Going concern qualification definition
/What is the Going Concern Qualification?
The going concern principle is that you assume a business will continue in the future, unless there is evidence to the contrary. When an auditor conducts an examination of the accounting records of a company, he or she has an obligation to review its ability to continue as a going concern; if the assessment is that there is a substantial doubt regarding the company's ability to continue in the future (which is defined as the following year), a going concern qualification must be included in his or her opinion of the company's financial statements. This statement is typically presented in a separate explanatory paragraph that follows the auditor's opinion paragraph.
The Importance of the Going Concern Qualification
The going concern qualification is of great concern to lenders, since it is a major indicator of the inability of a company to pay back its debts. Some lenders specify in their loan documents that a going concern qualification will trigger the acceleration of all remaining loan payments. A lender is typically only interested in lending to a business that has received an unqualified opinion from its auditors regarding its financial statements.
Similarly, customers and suppliers may have clauses in their contracts with a company, giving them the right to cancel the contracts if a going concern qualification has been issued. This clause protects them from doing business with a company that may not pay them (in the case of a supplier) or ship goods to them (in the case of a customer).
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Indicators of a Going Concern Problem
There are no specific procedures that an auditor must follow to arrive at a going concern opinion. Instead, this information is derived from the sum total of all other audit procedures performed. Indicators of a potential going concern problem are noted below:
Negative trend indicators. Negative trend indicators can include declining sales, increasing costs, recurring losses, adverse financial ratios, and so forth. The presence of recurring losses is a particularly telling indicator, since it is likely associated with a decline in a firm’s cash flows.
Employee indicators. The loss of key managers or skilled employees, as well as labor difficulties of various types, such as strikes, are indicators of a going concern problem. This is more of a secondary indicator, where employees are aware of other problems within a business that cause them to look elsewhere for employment.
Systems indicators. Inadequate accounting record keeping can be an indicator of a going concern problem. At a minimum, it is an indicator of reduced experience within a business that increases the risk of fraud, as well as of issuing incorrect financial statements.
Legal indicators. Legal proceedings against the company, which may include pending liabilities and penalties related to the violation of environmental or other laws, can be indicators of a going concern problem. This is a particular concern when the firm will have difficulty finding the funds for a major payout.
Intellectual property indicators. The loss or expiration of a key license or patent can negatively impact the competitiveness of a business, and so can be an indicator of a going concern problem.
Business structure indicators. When a company has lost and been unable to replace a major customer or key supplier, this can impact its ability to continue as a going concern. This is a particular concern when it has lost an unusually profitable customer.
Financing indicators. One of the strongest going concern indicators is when a company has defaulted on a loan or is unable to locate new financing. In these situations, there is a heightened risk of bankruptcy.
How to Mitigate a Going Concern Issue
The auditor's going concern qualification can be mitigated by management if it has a plan to counteract the problem. If such a plan exists, the auditor must assess its likelihood of implementation and obtain evidential matter about the most significant elements of the plan. For example, if the CEO has declared that he will extend a loan to the company to cover a projected cash shortfall, evidential matter might be considered a promissory note in which the CEO is obligated to provide a stated amount of funds to the company.
An auditor who is considering issuing a going concern qualification will discuss the issue with management in advance, so that management can create a recovery plan that may be sufficient to keep the auditor from issuing the qualification. Thus, the going concern qualification is a major issue, but you will have a chance to find a way around the problem and potentially keep the auditor from issuing it.