"Going concern" v "insolvency": there is a difference

There are still too many among directors and senior management that believe an auditor's assessment of  a company as a going concern is the same as as a directors' assessment of its potential for insolvency. That is not a correct view, because the two concepts can diverge either way:

• an entity may still be capable of paying its debts as and when they fall due, but at the same time not be a going concern because the directors intend to liquidate or significantly curtail its operations within the relevant reporting period; and
• a company may still meet the criteria of being a going concern because of its intention and capacity to maintain the scale of its operations, while still facing significant uncertainty in being able to pay longer-term debts as and when they fall due.

An entity's status as a going concern arises from IAS 1, which is its current foundation  in Canadian GAAP. Securities laws require it to be addressed in an annual report's Management Discussion and Analysis, although the Ontario Securities Commission has noted major deficiencies in that regard.

The directors' assessment for the potential of insolvency is preemptive in nature, and arises from both statutory and contractual duties. CPA Canada has noted that there is a crucial need to ensure an early determination, in order to employ available  options and avert potential default on a timely basis.

Even if there are no immediate concerns, auditors must still address whether any material uncertainties may exist that need to be noted in a company's financial statements, and be prepared to issue an adverse opinion if such uncertainties are not addressed therein.

This is further evidence of the current requirement of directors and management to be proactive in addressing their duties, as being reactive will, in almost all cases, will be too late.

In performing their duties, directors must act reasonably.  It has been held that reasonable grounds do not include "unquenchable optimism," and the following list indicates factors that suggest where an unreasonable action has occurred in assessing insolvency:

1. Where, although the officer has never adverted to it, there is at the objective level no reasonable or probable ground of expectation  to the relevant effect;
2. Where the officer himself has a subjective expectation of the relevant kind, that there is no objective ground for the expectation;
3. Where, as a matter of subjective judgment, the officer lacks the expectation yet, unknown to him, there is, on an objective appraisal, a reasonable or probable ground of expectation; and
4. Where the officer does not care whether the postulated event of payment will occur, and it appears that objectively there was no ground of expectation.

On the other hand, directors cannot give a qualified opinion as to material uncertainties, either through an expression of hope or envisaging unlikely scenarios, and the use of boilerplate statements in either the MD&A or the notes to financial statements is viewed as being very unhelpful. For example, if a qualified opinion is being considered as to the availability of financing from a financial institution or shareholder to ensure continuing as a going concern, genuine negotiations with a reasonable likelihood of success should be shown to be underway at the date of the statement.