of information that is useful to current and potential investors and creditors,” said Mary Cowx, Assistant Professor at the W. P. Carey School of Accountancy at Arizona State University.

The Financial Accounting Foundation (FAF), which governs the FASB, recently said tax and public policy matters are outside the FASB’s mission and should be left to Congress and other regulatory agencies. The FAF’s statement is consistent with a letter signed by more than 300 accounting professionals that was sent to Congress when it was considering the Build Back Better (BBB) bill. However, Congress made major changes to the book minimum tax provision from what was proposed under the BBB and what was signed into law under the IRA.

Stay tuned

It’s currently uncertain whether the new law will lead to unintended changes in GAAP. But the FAF is committed to maintaining the FASB’s independence and avoiding any adverse effects on investor confidence and capital markets. Contact us to discuss the status of current FASB projects that could affect income reporting, such as those related to bolstering income tax disclosures and disaggregating expense information on the income statement.

Auditors commonly use confirmations to verify such items as cash, accounts receivable, accounts payable, employee benefit plans and pending litigation. Under U.S. Generally Accepted Auditing Standards, an external confirmation is “a direct response to the auditor from a third party either in paper form or by electronic other means, such as through the auditor’s direct access to information held by a third party.”

Some companies may be put off when auditors reach out to customers, lenders and other third parties — and sometimes confirmation recipients fail to respond in a timely, complete manner. But confirmations are an important part of the auditing process that you’ll better appreciate if you learn more about them.

Three formats

The types of confirmations your auditor uses will vary depending on your situation and the nature of your organization’s operations. Confirmations generally come in the following three formats:

1. Positive. Recipients are requested to reply directly to the auditor and make a positive statement about whether they agree or disagree with the information included.

2. Negative. Recipients are requested to reply directly to the auditor only if they disagree with the information presented on the confirmation.

3. Blank. The amount (or other information) isn’t stated on this type of request. Instead, it requests recipients to complete a blank confirmation form.

Confirmation procedures may be performed as of a date that’s on, before or after the balance sheet date. If the procedures aren’t performed as of the balance sheet date, the account balance will need to be rolled forward (or backward) to the balance sheet date.

Mailed vs. electronic forms

In the past, auditors sent out confirmation letters through the U.S. Postal Service. Then, they waited to receive written responses from their audit clients’ customers, suppliers, banks, benefits plan administrators, attorneys and others. This was a cumbersome process. If an auditor failed to receive an adequate level of response, follow-up confirmation letters could be sent, which could lead to delays in the audit process. Alternatively, the auditor could contact nonresponding recipients by phone or in person. Otherwise, the auditor would need to perform alternative procedures.

Although written confirmations are still permitted, auditors routinely use electronic confirmations today. These may be in the form of an email submitted directly to the respondent by the auditor or a request submitted through a designated third-party provider.

Electronic confirmations can be considered reliable audit evidence. Plus, they overcome some of the shortcomings of written confirmations. That is, they’re sent and received instantaneously at no cost, and the electronic confirmation process is generally secure, minimizing the risks of interception or alteration. As a result, some financial institutions no longer respond to paper confirmation requests and will respond only to electronic confirmation requests.

Let’s work together

External confirmations can be a simple and effective audit tool.  if you have questions about how we plan to use confirmations during your next audit or if you have concerns about the efficacy or security of the confirmation process.

Under U.S. Generally Accepted Accounting Principles (GAAP), financial statements are normally prepared based on the assumption that the company will continue normal business operations into the future. When liquidation is imminent, the liquidation basis of accounting may be used instead.

It’s up to the company’s management to decide whether there’s a so-called “going concern” issue and to provide related footnote disclosures. But auditors still must evaluate the appropriateness of management’s assessment. Here are the factors that go into a going concern assessment.

Substantial doubt and potential for mitigation

The responsibility for making a final determination about a company’s continued viability shifted from external auditors to the company’s management under Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. The updated guidance requires management to decide whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).

Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:

• Recurring operating losses,
• Working capital deficiencies,
• Loan defaults,
• Asset disposals, and
• Loss of a key franchise, customer or supplier.

After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.

Aligning the guidance

After the FASB updated its guidance on the going concern assessment, the Auditing Standards Board (ASB) unanimously voted to issue a final going concern standard. The ASB’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, was designed to promote consistency between the auditing standards and accounting guidance under U.S. GAAP.

The updated guidance requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. It also addresses uncertainties auditors face when the going concern basis of accounting isn’t applied or may not be relevant.

For example, SAS No. 132 doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts, or items of a financial statement. Some auditors contend that the evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level.

Prepare for your next audit

With increased market volatility, rising inflation, supply chain disruptions, labor shortages and skyrocketing interest rates, the going concern assumption can’t be taken for granted. Management must take current and expected market conditions into account when making this call — and be prepared to provide auditors with the appropriate documentation. Contact us before year end if you have concerns about your company’s going concern assessment. We can provide objective market data to help evaluate your situation.