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Consultation Paper May Set Stage for Revising Going Concern Standard

The PCAOB’s staff is working on a consultation paper on the audit standard on going concern warnings. Investors believe the current guidance is flawed and want earlier warnings when companies are in such deep financial trouble that their survival is in doubt.

The PCAOB is planning to issue a staff consultation paper at the end of 2014 or early 2015 on the audit standard on going concerns.

The regulatory board is considering making revisions to Statement on Auditing Standards (SAS) No. 59,The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, and related standards to push auditors to put more rigor into the evaluations they perform about a company’s prospects for survival.

In the 2008 financial crisis, several large financial companies collapsed, two of the nation’s Big Three car makers had to be rescued by the federal government, and the pain was felt throughout the economy.The failures happened with little to no advance warning from the companies involved. Since then, regulators have sought to change the accounting and auditing standards and reporting rules to produce a better warning system.

SAS No. 59 is among the standards that places the burden on the auditor for alerting the markets when a company is about to fail. When the auditor concludes that there is “substantial doubt” about a company’s ability to meet its obligations, the auditor needs to issue a going concern warning.

In August, the FASB established a comparable requirement for management in 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 standard requires businesses to disclose new information in their financial statement footnotes when there is substantial doubt about their survival. The doubt exists when it’s “probable” that there would be a “severe impact” on the business’s ability to realize its assets in the next 12 months.

PCAOB staff members are considering whether auditors should get an additional explanation for key concepts when they make a going concern evaluation. For example, there’s no set definition for “substantial doubt” in the auditing literature.

During a meeting of the PCAOB’s Investor Advisory Group in Washington on October 20, 2014, University of Tennessee accounting professor Joseph Carcello said the FASB now uses “probable,” while the auditing literature discusses “substantial doubt.”

“If you go into the academic literature, which is pretty voluminous on this, there would clearly be a higher threshold on ‘probable’ than ‘substantial doubt,'” Carcello said. “In all likelihood, the information content to users will go down if the PCAOB was to adopt the same language.”

Ann Yerger, executive director of the Council for Institutional Investors, said the revised language will result in fewer going concern opinions, shifting the responsibility to make the call. She fears that the disclosure will come too late to be useful to investors.

PCAOB Chief Auditor Martin Baumann said the board has “heard loud and clear” that the existing auditing standard isn’t working and has a project to address the issue.

Some investors have said the “probable” threshold is going to be triggered less frequently than the undefined substantial doubt threshold and will result in fewer instances of going concern opinions, Baumann said.

The PCAOB in September issued Staff Audit Practice Alert (APA) No. 13, Matters Related to the Auditor’s Consideration of a Company’s Ability to Continue as a Going Concern.

The consultation paper, he said, will “lay out some views around this issue to improve auditor performance” and “issues about at what point should an auditor warn investors about a going concern uncertainty.”

“What is the early warning signal when they should give it?Is it at FASB level of probable? Is it substantial doubt?Or is there some other level where an early warning should be given?” he said.

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