How to get on top of going concern assessment during COVID-19

The assessment date

Management’s evaluation should be based on relevant conditions and events that are known or reasonably knowable at the date that the financial statements are issued or available to be issued (“the assessment date”). Practically speaking, management likely will begin its assessment well before the assessment date, updating as necessary right up to issuance or availability. U.S. GAAP does not require management’s assessment to go beyond the look-forward period. 

The assessment period

The assessment period is the one-year period from the assessment date. Management is required to look ahead one year from the date the financial statements are issued or available to be issued.

The two steps of ASU 2014-15

The following diagram illustrates the two-step process that management should follow when assessing going concern:

Exhibit 2: Two-step process

Step one: Management’s assessment of whether substantial doubt is raised

While COVID-19 in and of itself is not necessarily an adverse event or condition, for many companies it likely will cause several adverse conditions from the list below contained in ASU 2014-15.

Exhibit 3: Adverse conditions and events contemplated in ASU 2014-15

Evaluating negative events and conditions

U.S. GAAP requires management to consider both quantitative and qualitative information about the following conditions and events, among other relevant conditions and events, that are known or reasonably knowable as of the date financial statements are issued or available to be issued, or the assessment date:

• The entity’s current financial condition, including what liquidity sources the entity currently has (such as available cash or available access to credit) 
• The entity’s obligations, or amounts owed, both conditional and unconditional, recognized and unrecognized, due or anticipated within one year of when the financial statements are issued or available to be issued 
• The funds needed to maintain the entity’s operations
• Other conditions or events that might adversely affect the entity’s ability to meet its obligations as they fall due

This evaluation does not consider management’s plans that have not been fully implemented as of the assessment date. In other words, if reactions to initially assessed negative events and conditions have been fully implemented, including during the subsequent events period through the assessment date, these reactions likely are not management plans and substantial doubt is not considered to be raised. Disclosure of subsequent events might be required.

When management’s plans are considered fully implemented

While ASU 2014-15 does not define “fully implemented,” in most cases it is relatively easy to determine. 

• If the only negative condition or event is the upcoming repayment of all outstanding principal associated with debt that matures within the assessment period, and prior to the assessment date the lender has extended the due date or provided a binding commitment to do so, then management’s plans have been fully implemented. As such, uncertainty surrounding going concern has not been raised. However, the lender’s extension or commitment will need to be disclosed as a significant subsequent event. 
• If the entity and the lender are still negotiating terms as of the assessment date, management’s plans have not been fully implemented. Therefore, management will have to complete step two. 
• In some instances, when the lines might not be clear, management will need to determine if plans have been fully implemented. If there is something significant that remains to be done and is outside the normal course of business, then what remains to be done is a management plan that has not been fully implemented, and the evaluation generally moves to step two. 

Considerations in management’s assessment of the entity

1. Current financial condition. The ASU requires consideration of the “entity’s current financial condition, including its liquidity sources” at the assessment date, when determining whether there are events or conditions that raise concerns about the entity’s ability to continue as a going concern. Consider the following when reviewing liquid funds:

Exhibit 4: Liquidity considerations

Available credit that is conditional, is, by its nature, forward-looking. Management will need to exercise judgement in concluding that its forecasts support a determination that substantial doubt has not been raised. 

2. Obligations. ASU 2014-15 explicitly states that an entity must consider both “conditional and unconditional obligations due or anticipated within one year after the date that the financial statements are issued (regardless of whether those obligations are recognized in the entity’s financial statements).” Careful evaluation of all contractual agreements will be necessary to identify unconditional obligations due in the look-forward assessment period, such as scheduled debt repayments, pension obligations, lease payments, and unconditional purchase obligations. 

3. Operating needs. Management’s budgeting and forecasting functions should include cash flow forecasts that can be used in the assessment of the funds necessary to maintain the entity’s operations. These forecasts should consider current financial conditions, obligations, and other expected cash flows within one year after the date the financial statements are issued or available to be issued. The timing of projected cash flows or covenant compliance and measurement dates will influence the forecasting process, including whether monthly or quarterly forecasts are necessary to appropriately articulate and anticipate liquidity needs.

Concluding step one

At the conclusion of step one, management will have reached a critical juncture in its application of ASU 2014-15. If substantial doubt has not been raised, the assessment stops here and there are no required financial statement disclosures under the ASU. If, however, management concludes that it is probable that the entity will be unable to meet its obligations as they fall due within one year after the financial statements are issued or available to be issued, management moves to step two. Note, once the assessment moves to step two, disclosure is required. 

Step two:  Management’s assessment of whether substantial doubt exists

Step two takes management from a negative probability assessment that the entity will be unable to meet its obligations as they fall due to a positive probability assessment that is two-fold, as follows:

1. Management’s plans can be effectively implemented. 
2. It is probable that management’s plans will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

Both of these conditions must be evaluated through the end of the assessment period. 

Management plans to mitigate conditions or events that raise substantial doubt

As noted in step one, management plans that have not been fully implemented as of the assessment date must be further evaluated. The evaluation of whether it is probable that management’s plans will be effectively implemented within one year after the assessment date is based on the feasibility of implementation of the plans in light of an entity’s specific facts and circumstances. Generally, to be considered probable of being effectively implemented, management (or others with the appropriate authority) must have approved the plan before the assessment date. If not properly approved before the assessment date, management’s plans are not considered probable of being effectively implemented and therefore consideration of mitigating effects is not applicable.

Examples of items to consider when evaluating management plans to mitigate factors that raise substantial doubt:

Exhibit 5: Management considerations

Assessment of the feasibility of implementing management plans

Assuming the appropriate approvals have been obtained and that it is probable that the plans are capable of being effectively implemented, management will have to assess its plans to:

1. Determine whether it is probable that those plans will mitigate the conditions or events that raised substantial doubt.
2. Consider the expected magnitude and timing of the mitigating effect of the plans in relation to the magnitude and timing of the relevant conditions or events that the plans intend to mitigate.

If plans include items that are outside of the entity’s control, then it is more difficult for management to conclude that it is probable that the plans can be effectively implemented. For example, plans to obtain new or extended debt financing are generally outside of management’s control. Even though the entity has a history of renewals or extensions, in the COVID-19 world, lenders’ past actions might no longer be indicative of their future actions. However, this depends on the facts and circumstances, and instances might exist in which management can conclude that items not fully within its control are probable of being effectively implemented.

After completing step two, management will conclude that its plans are either probable of being effectively implemented and that they are probable of mitigating the negative events and conditions or not. Either way, financial statement disclosures are required.

Financial statement disclosures

Regardless of whether substantial doubt has been alleviated, disclosure is required, as follows:

Moving forward

While the COVID-19 pandemic is not in and of itself a negative condition – as it depends on the individual company’s financial circumstances – and might not result in substantial doubt being raised, it has had a far-reaching impact on the operations of many companies. While uncertainty always exists, it has been exacerbated by the pandemic. Notwithstanding, management’s responsibility continues to be the same: to assess the information known and reasonably knowable at the assessment date. This will likely include historical results and whether they continue to be good indicators for the future, industry statistics, macroeconomic conditions, and economic forecasts.