Not-for-profit financial reporting: management’s going concern analysis – step by step

As a result of the COVID-19 pandemic, many not-for-profit organizations are faced with significant declines in revenues due to program closures and decreased contributions. Not only does this present significant operational challenges for not-for-profit organizations, it presents financial reporting considerations as well.

At each annual and interim reporting period, accounting standards require management to evaluate whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern.

What process should a not-for-profit management team follow in this evaluation?

Step 1: Are there conditions or events, considered in the aggregate, that raise substantial doubt about the not-for-profit entity’s ability to continue as a going concern within one year after the date the financial statements are issued (or are available to be issued)?

Substantial doubt exists when it is probable(1) that the not-for-profit entity will be unable to meet its obligations as they become due within one year after the date the financial statements are issued or available to be issued.

Management’s evaluation of whether substantial doubt is raised should not take into consideration management’s plans that have not been fully implemented (e.g., plans to borrow money, sell assets, etc., that have not already been completed at the time of management’s evaluation).

What are some considerations for management as they evaluate whether substantial doubt exists under the current environment?

• Management’s evaluation is required to include all conditions or events that are “known or reasonably knowable” at the date the financial statements are issued or available to be issued.
• As COVID-19-related conditions and events are evolving rapidly, management needs to monitor these conditions and events up to the date the financial statements are issued or available to be issued.
• This may require management to refresh evaluations that may have taken place weeks ago.

Management should prepare an analysis showing their current liquidity and cash flow projection for the upcoming year to assist in this evaluation.

How should a not-for-profit’s cash flow forecast be factored into this section of their going concern assessments?

• Due to the uncertainty related to COVID-19, in many cases, the ability to accurately forecast cash flows may be severely limited. Thus, in circumstances where there is considerable uncertainty in future projections, it may be difficult for management to place a heavy reliance on their projection for their conclusion.
• In some situations, to meet or exceed the probable threshold, worst-case-scenario cash flows are likely the required starting point until there is more clarity regarding the course of COVID-19 and its impact on the not-for-profit’s operations

Based on the analysis prepared, if management concludes that substantial doubt does NOT exist regarding the not-for-profit entity’s ability to continue as a going concern, no disclosures are required specific to going concern uncertainties.

Based on the analysis prepared, if management concludes that substantial doubt does exist, Step 2 is required.

Step 2: Consider management’s plans intended to mitigate the adverse conditions or events. Is it probable that management’s plans will be effectively implemented?

What are some considerations for management as they evaluate their plans?

When evaluating whether their plans are probable, management should first consider what is under their control (i.e., not dependent on third parties, need to consider whether approval by the board of directors may be required):

• Cash on-hand
• Ability to borrow from unrestricted/quasi endowment funds
• Borrowing capacity (not-for-profits must understand their lenders’ ability to: prevent borrowings on lines of credit, require accelerated repayment due to covenant violations and/or subjective acceleration/material adverse change clauses, etc.)
• Ability to eliminate or defer cash payments, sell assets to generate cash (if not restricted due to lending or other agreements), etc.
• Ability to accelerate pledge payments or payments from other significant contributors or funders
• Ability to raise additional capital from related parties, etc.

If it is probable that management’s plans will mitigate the conditions or events that raised substantial doubt, the not-for-profit should disclose information to help the users of the financial statements understand management’s plans by disclosing the following:

1. The conditions or events that raised the substantial doubt before consideration of management’s plans
2. Management’s evaluation of the significance of those condition or events
3. Management’s plans that alleviated the substantial doubt

If it is not probable that management’s plans will mitigate the substantial doubt, in addition to disclosing the three items noted above, the not-for-profit should also include in the notes to the financial statements a statement indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or available to be issued).

The evaluation described above will take additional time and significant judgment. We encourage not-for-profits to begin discussions with key stakeholders, auditors and boards of directors early in the evaluation process. Depending upon the not-for-profit’s specific facts and circumstances, it may be prudent for management to consider asking for financial reporting extensions allowing them more time to assess the impact of COVID-19 and their plans to mitigate that impact.

For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.

(1) Not-for-profits need to understand the definition of probable. Under ASC 205-40-20, probable is defined as, “The future event or events are likely to occur.” In terms of probabilities, think of probable as 75% +/- 5% to 10%