This article was written and produced by Terrence J. Phillips, CPA, Partner, The Bonadio Group. Looking to get in touch with Terrence? Reach out today: tphillips@bonadio.com.
Imagine this: you have auditors on-site performing fieldwork and they say to your CFO, “Because your organization saw a significant deficit in the current year, we are required to complete this ‘Going Concern Checklist.’” The CFO, recognizing the potential impact of the auditor’s opinion on the organization’s financial statements, informs the CEO and members of their audit committee. This is followed by a flurry of questions and anxiety from both management and the audit committee members as they try to understand the impact to the organization if, in fact, the auditor’s opinion was to be modified due to substantial doubt regarding the organization’s ability to continue as a going concern.
Unfortunately, New York State (NYS) continues to grapple with controlling the increasing cost of its Medicaid program, which is estimated to be $6 billion over its approved $75 billion 2020 NYS budget amount. As part of NYS’s solution, oversight agencies have introduced new cost-control programs and changes to reimbursement methodologies and even limited access to traditional programs. The result of these actions has been, and will continue to be, an increase in the number and size of annual operating deficits sustained by health and human service organizations; of which are extensively dependent upon the NYS Medicaid program to reimburse them for services provided. Depending on an organization’s available financial resources, continued annual operating deficits could impair its financial viability and, therefore, its ability to continue as a going concern.
Disclosure of uncertainties in the organization’s ability to continue as a going concern
The going concern principle is that you assume a business will continue into the foreseeable future unless there is evidence to the contrary. Such evidence exists when conditions and events, considered in the aggregate, indicate that it is probable that the organization will be unable to continue normal business operations and meet its obligations as they become due.
Management should regularly evaluate whether there are conditions and events that raise substantial doubt about an organization’s ability to continue as a going concern. This evaluation should consider the industry in which the organization operates, its ability to pay staff and vendors for services and goods provided for the period noted (i.e., future cash flow from all sources), among other considerations. If management’s plans alleviate the substantial doubt, the organization should provide the following information to the users of the financial statements in footnote disclosures:
- Conditions or events that raised substantial doubt about the organization’s ability to continue as a going concern.
- Management’s evaluation of the significance of those conditions or events, in relation to the organization’s ability to meet its obligations.
- Management’s plans that alleviated the substantial doubt about the organization’s ability to continue as a going concern.
If management’s plans do not alleviate substantial doubt, they will be required to include a statement similar to the above in the footnotes to the financial statements. These will indicate that there is substantial doubt about the organization’s ability to continue as a going concern within one year after the date that the financial statements are issued or are available to be issued.
Auditor’s consideration of the organization’s ability to continue as a going concern
The auditor has the responsibility to consider an organization’s ability to continue as a going concern on all financial statement audits, other than financial statements prepared on the liquidation basis of accounting. When the auditor has doubt about the organization’s ability to continue as a going concern, additional evaluation is required, including evaluation of the conditions and circumstances surrounding the organization’s ability to continue as a going concern, management’s plan to rectify such doubt, and its ability to successfully implement the plan.
Once the auditor has completed their evaluation, they then determine the impact on the auditor’s report. The following summarizes the options available to the auditor:
- Qualified or Adverse Opinion On Financial Statements – Indicates that the auditor has substantial doubt that the organization will be able to continue as a going concern, and the financial statements are not prepared in accordance with US GAAP, either because they should be using the liquidation basis of accounting, or because disclosures regarding its ability to continue as a going concern are inadequate.
- Emphasis of Matter in the Auditor’s Opinion – The auditor adds a paragraph to the auditor’s opinion stating the condition(s) that existed and references a note in financial statements that clearly summarizes the conditions (referred to above).
- Unmodified Opinion on Financial Statements – The auditor has evaluated the doubt that the organization will continue as a Going Concern, has determined that the doubt has been eliminated, and has issued an Unmodified Opinion (better known as a “Clean Opinion”).
How do changes to the auditor’s opinion affect the organization?
There are several interested parties (stakeholders) to an organization’s financial statements and the auditor’s opinion that accompany those statements. These Stakeholders include:
- Individuals and families served by the organization
- State oversight agencies
- Donors
- Creditors
- Employees
Over the past decade, there have been some notable failures of nonprofit organizations in NYS that have caused stakeholders to review financial statements and the auditor’s opinions with more attentiveness, looking for disclosures or changes to reports that would indicate potential issues. The opinion that causes the most reaction from stakeholders is the issuance of a qualified or adverse opinion, which would indicate that the organization’s ability to continue is in doubt. One of my partners has even described that opinion as a “dagger to the heart of the organization,” meaning that the stakeholders will take steps to protect their interest in the organization. State oversight agencies will perform their own due diligence, once aware of the opinion, which could lead to regulatory action by the oversight agency to protect individuals served by the organization. Potential actions range from a requirement to seek additional/alternative financing to a change in auspice moving programs to another organization, resulting in the possible closure of the organization.
Such an opinion may also negatively impact the organization’s ability to raise donations, receive bequests or grants to continue its programs. Most donors, foundations, and state agencies do not want to waste their limited resources on high-risk agencies or are prohibited under their bylaws or grant requirements from granting funds to an organization that has these opinions.
What steps should be taken by management and the board?
So, what steps should be taken by management and the board to reduce the risk of the audit firm modifying its opinion on the organization’s financial statements? Although, as noted earlier, management needs to complete a detailed assessment of its ability to continue as a going concern and, if required, develop and implement a plan to ensure that it is implemented and successful, we believe there are some basic steps that should be performed to ensure that the auditor isn’t required to issue a going concern opinion. Consider the following recommendations:
- Understand that the organization isn’t the first organization to experience this situation, so don’t panic.
- Perform an objective assessment of all programs conducted by the organization. A sample of steps would include:
- Analyze financial results, by program, including an objective review of the root causes for poor performance.
- When determining the continued operation of a specific program, consider if the program is core to the organization’s mission.
- Identify what the state is doing on a universal basis with each program and how that impacts program future viability.
- Based on your assessment, develop a plan to transform the organization back to stable financial operations. The plan should be prepared in enough detail, including financial projections, to demonstrate to the board, creditors, and auditor that once successfully implemented, it will return the organization to being financially viable.
- If it is determined as part of the transformation plan that the organization should devest itself of a certain program, the plan should consider the impact on the organization’s ability to cover agency administrative costs that were previously charged to that program.
- As an alternative to a detailed transformation plan, management and the board should review the financial viability of the current organizational structure and determine if a management services agreement, affiliation, or merger with another organization is a potential solution. Factors to consider are agency administration reimbursement limits, improved rates of other organizations, and efficiencies of scale for shared costs.
- Whatever model is recommended by management, the board needs to review and approve the model that they believe is the most viable for the organization and the stakeholders. Once that plan is approved by the board, management must develop a monitoring process to ensure that the outcomes specified in their plan are successfully implemented. Thus, consistent and objective monitoring and reporting of plan results will help accomplish the goals outlined in the plan.
Still have questions about the going concern principle and how it may impact your organization? Reach out to our experts today to further discuss and develop a proactive plan.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
