By 4-3 Vote, FASB Decides not to Require Managers to Make Going-Concern Assessment
The FASB’s project on Risks and Uncertainties (formerly “Going Concern”) has been full of twists and turns. The most recent decision on this project was made this past Wednesday when the Board voted 4-3 against a proposal that would switch the responsibility of assessing the going concern assumption from auditors to managers.
To illustrate how this project has taken several turns, here is a brief history. The project was initially added to the FASB’s agenda in May 2007 as an effort to converge standards with IFRS, which already requires that managers make the going-concern assessment. The other objective of the initial project was to determine when the liquidation basis of accounting should be adopted. After being removed as a separate project from the Board’s agenda, it later resurfaced as the Board expanded its scope in mid-2009 to include enhanced disclosures about risks and uncertainties (motivated by events surrounding the financial crisis), and a definition for substantial doubt. The idea behind the enhanced disclosures was that managers would provide early warning signals to users about conditions and events that indicate the entity will not be able to meet its obligations within the foreseeable future without significant actions taken outside its ordinary course of business. These requirements require a triggering event, and over the course of further deliberations, the Board determined that the disclosures should escalate as the economic conditions surrounding the entity become more severe.
In a 2011 October meeting, the Board decided that providing early warning signals would not be an objective of the project because identifying the triggering event is problematic, and similar disclosures pertaining to liquidity were being deliberated on another project. As I wrote here, defining substantial doubt remained a significant challenge and the project’s primary objective was now to determine whether management should be ultimately responsible for the going-concern assessment.
With Wednesday’s decision, the Board has again expressed a preference for providing early warning disclosures such that when a going concern assessment is made by the auditor, users will not be surprised. Some board members expressed a concern that since substantial doubt is a term used in the auditing and securities law literatures, the FASB should not be trying to define what that term means because developing a definition could potentially be different from the intended meaning. (My opinion is still that a clear definition for substantial doubt is essential, but it appears that definition will need to be developed by regulators who initially created the term.)
Other opinions expressed by Board members and outreach groups (particularly users) do not appear to be based on empirical evidence and therefore, in my opinion, are great topics for academic research. The first is the notion that a going concern opinion is a self-fulfilling prophecy and that in expressing the opinion, managers/auditors are leading the charge to the entity’s demise. However, as I expressed here, there is no strong evidence that I am aware that would support this self-fulfilling prophecy notion and some simple statistics suggest it is a fallacy.
Second, multiple Board members expressed the opinion that management could not be objective when expressing their opinion. However, one Board member explicitly rejected that notion on the basis that management is asked to provide objective evidence in several other places within the financial statements. With management going-concern opinions from IFRS, it would seem that data are available for academics to directly test this notion.