Sears ‘Going Concern’ Warning Is New Accounting Rules’ First Test

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By Steve Burkholder

Investors, accountants and companies should welcome the kind of new information that the parent of Sears and Kmart offered in a disclosure that it might not be in operation a year from now, according to Bloomberg BNA interviews.

Auditors and corporations are in “a much better position” under newly effective accounting rules that drove Sears Holding Corporation to signal in a March 21 regulatory filing that it has “substantial doubt” it can continue as a “going concern,” Baruch College professor Douglas Carmichael said March 26.

“This has got to be a net positive for investors,” Jeffrey Mahoney, general counsel at Council of Institutional Investors, said of the more complete, earlier-warning reporting under accounting principles that were spurred in part by the financial crisis of 2008-09.

Companies must follow the accounting rules on going concern starting in their 2016 annual reports. Previously, a company’s auditor had the task of seriously assessing the company’s future viability and disclosing the outlook.

A warning that a company might not be operating in a year could affect stock price. Sears experienced a steep share price slide in the hours after it filed the annual report with the warning.

The presumption that a company can go on operating for the foreseeable future is critical to financial reporting, according to the Financial Accounting Standards Board, which issued the rules on going concern—ASU 2014-15; ASC 205-40.

That presumption serves as the basis for measuring and classifying assets and liabilities. Going concern also affects such things as the funding of pensions and write-offs of goodwill and other intangible assets.

Jack Ciesielski, publisher of Analyst’s Accounting Observer, called the Sears disclosure the “first test case” of the 2014 FASB standard.

Going concern findings are relatively rare at Fortune 500 companies. They are more common at smaller companies, public and private, and particularly among start-up enterprises, one accounting and auditing source told Bloomberg BNA March 25. He, as did others, requested anonymity because of the sensitivity of his position.

‘Conditions or Events’ That Raise Doubts

A company’s managers must gauge whether “there are conditions or events that raise substantial doubt” about the company’s ability to continue as a going concern for a year after the issuance of financial statements, according to the FASB principles.

The company has to make that evaluation and a report if it finds such doubt on a quarterly basis. Before the FASB rules took effect, the auditor’s work on going concern was reported only on an annual basis.

FASB also defines the term “serious doubt,” which gives more clarity on the probability of a finding on future operations that the auditing standards lacked.

Auditor Deloitte’s Silence on Going Concern

Carmichael, the first auditor of the Public Company Accounting Oversight Board, said it is “very important” to note that Deloitte & Touche LLP, as Sears’s independent auditor, didn’t refer to the company’s going concern finding in the audit firm’s report that accompanied the retail giant’s SEC filing.

“That would indicate that it is likely that Deloitte was satisfied that substantial doubt had been alleviated,” Carmichael said.

Sears echoed that point, referring to an absence of words in the auditor’s report, which sowed some confusion in financial reporting circles in the days after the company filed its annual report with the Securities and Exchange Commission.

The retailer’s chief financial officer, Jason Hollar, wrote in a March 22 blog that it is “critical,” in understanding the full disclosure about the company’s operational problems, and efforts to solve the, that Deloitte issued an unqualified opinion in its audit.

“This indicates the company remains a ‘going concern,’ which means we are a viable business that can meet its financial and other obligations for the foreseeable future,” wrote Hollar.

Olga Usvyatsky, vice president of research at financial reporting research company Audit Analytics, told Bloomberg BNA March 27 that PCAOB auditing standards don’t require the independent auditor to state whether it agrees or disagrees with management’s assessment on operational outlooks and going concern.

Take In the Whole Story

Carmichael also urges readers of financial statements to read all of company’s newly-prescribed disclosures that surround a going concern warning. He referred to those that lay out the company’s plans to keep the bankruptcy wolf from the door.

If a going-concern evaluation leads to the unwelcome conclusion, FASB requires descriptions in a linked footnote that lays out management’s plans to alleviate doubts about operational worries and actions that worked to lessen those doubts.

Research Pending

Audit Analytics is analyzing the effects of the new financial accounting regime on going concern. It might be early in the annual reporting season to draw conclusions.

“There were few smaller companies that provided” disclosures similar to Sears’s, Audit Analytics’s Usvyatsky wrote in an email message.

“In all the cases we identified, the management conducted an evaluation” of going concern “and concluded that the mitigating plans are sufficient to alleviate the doubt and that the company will have sufficient liquidity to continue as a going concern,” Usvyatsky wrote.

Important Talks Between Company and Auditor

Ciesielski, an analyst and accountant who heads investment firm R.G. Associates, Baltimore, spoke about the sensitive nature of issues such as going concern. The future viability question is certainly a topic of “negotiation” between the company and its auditor when the former assembles its annual report for a Form 10-K filing with the SEC, he said.

“It’s not usually about the size of the font” for the annual report, Ciesielski said March 23 of those conversations. “It’s usually about sensitive things.”

One veteran standard-setter, who requested anonymity, said he wouldn’t call such talks “negotiations,” but “it’s definitely a discussion between the two parties,” he said.

Asked about discussions on going concern issues between Sears and its auditors, a Deloitte spokesman told Bloomberg BNA: “Professional standards prohibit us from discussing client matters.”

To contact the reporter on this story: Steve Burkholder in Norwalk, Conn. at sburkholder@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

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