What Is a Going Concern Opinion in an Audit Report?

An audit opinion is a formal statement issued by an external auditor regarding the reliability and fairness of a company’s financial statements. This opinion provides assurance to stakeholders about the accuracy of financial reporting and adherence to accounting standards. An important element within this assessment is the “going concern” assumption, which assumes a business will continue to operate indefinitely.

Understanding a Going Concern Opinion

A “going concern opinion,” often referred to as an explanatory paragraph, is included in an auditor’s report when there is substantial doubt about a company’s ability to continue operations. The underlying accounting principle assumes a business will continue for at least one year from the financial statement issuance date. This opinion alerts financial statement users that significant uncertainties exist regarding the entity’s future viability. It is not a prediction that the company will fail, but a warning based on current conditions and management’s plans.

Common Indicators of Substantial Doubt

Auditors consider various conditions and events that may raise substantial doubt about an entity’s ability to continue as a going concern. Financial indicators include recurring operating losses, deficiencies in working capital, negative cash flows from operations, or adverse financial ratios. Other signs of financial distress involve defaults on loan agreements, inability to pay debts as they mature, arrearages in dividends, or denial of trade credit from suppliers.

Operational indicators can also signal potential issues, such as the loss of a major customer or supplier, labor difficulties like work stoppages, or the departure of key management personnel. Dependence on a single project or uneconomic long-term commitments may also raise concerns. External factors, such as new legislation, uninsured catastrophes, or other events, can also contribute to substantial doubt.

Auditor’s Assessment and Reporting Standards

The auditor’s responsibility involves obtaining sufficient audit evidence concerning management’s use of the going concern basis of accounting. This assessment requires the auditor to evaluate management’s plans to mitigate conditions that raise substantial doubt. The auditor assesses whether these plans are feasible and effective in addressing the identified concerns.

If substantial doubt about the entity’s ability to continue as a going concern remains after evaluating management’s plans, the auditor modifies their report. Auditors follow relevant accounting standards, such as PCAOB AS 2415 for public companies and AICPA AU-C Section 570 for non-public companies. This modification involves adding an explanatory paragraph following the opinion paragraph, which describes the conditions leading to the doubt and management’s efforts to address them.

Consequences of a Going Concern Opinion

Receiving a going concern opinion has significant practical implications for a company. It signals financial distress to stakeholders, potentially leading to a decline in investor confidence and a reduction in stock price. Companies may find it more challenging to raise capital, facing higher interest rates or stricter terms for loans or equity investments.

Relationships with suppliers and customers can also be impacted, as they may become hesitant to extend credit or commit to long-term contracts due to perceived instability. A going concern opinion can also lead to increased scrutiny from regulators and other oversight bodies. While not a definitive statement of failure, it serves as a public warning that can restrict a company’s financial flexibility and operational capabilities.