SAS no. 59: Going concern evidence

CPA Journal, The, Jul 1999 by Behn, Bruce K, Pany, Kurt, Riley, Richard

Statement on Auditing Standards No. 59, The Auditors Consideration of an Entity's Ability to Continue as a Going Concern, requires auditors to evaluate whether substantial doubt exists about an audit client's ability to continue as a going concern. The first stage in making this going concern evaluation requires consideration of whether the results of audit procedures performed related to the various audit objectives identify existing conditions and events that indicate substantial doubt about the client's ability to continue as a going concern. Those conditions and events are divided into four categories: 1) negative trends, 2) other indications of possible financial difficulties, 3) internal matters, and 4) external matters. The sidebar gives examples from SAS No. 59.

When, after considering conditions and events in the aggregate, the auditors believe that substantial doubt may exist, they should consider management's plans for dealing with the effects of those conditions and events. If, after considering the conditions and events and management's plans, the auditors conclude that substantial doubt remains, the audit report should include an explanatory paragraph to reflect this uncertainty. Alternatively, the auditors may choose to issue a disclaimer of opinion upon the financial statements.

The purposes of this paper are to 1) present a summary of the conditions and events present when auditors have issued reports modified as to a client's going concern status and 2) consider the manner in which the going concern uncertainty was subsequently resolved. To learn of the conditions and events that are leading to disclosure of going concern uncertainties, we used the CD Disclosure database to examine data from 135 companies receiving first-time going concern explanatory paragraphs between 1989 and 1992. For these companies we also analyzed the subsequent resolution using the following three categories:

37 Successful resolutions within one year

62 Continuing going concern explanatory paragraphs

36 Bankrupt companies

135 Total

With the exception of bankrupt companies, the sample of 135 companies was categorized by the going concern modification status in the year subsequent to the initial going concern. Bankrupt companies include those that filed for bankruptcy up to four years after the initial going concern modification (13 of the 36 bankrupt companies filed within one year and 13 more petitioned for bankruptcy in the second year).

The Exhibit is structured using the existing conditions and events discussed in SAS No. 59 and the resolution outcome. For the total sample of 135 companies, 348 existing conditions and events (an average of 2.6 per company) were mentioned in either the audit report or financial statement notes referenced in the audit report in the year of the initial going concern modification. The lowest average, 2.4 existing conditions or events per company, was found among successful resolution companies, compared with averages of 2.7 and 2.6 found among continuing going concern modification and bankrupt companies, respectively.

Recurring operating losses (under negative trends) and default (under other indications) are by far the most frequently occurring conditions identified in the audit reports, occurring 54.1% and 58.5%, respectively. Conditions and events within the negative trends and other indications categories were disclosed more frequently than were internal or external matters.

When comparing the three groups-- successful resolution, continuing going concern, and bankruptcy-recurring operating losses occurred approximately 58.3% of the time for companies that subsequently filed for bankruptcy, while that condition existed much less frequently for the successful resolution companies (43.2%). Also, negative retained earnings were associated with 38.9% of companies that filed for bankruptcy as contrasted with the 10.8% of companies that successfully resolved the going concern uncertainty.

While we identified few systematic dif ferences between companies that successfully resolved their going concern status and those that did not, we did find-perhaps not unexpectedly-that recurring operating losses and negative retained earnings most frequently led to bankruptcy.

Bruce K. Behn, PhD, CPA, is an assistant professor at the University of Tennessee, Kurt Pany, PhD, CPA, a professor at Arizona State University, and Richard Riley, PhD, CPA, an assistant professor at West Virginia University.