Going Concern Warnings

By James Gentry
March 19, 2009 06:21 PM

In a normal year, relatively few public companies receive going concern warnings from their auditors. But this year so many going concern warnings are anticipated that auditing firms and professional groups have been publishing primers to ensure accountants are prepared.

Yet do going concern opinions really matter?

A company’s financial statements are put together based on the belief that the firm will be able to operate into the foreseeable future. On occasion, however, auditors come to the conclusion that the company might not be able to continue as a viable entity and, therefore, issue a going concern warning.

These warnings appear in the auditor’s opinion in the company’s 10-K filing. For example, General Motors’ recent filing has the following language from Deloitte and Touche, its auditors:

“As discussed in Note 2 to the consolidated financial statements, 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.”

In this case, the auditors’ warning also was cited frequently under “risk factors.”

To prepare auditors to deal with such difficulties, organizations such as the auditing firm of KPMG and the trade group American Institute of Certified Public Accountants (AICPA) have published guidelines for the profession.

Here is an example of a warning from KPMG’s Audit, Tax & Advisory Insights: “Directors and auditors will need to look very carefully at the cash flow forecasts, subject them to rigorous stress testing… Assumptions made with confidence in the past may no longer be valid.” The firm also cautions that, “Now more than ever companies in their business review and in the accounts should be providing full disclosures around their business risks and the factors and assumptions.”

According to one set of regulations that auditors follow, some indicators that could raise doubt about a company’s future include:

• Issues such as negative cash flows from operating activities, repeated operating losses, negative working capital or the inability to line up new financing.


• Other financial problems such as defaults on debt, debt covenants, or both; being behind in dividend payments, and the need to develop new financing.


• Undercapitalization.


• Turnover of important managers such as CEO, CFO, and controller.


• Uncertain market conditions.

Given the companies suffering most from the ongoing economic collapse, it is no surprise the most likely candidates for a going concern warning are auto manufacturers, auto suppliers (including American Axel and Manufacturing Holdings), retail businesses, homebuilders and financial firms. However, the warnings aren’t limited to them. Six Flags Inc., the theme park operator, and Avanex Corp., a provider of photonics for next-generation optical networks, recently received the warnings.

And then there are media companies, especially those owning newspapers. In Lee Enterprises’ 10-K for 2008, auditors at KPMG wrote that Lee’s declining cash flows and profitability make it questionable as to whether the company can fund its debt burden. Because of these problems, and since Lee had violated debt covenants, there is “substantial doubt about (Lee’s) ability to continue as a going concern.”

The growing awareness of going concern opinions should be no surprise. According to research by professors at the University of Arkansas and at Texas A&M University, going concern warnings have climbed since 2001. According to Reuters, the study indicated that 52 percent of distressed and subsequently bankrupt companies received going concern opinions in 2001. The percentage increased to 72 percent after that.

Despite this increase in going concern opinions, some experts assert that such warnings actually hold little weight. They argue that the causes of the warning often will be remedied and the company will survive. Several years ago, Delta Airlines received a warning and went into bankruptcy. Today the airline is alive and has taken over Northwest Airlines.

Other observers say that the auditor is looking at the issue only once a year and that point in time might not be representative of the company’s condition.

On the other side, some point to the expectation that auditors always take a conservative approach to issues, which makes them less likely to determine that a company warrants a going concern opinion.

Trent Gazzaway, a partner audit and advisory firm Grant Thornton, argues for balance in viewing the warnings.

“Just as a clean opinion is not a guarantee of financial health, a going-concern opinion is not a guarantee of impending failure,” Gazzaway told Compliance Week.

Simply put, a going concern warning is just an assessment of risk. Some assessments are more thorough and more credible than others.

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Copyright © 2009 Donald W. Reynolds National Center for Business Journalism