What is a going concern qualification?
A going concern qualification refers to an opinion of substantial doubt as to a company’s ability to continue operations in the foreseeable future, and it is typically issued by an auditor overseeing the review of a company’s financial statements.
The root of the phrase “going concern” is an accounting term that refers to an entity having the financial resources to continue operating. It’s presumed a company will continue to operate as a going concern as the basis for financial reporting unless liquidation is imminent.
Under the generally accepted accounting principles (GAAP) established by the Financial Accounting Standards Board in the U.S., this is commonly referred to as the going concern basis of accounting. If a company faces liquidation, then it must proceed under the liquidation basis of accounting.
What is substantial doubt in a going concern qualification?
Reference to “substantial doubt” in a going concern qualification means that it is probable that a company will not be able to meet its obligations within one year from the release of its most recent financial statement. In other international accounting standard frameworks, a similar term for substantial doubt is “material uncertainty.”
How is a going concern qualification initiated?
Typically, management of a company assesses whether there are issues about its going concern, and an auditor makes a conclusion in a financial statement whether substantial doubt exists as to the company’s continued ability to meet its financial obligations.
According to the Public Company Accounting Oversight Board (PCAOB)—a nonprofit corporation established by the U.S. Congress that oversees the audits of public companies in order to help protect the interests of investors—a company’s auditor has a responsibility to evaluate whether there exists substantial doubt about a company’s ability to operate.
After the management of a company organizes its financial records for a reporting period, its auditor reviews the financial statement and can offer an opinion about its going concern. Typically, if there are no doubts about a company’s ability to operate, a statement about going concern may not be necessary.
The PCAOB, though, says a company’s auditor has a responsibility to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, typically 12 months from the date of the financial statements being audited.
Specific language in a company’s report might include “substantial doubt about the entity's ability to continue as a going concern,” skepticism on the “continuation of an entity as a going concern,” or that the entity may “cease to exist as a going concern.”
What constitutes substantial doubt?
Substantial doubt about a company’s ability to continue as a going concern tends to focus on its financial obligations, primarily whether it has enough cash and other forms of capital to continue its day-to-day operations.
A force majeure event, for example, may occur unexpectedly, and a company may need to pay for damages by dipping into its cash reserves and lines of credit, leaving it with just enough cash to stay in business for a few months.
Some factors contributing to doubts about going concern, according to the PCAOB, include the following:
Negative trends
Negative trends can include recurring annual losses, negative cash flow from operations, and adverse key financial ratios (e.g. a high debt-to-equity ratio).
Other indications of possible financial difficulties
Other indications may include debt default, inability to borrow from banks, declined access to lines of credit, debt restructuring, or the inability to raise new capital.
Internal matters
Internal matters could refer to work stoppages, overreliance on a single customer for revenue, or uneconomic long-term commitments.
External matters that have occurred
External matter could include the loss of a major customer, legal issues such as lawsuits, adverse legislation affecting operations, and catastrophic events that are expensive to recover from without insurance coverage.
How does a company’s management respond to a going concern qualification?
A company’s management may respond to an auditor’s doubt about its going concern by sharing plans to raise capital to boost its financial position, such as selling assets, restructuring debt, borrowing, cutting expenses, and reducing or eliminating dividends.
Examples of going concern qualifications
A string of annual losses may compel a company to disclose reservations about its ability to continue as a going concern.
In August 2023, following the release of its second-quarter financial results, WeWork reported that “substantial doubt exists about the Company’s ability to continue as a going concern.” WeWork’s cash reserves had dwindled, it posted billions of dollars of losses for years, and its membership fell to below pre-COVID-19 pandemic levels. To counter the risk, management outlined plans over the 12-month month period to improve liquidity and profitability.
One theoretical example is an oil production company declaring force majeure on a distilling facility for fuel and petrochemicals and issuing a statement about future production affecting revenue for subsequent quarters. Yet another might be an insurer raising doubts about its ability to continue operating due to a significant amount of insurance claims by many homeowners following a catastrophic storm.
Where is a going concern qualification found in the financial statement?
Text relating to substantial doubts as to a going concern’s ability to continue to operate may appear in the sections on forward-looking statements and risk factors in a company’s financial statement.
