First Class Telecommunications Inc. (“FCT” or “the Company”) is a leading regional wireless telecommunications service provider in the United States serving approximately 3 million wireless customers in markets in small cities and rural areas covering parts of seven states in the Midwest and Northeast. In addition to providing wireless service to subscribers (i.e., customers), the Company also sells cell phones. The Company has two operating segments: retail (selling of cell phones) and services (providing wireless service). See Appendix A for financial highlights and excerpts from a draft of FCT’s 2012 Form 10-K.

In addition, the entity has debt totaling $200 million. The debt has financial covenants as well as a material adverse change clause, which if triggered may result in the lender demanding full payment of all outstanding amounts. See Appendix B-1 for the audit team’s debt compliance memo and Appendix B-2 for management’s calculation of the actual covenant ratio calculation as of December 31, 2012, as well as the projected covenant ratio calculations for each of the quarter-ends in FY2013.

Finally, before the annual assessment of goodwill performed at year-end, FCT had goodwill of $230 million recorded on its books. As of the testing date, the team is not aware of any events or circumstances that would have resulted in an impairment of goodwill since the December 31, 2011, assessment. During the annual goodwill impairment analysis as of December 31, 2012, the Company did not elect the option of performing a Step 0 assessment of goodwill under ASC 350-20-35, but rather elected to start with the Step 1 approach discussed in ASC 350-20-35-4. The Company determined both segments passed the first step of the goodwill impairment test. Refer to Appendix C for excerpts of the valuation analysis provided to the audit team directly from management’s third-party valuation firm, VALU.

Required: 1. Read and consider the information in Appendixes A through C. What events or conditions may cause substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time?

2. Assuming the events or conditions identified in Question 1 cause the audit team to believe substantial doubt exists about FCT’s ability to continue as a going concern for a reasonable period of time, what are the next steps the audit team needs to perform?

3. Upon completing the steps in (2) above, the engagement team obtained additional information from management included in Appendix D. Read and consider this information and determine what type of audit evidence the audit team may consider obtaining, or what type of audit procedures it may perform, to confirm or dispel whether there is substantial doubt about FCT’s ability to continue as a going concern for a reasonable period of time?

4. After considering identified conditions and events and management’s plans, assume that the audit team concluded that as of December 31, 2012, there is not substantial doubt about FCT’s ability to continue as a going concern for a reasonable period. What are the audit team’s responsibilities regarding its consideration of the Company’s ability to continue as a going concern during its review of the Company’s interim financial information for the three months ended March 31, 2013?

PROFESSOR’S DISCUSSION MATERIALS Objective of the Case

This case allows students the opportunity to consider the level of judgment involved

when determining the appropriateness of an entity’s use of the going-concern assumption in preparing its financial statements.

Applicable Professional Pronouncements

ASC 470-10, Debt: Overall (ASC 470)

PCAOB AU Section 341, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern (PCAOB AU Section 341)

PCAOB AU Section 722, Interim Financial Information (PCAOB AU Section 722)

Securities Laws

Section 10A of the Securities Exchange Act of 1934 (as amended by the 1995 Private Securities Litigation Reform Act) requires that audits include “an evaluation of whether there is substantial doubt about the ability of the issuer to continue as a going concern during the ensuing fiscal year.”

Professor’s Note: The FASB has an ongoing project relating to going concern and issued an exposure draft for public comment on June 26, 2013. Under the proposal, management would be required to perform interim and annual assessments of an entity’s ability to continue as a going concern within 24 months of the financial statement date. An entity would have to disclose uncertainties about such ability if (1) it is “more likely than not” (MLTN) — that is, a likelihood of more than 50 percent

— that it will not be able to meet its obligations within 12 months of the financial statements or (2) if it is “known or probable that the entity will be unable to meet its obligations within 24 months after the financial statement date.” The proposed ASU applies to all entities; however, a public entity would also have to assess whether there is “substantial doubt” about its ability to continue as a going concern and provide specific disclosures if that threshold is met. Comments on the proposal are due by September 24, 2013. The FASB Staff is drafting a proposed Accounting Standards Update. Note that this case does not take into consideration the FASB’s proposed new standard. See www.fasb.org for additional and updated information about this project.

This case does not make reference to the auditing standards issued by the Auditing Standards Board (ASB), because the company in the case is a public company and accordingly, the applicable standards are the standards of the Public Company Accounting Oversight Board (PCAOB). The PCAOB has indicated that it intends to issue an exposure draft of a proposed standard to amend PCAOB AU Section

341 once the FASB publishes its exposure draft. See www.pcaobus.org for additional and updated information about this project, including the discussion at the PCAOB’s Standing Advisory Group on November 9-10, 2011.

Additionally, it should be noted that the ASB recently revised its auditing standards addressing going concern as part of its clarity project, and issued AU-C Section 570

The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern to supersede AU Section 341. In finalizing AU-C Section 570, the ASB elected to defer convergence efforts with International Standard on Auditing (ISA) 570, Going Concern, until further action is taken by the FASB. The revisions proposed were editorial in nature, the most significant of which was to include within the standard (rather than the introductory paragraph) the 12-month horizon for evaluating whether an entity has the ability to continue as a going concern. The ASB may make further revisions to its standards once the FASB’s project is complete. Continue to visit the www.aicpa.org for current updates on the status of this project.

Discussion 1

Read and consider the information in Appendixes A through C. What events or conditions may cause substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time?

Solution 1

PCAOB AU Section 341 paragraph 02 states:

 

Paragraph .05 of AU Section 341 provides examples of auditing procedures that may identify such conditions and events :

Professor’s Note: The statement of cash flows (SOCF) includes critical information that auditors refer to when (1) assessing a company’s ability to meet its cash obligations as

the obligations become due and (2) evaluating a company’s ability to continue as a going concern. However, cash flow information is intentionally left out of these case materials because the focus of this case is on other key areas of the going-concern assessment. Therefore, students should not assume the SOCF was not referred to when evaluating FCT’s ability to continue as a going concern, rather the SOCF did not contain any information that would question the Company’s ability to continue as a going concern for a reasonable period of time.

Discussion 2

Assuming the events or conditions identified in Discussion 1 cause the audit team to believe substantial doubt exists about FCT’s ability to continue as a going concern for a reasonable period of time, what are the next steps the audit team needs to perform?

 

 

 

Solution 2

Discussion 3

Upon completing the steps in Discussion 2, the engagement team obtained additional information from management included in Appendix D. Read and consider this information and determine what type of audit evidence the audit team may consider obtaining, or what type of audit procedures may the audit team perform, to confirm or dispel whether there is substantial doubt about FCT’s ability to continue as a going concern for a reasonable period of time?

Solution 3

Discussion 4

After considering identified conditions and events and management’s plans, assume that the audit team concluded that as of December 31, 2012, there is not substantial doubt about FCT’s ability to continue as a going concern for a reasonable period. What are the audit team’s responsibilities regarding its consideration of the Company’s ability to continue as a going concern during its review of the Company’s interim financial information for the three months ended March 31, 2013?

Solution 4

 

Professors Note: If the audit team concluded there is substantial doubt about FCT’s ability to continue as a going concern for a reasonable period, it must also consider the effects on the Company’s financial statement disclosures and the audit opinion. PCAOB AU 341.10-.11 state:

.10 When, after considering management's plans, the auditor concludes there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, the auditor should consider the possible effects on the financial statements and the adequacy of the related disclosure. Some of the information that might be disclosed includes—

•      Pertinent conditions and events giving rise to the assessment of substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time.

•      The possible effects of such conditions and events.

•      Management's evaluation of the significance of those conditions and events and any mitigating factors.

•      Possible discontinuance of operations.

•      Management's plans (including relevant prospective financial information).fn 3

•      Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

.11 When, primarily because of the auditor's consideration of management's plans, he concludes that substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time is alleviated, he should consider the need for disclosure of the principal conditions and events that initially caused him to believe there was substantial doubt. The auditor's consideration of disclosure should include the possible effects of such conditions and events, and any mitigating factors, including management's plans.

In addition, the audit team must also modify its standard audit opinion to include an explanatory paragraph after the opinion paragraph to address the fact the auditor concluded there is substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time. PCAOB AU 341.13 includes an example explanatory paragraph. The audit team must also consider if the disclosures the Company included in its financial statements are adequate (PCAOB AU 341.14).

Fellow the PROFESSOR’S DISCUSSION MATERIALS and answer 5 case questions for 5 pages.

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