New Audit Standard – What You Need to Know for December 15, 2017, and Later Year-ends

The Auditing Standards Board has issued a new standard on the auditor’s consideration of an entity’s ability to continue as a going concern. The impetus for this standard was the new FASB accounting standard on going concern. As an auditing standard, it will impact all audit clients with year-ends December 15, 2017, and later.

What hasn’t changed? The overall broad-based concept that the auditor needs to make certain that the going concern basis of accounting is an appropriate basis of accounting and that the required disclosures have been made.

What are the major changes?

The first major change is the time period evaluated by the auditor. It is still a “reasonable period of time,” but the definition is different. The definition first points back to the basis of accounting and then, if the basis of accounting is silent, it says one year from the issuance date (which is what FASB’s new standard uses). That means if you have a 12/31/17 year end, but the audit is not issued until 4/15/18, the reasonable period of time goes through 4/15/19.

The second major change is that auditors will inquire of all clients about the client’s evaluation of the entity’s ability to continue as a going concern. In the past, many times the evaluation was more of a joint effort between the auditor and the client, if the client’s financials were weak enough to warrant it. Now all clients, no matter how strong their financial statements are, will be asked about their evaluation. Those clients with weaker financial statement positions will be expected to have done this evaluation and have it documented before the auditors ask.

As a best practice, this evaluation should be documented in some manner as it may need to be audited. This means analyzing and documenting the analysis of whether or not the entity is likely to be able to pay their bills as they become due. If your current assets are larger than the entire year’s expenses, the documentation is probably just showing that even without any additional revenue, current assets could cover it. However, if current assets and current liabilities are significantly closer together, a cash flows forecast may be necessary to evaluate whether the entity will be able to pay bills as they become due or evaluate what line of credit options are available, etc. That would be a more complex situation and necessitate more documentation that the auditor will need to audit. Support for key assumptions may need to be audited.

What if that evaluation isn’t done? At a minimum, if no evaluation is done, there is an internal control deficiency. That deficiency may be a significant deficiency or material weakness, and therefore reported in the internal control letter. The audit standards also say that refusal by a client to perform the evaluation could result in a qualified or adverse audit opinion.

Financial support by third parties

The next change relates to auditing financial support by third parties or the entity owner-manager. In the past, we may have simply accepted an additional written representation in the management representation letter that the owner-manager is willing to put money into the entity if needed. That will no longer suffice. Auditors need sufficient appropriate audit evidence of:

1) written intent of the parties to support the entity, and

2) ability of the parties to provide the support.

For intent, the suggested audit procedures are either obtaining a support letter, which has a specific example wording in the standards, or sending a confirmation directly to the supporting party. Both of those are more formal processes that what may have been done in the past.

Several suggestions are also made for auditing the party’s ability to provide support and those include:

1) auditing evidence of past support,

2) evidence of the supporting party’s solvency (i.e., performing procedures on information of that supporting party, even though it is not consolidated into the audited financials),

3) verifying the ability to provide the support timely, and

4) if in different countries, verifying the ability to transfer the funds.

This may be more extensive than it has been in the past, especially if there is not a history of past support.

Adequacy of disclosures

Auditors continue to need to audit the adequacy of disclosures. However, the new FASB standard has made the requirements for disclosures in FASB financial statements more extensive and more explicit. If the disclosures are inadequate, a qualified or adverse opinion could be warranted.

Expect changes in the audit process

As you can see, this new audit standard will incorporate changes into the audit process. The client will need more documentation and more formal evaluation than may have been done in the past. Auditing management’s plans may also involve more formal processes than in the past, and additional communications with governance. Clients can expect additional time spent by management in evaluating the longevity of the company.