The “Going Concern” Assumption: Accounting and Auditing Implications - 1991

The “Going Concern” Assumption: Accounting and Auditing Implications was published by the Canadian Institute of Chartered Accountants (CICA) in 1991. This 262-page research report was prepared by J.E. Boritz, PhD, FCA, supported by a seven-member advisory group. It assesses the financial reporting and auditing implications of the “going concern” assumption. Particular attention is given to the nature and extent of disclosures in the financial statements and/or auditor's report when there is insufficient support for the assumption due to significant risks or uncertainties facing either the industry or the enterprise.

The “going concern” assumption is important because it underlies generally accepted accounting principles. Financial statements are prepared on the basis that the entity is a “going concern”, meaning that it will continue in operation for the foreseeable future and will be able to realize assets and discharge liabilities in the normal course of operations.

According to the report, there were 8,664 business bankruptcies in Canada in 1989, accounting for about $2.2 billion in liabilities against assets of only $774 million, representing losses to creditors of more than $1.4 billion. In view of the economic significance of “going concern” disclosures, the lack of professional guidance, and the absence of standards in this area, the purpose of the report is to provide the basis for: 

• an accounting standards project to address the financial reporting implications of the “going concern” assumption in the accounting section of the CICA Handbook;
• an auditing standards project to modify CICA Handbook Section 5510, Reservations in the Auditor's Report, regarding auditor review of management's assertion as a “going concern”;
• an audit techniques study to support the professional judgment process.

The report summarizes relevant pronouncements and current literature and surveys reporting practices in Canada and the United States. In addition, it fulfills its mandate by:

• defining key terms including “financial distress”, “insolvency” and “bankruptcy”.
• discussing whether any reference should be made to the “going concern” assumption in the notes to the financial statements.
• assessing the financial reporting implications when there is insufficient support for the assumption.
• identifying conditions which may bring into question the continuance of an entity as a “going concern”.
• providing guidance on how doubts as to “going concern” status should be expressed.
• evaluating alternative principles governing the presentation of financial information including historical cost, value realizable in orderly liquidation and discounted value.
• determining the need for auditor review of the support for management's implicit or explicit “going concern” assumption.
• assessing the audit implications and providing guidance for reporting when there is insufficient support or inadequate disclosure in the financial statements.
• considering techniques to support the professional judgment process.

The report responds to recommendations in the 1990 publication Approaches to Dealing with Risk and Uncertainty and the 1988 Report of the Commission to Study the Public's Expectations of Audits, which noted the need to warn the public about the risk of business failure and the auditor's responsibility in that connection.

Information to be included in the Annual Report to Shareholders – 1991 Research Study updated 2008

In 1991, the Canadian Institute of Chartered Accountants (CICA) published a landmark research study called Information to be included in the Annual Report to Shareholders. This 317-page study was drafted by J. Paul-Emile Roy, CA under the direction of a seven-member Study Group chaired by Gerald Trites, FCA.

The Foreword to this study states: “The annual report has long been used by an enterprise as a primary vehicle of communication, not only with its investors or members, but also with other audiences who, for a variety of reasons, have a legitimate interest in the affairs and operations of the enterprise. Generally, the annual report contains the financial statements and associated notes. It also contains additional information which both elaborates upon the financial condition and operating results of the enterprise and provides non-financial information of interest and value to its audiences.”

It further notes: “To date, accounting and auditing standards have concentrated on the financial statements. They have paid relatively little attention to information outside the financial statements, which, to a large extent, has been regarded as the domain of the enterprise’s management. It is considered, in many circles, that a greater amount of discussion and analysis of the financial information needs to be provided than that currently contained in notes to the financial statements. This has resulted in a greater scrutiny being given to such matters, particularly by regulators such as the securities commissions.”

In addition, it states that “some concern has been expressed about the general quality of annual reports, which varies significantly among enterprises. It has been noted that the annual report has the potential of being "a shining affirmation of the company’s scope, strength, philosophy and aspirations"; on the other hand, "it can be dismal, ineffectual and boring - a wonderful opportunity lost".”

To address these matters, the CICA Accounting Standards Committee was prompted, in May 1989, to commission a research study to discuss the objectives of the annual report to shareholders and to recommend what information should be provided, beyond that which must be presented in the financial statements, to assist in achieving those objectives. Besides addressing information content, the study considers the form and presentation of information, reviews the concept of effective communication and considers annual reporting formats, summary reporting, graphics and other presentation matters.

It is noteworthy that this research study was updated and re-published by the CICA in 2008, under the title Corporate Reporting to Stakeholders (also refer to the August 25, 2008 blog posting). The updated study was prepared by J. Paul-Emile Roy, CA (author of the 1991 study) under the direction of a seven-member Study Group chaired by Gerald Trites, FCA (chair of the 1991 Study Group). It aims to promote effective communication between a company and its stakeholders by providing useful guidance to preparers of corporate reports. It is based on an in-depth review of the annual reports and websites of 125 companies that participated in the ongoing CICA Corporate Reporting Awards program. In addition, this study examines practices and significant trends in corporate reporting by analyzing:

·       more than 50 different types of information disclosed in 2004-2005 annual reports;

·       major changes in the 2004, 2005 and 2006 annual reports of award-winning companies;

·       information content, presentation and navigation on company websites in 2007.

Award for Excellence in Annual Reporting by Crown Corporations

Annual reporting is an important vehicle for accountability. In 1994, the Office of the Auditor General of Canada (OAG) launched the Award for Excellence in Annual Reporting by Crown Corporations. The program aimed to promote enhanced accountability through improved disclosure of information on corporate performance by recognizing Crown corporations that do this well. Awards were presented in two categories based on corporation size.

According to the Report of the Auditor General of Canada, 1993 (Chapter 4, paragraph 4.72): “The annual report gives management and boards of directors an opportunity to report to shareholders on how they have fulfilled their responsibilities. The private sector has shown considerable interest in the role of the annual report, and its importance is widely acknowledged. Both the Canadian Institute of Chartered Accountants (refer to the 1991 research study, Information to be included in the Annual Report to Shareholders) and the Society of Management Accountants of Canada have issued research reports detailing information that should be included in the annual report, and these are excellent references.”

It is clear that information on financial results alone does not adequately address the full range of stakeholders’ interests and information requirements. Because they deliver a mix of public policy and commercial objectives, improved performance reporting is especially important in the case of Crown corporations. The practice of reporting on performance in annual reports, though much improved, still has a way to go. The first important steps are: reporting against all objectives; stating objectives in more measurable terms; and reporting performance information that focuses principally on outputs and outcomes. Also, more attention needs to be given to providing more comparable and consistent information on parliamentary funding.

After operating this program for 12 years, the OAG transferred the administration of the Award for Excellence in Annual Reporting by Crown Corporations to the Canadian Institute of Chartered Accountants (CICA) in 2006. The CICA has incorporated the OAG program into its own annual Corporate Reporting Awards program (see the previous postings on November 17, 2010 and June 9, 2011).

Generally Accepted Auditing Standards – 1975

Thirty-seven years ago, in February 1975, the CICA’s Auditing Standards Committee proposed, subject to comments received following exposure, to publish the contents of an Exposure Draft as CICA Handbook: Section 5100 - Generally Accepted Auditing Standards. This Exposure Draft was a re-exposure of material previously included in a November 1973 Exposure Draft. At that time the Committee used wording closely following and, in most places, identical to that used in the AICPA Statement on Auditing Standards No. 1, Codification of Auditing Standards and Procedures.

The Introduction said: "Although the Committee’s intention remains, as a general principle, to use words closely following AICPA Statements (or other professional pronouncements) in cases where this is appropriate, consideration of responses received to the 1973 Exposure Draft indicated that several significant changes were desirable in this particular case. The November 1973 Exposure Draft contained two other Sections of background material, which have been eliminated. "Responsibilities and Functions of the Independent Auditor" required extensive changes and will be dealt with at a later date. The discussion previously included under the heading "The General Standards" related to ethical matters [emphasis added], which are within the jurisdiction of the provincial Institutes and Order. Accordingly, it is the Committee’s intention not to deal further with this topic in the Auditing Recommendations Section of the CICA Handbook, other than including the substance of the three November 1973 general standards as one general standard in paragraph 5100.02 in the interest of completeness."

It is noteworthy that the Introduction also said that, oncurrent with the issuance of this Exposure Draft as an Auditing Recommendation, the Committee would intend to amend the Introduction to Auditing Recommendations by inserting the following as a new paragraph in the "Application" section:

"Among the Recommendations issued, GENERALLY ACCEPTED AUDITING STANDARDS, Section 5100, constitute the basic professional standards with which, in the Committee’s view, the auditor should comply when reporting upon financial statements. In adhering to such basic standards the auditor should have regard to the specific Auditing Recommendations in the Handbook while exercising his professional judgment [emphasis added] as to what procedures are required for such adherence. In addition, the Handbook provides Recommendations with respect to unaudited financial statements, to which Generally Accepted Auditing Standards do not apply."