U.S. companies would have to regularly assess their ability to continue as a going concern under a proposal issued on Wednesday by accounting rule-makers, an attempt to ensure investors get timelier warnings when companies get in trouble.
The proposal from the U.S. Financial Accounting Standards Board calls for companies to evaluate each quarter their ability to survive as a going concern, or stay afloat and pay its obligations. Currently, the company's auditors are primarily responsible for making this evaluation.
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A company would have to issue its own warnings to investors when it is more likely than not that it would fail to meet its obligations over the next 12 months. Auditors would still be responsible for evaluating the company's going concern assessments.
FASB is seeking comment on the proposal through September 24. It did not give an estimate for an effective date.
Companies already have to disclose risks that they may run short of cash in footnotes to their financial statements, but those disclosures vary from company to company.
Going concern warnings are a highly sensitive issue for corporate managers, because lenders stop extending credit when they find out a company is near collapse.
FASB's proposal "makes it much more difficult for them to deny a difficult situation," said Paul Miller, professor of accounting at the University of Colorado at Colorado Springs.
Auditors also face huge risks in this area, because they can get hit with lawsuits if they fail to warn about a company that collapses, Miller said.
Going concern warnings were proven inadequate in the 2007-2009 global credit crisis when auditors failed to flag risks at banks that collapsed or required government bailouts.
A company's going concern status underpins every financial statement it prepares, with assets priced based on the assumption that the firm will survive to realize the assets' value. When the company is in danger of failing, its assets have to be re-priced based on what they would be worth in a liquidation.
Even before a company is in imminent danger of liquidation, there may be uncertainties about its going concern status, FASB said in a release. Accounting standards now have no guidance for managers on disclosing those uncertainties.
(Reporting By Dena Aubin; Editing by Kim Dixon and David Gregorio)