Substantial Doubt about Continued Operations

Earlier this month Deloitte & Touche issued their report on General Motor’s financial statements. According to CFO.com, March 5, 2009 article by Sarah Johnson, D&T’s opinion included the following going concern qualification, “The corporation’s recurring losses from operations, stockholders’ deficit, and inability to generate sufficient cash flow to meet its obligations and sustain its operations raise substantial doubt about its ability to continue as a going concern.”

Because of the sluggish economy and market conditions, many organizations are facing pointed questions from their auditors. These “going concern” questions are raised because of certain indicators that include the following:

1. Negative trends – recurring operating losses; working capital deficiencies (current liabilities exceed current assets [therefore cash and assets converting to cash in the current period] are not enouch to pay the obligations that are due); operating activities are not producing cash; adverse key financial ratios.

2. Other financial difficulties – default on bank loans or violations of debt covenants; denial of credit from suppliers; noncompliance with statutory capital requirements; seeking new sources of financing.

3. Internal matters – work stoppages; need to significantly revised operations; substantial dependence on new product; labor difficulties.

4. External matters – legal proceedings that may jeopardize operations; loss of principal customer or supplier; uninsured or underinsured catastrophic loss.

During the audit engagement the auditor, complying with generally accepted auditing standards, obtains information about the continued operations of the organization. If any of the above items have been identified, then the auditor must evaluate management’s plans to overcome the operational obstacles. Management must consider the following in order to eleviate a “going concern” by the auditor: 

1. Disposal of selected assets in order to provide funding to reduce current obligations.  

2. Debt restructuring or alternative financing 

3. Delay or reduce expenditures - focusing on overhead and administrative costs; postpone maintenance and product development.

4. Increase equity by raising capital via a special capital campaign. 

If your organization has experienced reoccuring losses and cash flows and is unable to meet obligations as they are due, management must be aggressive in devising a plan for continuing oeprations. If there is no plan,  the auditor may have no other alternative than to qualify his report, documenting that there is a substantial doubt that the organization may not continue for a reasonable period of time.  

During this recession I believe you will see more footnote disclosures addressing management’s plans for continuing operations.