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Fears Grow that Going Concern Amendments Will Spark a Surge in Litigation

The FASB knew it wouldn’t be easy to give investors and creditors earlier warnings about a company’s financial problems.

After almost five years of on-again, off-again discussions, the board in June released Proposed Accounting Standards Update (ASU) No. 2013-300,Presentation of Financial Statements (Topic 205)—Disclosure of Uncertainties about an Entity’s Going Concern Presumption, which requires businesses to make regular assessments about their financial health and disclose information about risks to their financial condition in the footnotes to their financial statements.

Comments on the proposal were due September 24, 2013, and they echo concerns FASB members raised while drafting the proposal.

Businesses almost overwhelmingly reject the plan, calling it a blueprint for lawsuits, while auditors, who express support for the overall model, are concerned about making the plan operational.

The U.S. Chamber of Commerce said the proposal would require complex judgments that would be “ripe” for second-guessing during audit inspections, lawsuits, and regulatory enforcement actions. Adding forward-looking information in audited footnotes also could expand the legal liability for businesses, the Chamber wrote.

The proposal “will represent a boon to the trial bar without providing any new useful information to investors and in fact potentially reducing return for investors,” the group wrote.

Proposed ASU No. 2013-300 was the culmination of a debate about the best way to warn investors and creditors when doubts materialize about a company’s ability to stay afloat. It was the second time the FASB formally sent out a proposal for public comment.

The proposal adds a definition of “going concern” to U.S. GAAP and calls for companies to make disclosures when there are questions about their viability. (See Proposed ASU No. 2013-300 Adds Going Concern Guidance, Disclosures to U.S. GAAP in the June 27, 2013 edition of Accounting & Compliance Alert.)

Companies prepare their U.S. GAAP financial statements with an assumption that they will remain a “going concern,” the built-in belief that they will be a viable business for the foreseeable future. Current practice calls for a company’s auditor to decide if there are doubts about this presumption.

But by the time the auditor weighs in, the company is often well on its way to collapse. After the bursting of the dot-com bubble in 2000 and again during the 2008 financial crisis, critics said auditors’ going concern assessments were issued well after the stock price had collapsed and came too late to be useful.

Under the proposal, when it is “more likely than not” that a company won’t meet its obligations within a year without taking action outside the normal course of business, or if it is “known or probable” it won’t be able to meet these obligations within two years, the company would have to disclose these concerns in its footnotes. It would have to provide details about the conditions and events that led to the problems and plans to address them, among other information.

A public company would have to take the extra step and evaluate every period whether there is “substantial doubt” about its ability to continue as a going concern and also disclose this information in the footnotes.

To auditors, the three thresholds for the different types of disclosure adds complexity to the proposal, some firms wrote to the FASB.

“As a result of such differentiation, determining the appropriate disclosure for the preparer, and auditing it, may be unnecessarily complex under the Proposed ASU and may result in inconsistent application, which could ultimately confuse financial statement users,” Deloitte LLP wrote.

Audit firms were much more supportive of the proposal than operating companies, however. Most firms said they agreed with the idea of adding comprehensive guidance to U.S. GAAP on the definition of going concern and requiring companies to make new disclosures.

KPMG LLP offered several clarifications, such as changing the initial disclosure threshold from “more likely than not” to “reasonably likely.” 

It also asked the FASB to get rid of the dual threshold for initial disclosure and provide additional guidance on how companies should make these disclosures.

“We acknowledge the reliability of predictions decreases over time, but the additional effort and risk of inconsistency in applying the dual threshold approach for initial disclosure outweighs the benefit,” KPMG wrote.

The Center for Audit Quality also called for getting rid of the “more likely than not” threshold and replacing it with a “reasonably likely” assessment.

“This approach embodies a range concept for the disclosure trigger, and should help drive earlier disclosure of certain conditions and events, which is an area that has been stressed by a number of financial statement user groups,” the CAQ wrote.

The Institute of Management Accountants outright rejected the proposal, calling it complex, tough to implement, and difficult to audit.

“The SEC has forward-looking and risk factor-type disclosure requirements, which are covered by safe-harbor provisions that could be revised or more strictly enforced to address investor concerns. Such concerns are better left to disclosures outside of the historical financial statements,” IMA wrote.

The FASB plans to evaluate the comments and begin redeliberations on the proposal in the coming months, according to the accounting board’s website.