Comment Letter Summary Disclosure about an Entity s Going Concern Presumption November 6, 2013

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1 Comment Letter Summary Disclosure about an Entity s Going Concern Presumption November 6, 2013 BACKGROUND AND PURPOSE 1. On June 26, 2013, the FASB issued proposed Accounting Standards Update, Disclosure about an Entity s Going Concern Presumption. The proposed Update provides guidance in U.S. generally accepted accounting principles (GAAP) about management s responsibilities in evaluating an entity s going concern uncertainties and about the timing and content of related footnote disclosures. The comment period ended September 24, The Board has received 46 comment letters. 2. The purpose of this paper is to provide the Board with a summary of feedback from stakeholders about the proposed Update. SUMMARY OF FEEDBACK AND STAFF ANALYSIS 3. The following table summarizes the demographics of respondents: Type Responses Practitioners 17 Preparers 7 Professional Organizations- 2 Practitioner 1 Preparer 2 Other State CPA Societies 11 Industry Organizations 3 Other (includes individuals and a standard 3 setter) Total The Board asked 19 questions in the proposed Update. For purposes of this summary, the staff has separated the feedback into the following categories: (a) (b) The project s objective Going concern assessment and disclosures

2 (c) (d) Substantial doubt assessment Other issues. The Project s Objective 5. The proposed Update states that the project s objective is to provide preparers with guidance about management s responsibilities for evaluating and disclosing going concern uncertainties and, thereby, reduce existing diversity in footnote disclosures. In doing so, the proposed Update would improve the timeliness and quality of footnote disclosures about going concern uncertainties. 6. While respondents expressed some concerns about whether the proposed Update would fully meet its objective, there was widespread agreement that management should be primarily responsible for assessing its ability to continue as a going concern. A significant majority of respondents also agree that the guidance should be provided in U.S. GAAP. Of the three respondents who disagreed with including guidance in U.S. GAAP, two stated that the information should remain in management s discussion and analysis (MD&A) because of its protection under the safe harbor provisions of the Private Securities Litigation Reform Act (PSLRA). Those respondents were both preparers. The third respondent noted that the disclosures about uncertainties should be in U.S. GAAP, but asserted that U.S. GAAP should not include any guidance on evaluating and asserting substantial doubt. The staff will summarize respondents additional concerns about legal liability within the next section. Definition of Going Concern 7. The proposed Update would define the term going concern presumption (which is not currently defined in the auditing literature) as follows: The inherent presumption in preparing financial statements under U.S. generally accepted accounting principles that an entity will be able to continue as a going concern; that is, the entity will continue to operation such that it will be able to realize its assets and meet its obligations in the ordinary course of business. 2

3 8. Of those who responded, 51 percent agree with the proposed definition. An additional 21 percent generally agree but have reservations about the phrase ordinary course of business. Many stated that the phrase could be misinterpreted with its use in paragraph on defining management s plans that are outside the ordinary course of business. Some respondents noted that the phrase should be emphasized or clarified. However, a larger percentage of those respondents suggested that the Board remove the phrase ordinary course of business from the definition because it could cause confusion or diversity in practice. 9. Respondents who disagree with the proposed definition (28 percent) are primarily concerned that the definition of going concern presumption could confuse the going concern basis of accounting with a solvency analysis. The Board recently issued a standard on liquidation basis of accounting that provides detailed guidance on when an entity must change its basis of accounting. Many of these respondents noted that the definition of going concern presumption would conflict with the triggers for applying the liquidation basis of accounting. One respondent noted: The uncertainties that may trigger the need for disclosures about future uncertainties generally do not cause a change in basis of accounting. Thus, combining the two issues (basis of accounting and need for disclosures about future periods) under the term going concern presumption confuses more than it explains the intended concept to preparers and users of the financial statements. [CL #43, Grant Thornton LLP] 10. Those who disagree with the proposed definition provided the following suggestions: (a) Do not define going concern presumption because its definition is implied through the criteria for applying the liquidation basis of accounting and it is not relevant to the proposed Update s main principles about the timing and content of disclosures. 3

4 (b) Define two terms. First, define going concern basis of accounting as the presumption that an entity will not liquidate. Second, define going concern presumption as the presumption that an entity will continue to operate normally. Improvement over Current Practice and Cost-Benefit Concerns 11. A primary goal of the proposed Update is to improve current practice by reducing diversity in the timing and content of footnote disclosures about going concern uncertainties. Of the respondents who provided feedback on this objective, a slight majority (51 percent) agrees that the proposal would reduce diversity in the nature, timing, and extent of footnote disclosures and provide users of financial statements with decision-useful information. Those respondents also noted that the requirements would offer users the following benefits: (a) (b) (c) Increased rigor around the assessment process Narrower focus of going concern disclosures than current MD&A requirements An assessment and disclosures that would be subject to audit. 12. Other respondents stated that the proposed Update would neither improve current practice nor provide useful or incremental information to users. Many of those respondents expressed concern that the proposed assessment would introduce new complexities and potential for new diversity and, even if the guidance reduced existing diversity, the cost of increased complexity would outweigh the benefit of standardization. 13. Of the respondents who commented about 60 percent on a cost-benefit analysis noted that the benefits of the proposal would outweigh the costs, which is a slightly greater percentage than those who believe that the proposal would achieve its objective. Several of those respondents qualified, however, that the assessment is entity-specific so there would be entities that bear more significant costs than others. Four additional respondents (15 percent) noted that the benefits would only outweigh the costs if certain aspects of the proposal were revised, particularly if the 4

5 24-month consideration period was reduced to 12 months. The remaining 25 percent of respondents noted that the costs of the proposed Update would be greater than its benefits and cited the following reasons: (a) (b) (c) The assessment is too complex (especially for small- and medium-sized entities). Large financial institutions already have similar/rigorous reporting requirements imposed on by regulators. Therefore, the requirements in the proposed Update would be duplicative. The proposed requirements would place an undue burden on financially healthy entities. 14. Approximately 40 percent of respondents who offered an opinion stated that the proposed disclosures would not provide incremental benefits to users over an SEC registrant s disclosure requirements. Most of those respondents were preparers and their primary argument was that there would be no new information disclosed in the footnotes that is not already disclosed in an SEC registrant s MD&A. Going Concern Assessment and Disclosures 15. The proposed Update would require an entity to evaluate going concern uncertainties at each annual and interim reporting period and introduce a threshold for initial disclosures and substantial doubt. Concerns about the proposed going concern assessment ranged from drafting suggestions to more substantive comments. Initial Disclosure Threshold 16. Of those who offered an opinion, about 75 percent of the respondents agree that more likely than not is generally the appropriate likelihood point to begin disclosures about going concern uncertainties in the footnotes to the financial statements. However, many of those respondents expressed concern that the proposed threshold has the connotation of a binary point at 50.1 percent. They 5

6 noted that a binary threshold could create significant complexity. One respondent stated: One particular concern is the precision for the disclosure thresholds included in the Proposal. For example, the use of more likely than not is a bright-line threshold that has the advantage of being objective in definition, but the disadvantage of being complex and subjective in application. A close call to disclose or not disclose going concern would ultimately be a judgment call despite the bright-line test. [CL #6, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce] 17. As an alternative, many respondents support a range-based threshold. Some noted that the Board could achieve this by incorporating into the standard itself the language from paragraph BC24 in the basis for conclusions, which clarifies that more likely than not should be considered a range rather than a precise point. 18. The remainder of the respondents disagree with both the timing of the threshold and its binary nature. Those respondents, however, are split on when an entity should begin disclosing its going concern uncertainties. About 60 percent (primarily practitioners) of the dissenting respondents support an earlier threshold such as reasonably likely because this term would more clearly imply a range and would provide investors with an earlier warning. Conversely, the remaining 40 percent (primarily preparers) support a higher threshold at either probable or, for consistency with International Financial Reporting Standards (IFRS), material uncertainty. Consideration of Management s Plans 19. Respondents indicated that the distinction of management s plans within and outside the ordinary course of business is one of the most challenging aspects of the proposed Update. Most respondents who addressed these questions agree with the Board s proposed definition of plans outside the ordinary course of business (86 percent), but only about half conceptually agree with the requirement to distinguish between management s plans. In addition, about 80 percent of respondents who offered an opinion noted that the requirement in its current form would be inoperable unless the final Update includes additional implementation guidance. 6

7 20. Those who conceptually disagree with distinguishing between management s plans noted that the consideration would add unnecessary complexity to management s assessment. Additionally, some respondents stated that the Board s rationale for requiring management to assess whether its plans were within or outside the ordinary course of business was not adequately explained or supported in the proposed Update. 21. Of those who considered the existing implementation guidance insufficient, half noted that these examples do not appropriately reflect all relevant considerations. Particularly, they asserted that the examples do not emphasize management s intent in making the determination of whether a plan is within or outside the ordinary course of business. They stated that this is particularly true of the example related to debt refinancing; half of respondents disagree with the conclusion that the refinancing would be outside the ordinary course of business. 22. Some respondents suggested including examples of management s plans that may not be customary in carrying out an entity s ongoing business, but customary for the entity s industry. Others suggested including additional guidance on refinancing activities. One respondent mentioned that the lack of clarity could have significant cost, complexity, and disclosure ramifications for small- and medium sized-entities. That respondent noted: The definition proposed by the Board, when coupled with the implementation guidance, will be difficult to apply in practice and takes an unnecessarily narrow view of the actions taken by management in the ordinary course of business, particularly for smaller public companies and private companies. The Board should consider modifying the definition or the implementation guidance to acknowledge that certain events, such as financing transactions, may not occur annually yet still occur with sufficient frequency to be considered within the ordinary course of business and which are adequately disclosed in other parts of the financial statements [CL #36, Moss Adams LLP] 23. Another respondent suggested that the standard include a table that would provide some basic questions for preparers to ask related to the nature, frequency, and magnitude of a variety of commonly seen management plans. The respondent also noted that additional implementation guidance should be introduced about 7

8 assessing the effectiveness of management s plans and the interaction between the risk conditions and management s plans. 24-Month Assessment Period 24. Respondents generally noted that the 24-month assessment period is another challenging aspect of the proposal. They noted that the complexities would affect both preparers, who would be expected to forecast conditions and events two years out, and auditors, who would need to obtain reasonable assurance about management s projections for a two-year period. As a result of those challenges, nearly two-thirds of the respondents disagree with the proposed assessment period, for both the initial disclosure threshold and the substantial doubt threshold. They explained that 24 months would not be operable, auditable, or cost-beneficial. Of the 12 respondents who proposed an alternative to the 24-month assessment, 9 supported a 12-month assessment period from either the financial statement date (balance sheet date) or the date financial statements are available to be issued. The remaining 3 respondents suggested an assessment period of at least 12 months. They noted that private entities could otherwise delay the release of their financial statements, and that at least 12 months would align with the existing guidance under IFRS. 25. Those who support the proposed assessment period of 24 months (13 respondents) were primarily practitioners and, while they acknowledged the complexities with the assessment period, they stated that a 24-month assessment period would be an improvement over current practice. 26. Despite general opposition to a 24-month consideration period, respondents generally agree that it is appropriate to distinguish between the first 12 months and the subsequent months. About 75 percent of respondents agree that because of increasing complexity in forecasting future events, the latter 12 months should have a higher disclosure threshold and that known or probable is the appropriate time to require disclosures. Many respondents noted, however, that known or probable is redundant and simply defining the threshold as probable would be 8

9 clearer. Those who disagree with the month distinction noted that the dual threshold would create additional and unnecessary complexity in the analysis. Consideration of Known Events at the Date Financial Statements Are Issued 27. Respondents generally agree that the going concern assessment should consider events and conditions that exist at the date financial statements are issued. There is some concern that the language in the proposed Update might imply a greater responsibility to predict future events than intended. One respondent stated: We believe it should be made very clear that the going concern assessment is not intended to incorporate future matters that cannot reasonably be expected to be known to the preparer at the time the financial statements are issued. Specific language should be built into the proposal, and perhaps be supplemented. [CL #14, Center for Audit Quality] Most of those respondents suggested general drafting changes to address their concerns about the future information that management is expected to consider in its assessment. Frequency of Assessment out of 30 respondents agree with the proposed annual and interim reporting requirements. Some of those respondents (primarily practioners) acknowledged that interim reporting requirements could be costly, but noted that the benefits of the timely disclosures would outweigh the costs. 29. In contrast, of the 11 respondents who disagree with the frequency of the assessment, most cited cost as their primary concern. One preparer noted that a financially healthy entity conducting a quarterly assessment would incur additional costs without significant benefits to its users. Another respondent expressed concern that an entity on the cusp of meeting the initial disclosure threshold also would experience significantly higher costs to track and monitor changes in its forecasts and financial position. As an alternative, six of the respondents who disagree with the proposed model suggested that the Board adopt a trigger-based model, much like long-lived asset impairments, for interim disclosures. 9

10 Disclosure Requirements 30. Respondents broadly support the proposed disclosure requirements. Several respondents suggested including additional disclosure requirements, but there were no common trends among those suggestions. 31. However, respondents noted some operational concerns about the disclosure requirements. The most common concerns include the following: (a) (b) (c) (d) Management s ability to appropriately assess and disclose forwardlooking information up to 24 months from the balance sheet date Exposure to legal liability from disclosing information without protection under the safe harbor provisions of the PSLRA Fear of self-fulfilling prophecy Auditors difficulty in reviewing management s judgments and subsequent disclosures, especially about management s plan. Of those concerned about some of the disclosures, two-thirds cited concerns about the legal ramifications of including forward-looking information in the financial statements. 32. In contrast, about a third of the respondents who addressed the disclosure requirements in their comment letters did not express concern about legal liability. They noted that forward-looking information exists elsewhere in the footnotes (impairment evaluations and deferred tax valuation allowances), so they analogized that these disclosure requirements also are well within management s capability. In order to reduce concerns about the inclusion of forward-looking information, some respondents suggested that the standard emphasize that the assessment is not intended to incorporate conditions that are unknown to preparers at the time the financial statements are issued. 33. In addition, respondents were asked whether there would be any limitations to the types of information preparers would disclose. Although only seven respondents answered this question, their comments echoed the general concerns about the 10

11 requirements. Four of the seven respondents listed concerns, which include the following: (a) (b) Preparers may be hesitant to disclose proprietary information about their plans or the potential effect of the conditions and events giving rise to the going concern uncertainties. Preparers may limit the amount of forward-looking information because the footnotes are not covered under the PSLRA. The other three respondents acknowledged that prepares may be uncomfortable disclosing some information about their going concern uncertainties, but noted that the benefits of the information provided in the disclosures would outweigh their costs. Disclosure Redundancy 34. Of the respondents who expressed an opinion, almost all agree that the proposed disclosures would have a narrower focus on going concern uncertainties than existing SEC disclosure requirements in the MD&A. In addition, of the 20 respondents who commented on the potential effect the disclosures would have on the timing, content, or communicative value of SEC requirements, none raised significant concerns. 35. As noted earlier, 40 percent of respondents noted that the proposed Update would not provide incremental information over existing SEC disclosure requirements. Nineteen respondents commented on the incremental benefits of the proposed disclosures for SEC registrants, and eight of those respondents noted that the proposed disclosures would provide no incremental benefit to users. Of those eight respondents, six also expressed an opinion on the disclosure requirements. One of those six disagrees with the proposed disclosures on the basis that forward-looking information does not belong in the historical financial statements. A more common perspective among the six respondents was that U.S. GAAP is the appropriate location for such disclosures. One respondent stated: 11

12 Since there are no current requirements in U.S. GAAP, the proposed amendments put the guidance in the proper place; in the accounting standards, not the auditing standards. While there is currently some diversity in practice as a result of auditor requirements, we do not believe there will be significant incremental benefits relative to current practice. Nevertheless, we believe it makes sense to move forward with an accounting standard. [CL #10, Marcum LLP] 36. A separate respondent raised concerns about potentially duplicative requirements with regulating bodies beyond the SEC. Large U.S. financial institutions with assets greater than $50 billion are subject to requirements under the Dodd-Frank Act, the regulatory capital standards of the Basel Accords, and the Comprehensive Capital Analysis and Review (CCAR) rules instituted by the Federal Reserve Bank. The respondent noted: We believe that our ability to successfully pass these tests is a more than adequate assessment of our ability to continue as a going concern. Moreover, the Federal Reserve discloses the results of these stress tests to the public on an annual basis.... If we failed such tests, we would be required to disclose such information to our shareholders and creditors. [CL #11, PNC Financial Services Group, Inc.; Footnote reference omitted.] Substantial Doubt Assessment Substantial Doubt Threshold 37. Of those who addressed the issue, 71 percent of respondents agree that an SEC filer s management should be required to evaluate and determine when there is substantial doubt. They reasoned that management is responsible for the disclosures in the financial statements and is in a better position than the auditor to evaluate and communicate such information to investors. Those who disagree with the additional requirement for SEC filers stated that the assessment would add an unnecessary level of complexity, increase legal liability, and create an adversarial relationship between management and its auditor. However, one respondent noted that those challenges could be partially alleviated by requiring management to assert that there may be substantial doubt rather than that there is substantial 12

13 doubt.(cl#12, New York State Society of Certified Public Accountants Financial Accounting Standards Committee) 38. Respondents also support the proposed definition of substantial doubt (except for the 24-month consideration period previously discussed). Of the respondents who disagree with the definition (four respondents), two support a single threshold model and one noted that there could be legal ramifications associated with the term probable. The latter respondent explained: Our experience is that Topic 450 s use of probable to mean a substantially greater likelihood than 50% often takes less experienced member of the financial reporting community by surprise. See Dronsejko v. Grant Thornton, 632 F.3d at 658 (10th Cir. 2011). It is true that this risk of misunderstanding has existed for some time under Topic 450 and other topics and that preparers and auditors seem to have successfully navigated the difficulties. However, our concern increases as we see the term probable being imported into the new going concern standard which we expect to be the subject of much greater focus, and potentially more extensive judicial proceedings, than has historically been the case under Topic 450. [CL #41, Committee on Financial Reporting of the Association of the Bar of the City of New York] 39. Approximately two-thirds of the respondents agree that the substantial doubt threshold most closely approximates the upper end of the range in the present interpretation of substantial doubt by auditors. However, most would not expect a significant decrease in the number of emphasis of matter paragraphs because the higher threshold would be offset by the extended 24-month consideration period. The staff notes that only 15 respondents answered this question. Applicability of Substantial Doubt to Non-SEC filers 40. In contrast to the general support for a substantial doubt threshold, 87 percent of respondents who addressed the issue disagree with the distinction between SEC filers and non-sec filers for evaluating and disclosing substantial doubt. Most of the respondents who addressed this question were state CPA societies and larger practioners. They cited the following reasons for their disagreement: 13

14 (a) (b) (c) (d) Users of non-sec filers financial statements would receive similar benefit from the evaluation and disclosure. The distinction is inconsistent with auditing standards The distinction would create a competitive disadvantage for public entities and potentially create confusion about a non-sec filer s financial position. The explanation in the basis for conclusions was not persuasive to substantiate different treatment. 41. Of the four respondents who agree with the distinction, two noted that there would Other Issues be no incremental benefit to users of non-sec filer financial statements. The other two respondents agree because no entity should have to declare substantial doubt. One of those respondents, however, explained that it otherwise does not support the distinction between SEC and non-sec filer s reporting requirements. Coordination with Accounting Standards Board (ASB) and Public Company Accounting Oversight Board (PCAOB) 42. A significant number of respondents, particularly audit firms, cited the importance of the FASB working with the ASB and PCAOB to coordinate standards. Many firms explained that the inconsistencies with the auditing literature would be a significant road block in the operability of the standard if those inconsistencies are not resolved. Transition 43. Although no specific questions were asked regarding the appropriate transition and effective date, one respondent suggested that the Update be effective for periods beginning after December 15, 2015, to allow time for changes to audit documentation, procedures, and disclosures. No other respondents proposed a specific date, but respondents stressed the importance of coordinating the effective date with the ASB and the PCAOB. 14

15 44. In addition, one respondent disagrees with the proposed transition guidance and requested that an entity be permitted to initially apply the amendments at a fiscal year-end to coincide with preparation of annual financial statements, rather than at an interim period. Convergence with IFRS 45. Eight respondents urged the Board to consider working with the IASB because both Boards have an active project on going concern. The comments ranged from those supporting complete convergence to those suggesting that the Boards align key concepts. One respondent who supports complete convergence stated that It is important that users understand the concept of going concern and the meaning of any disclosures given in this area. Differences between IFRS and US GAAP would not contribute to market confidence and could diminish the benefits of changes being made to audit reports (CL #17, Institute of International Finance). 15