Application of the Going Concern Concept to Audits.
ISA 570 GOING CONCERN
Actions that an auditor should carry out to try and ascertain whether an entity is a going concern:-
“During planning and performing audit procedures and in evaluating the results the auditors should consider the appropriateness of management assumptions when preparing the financial statements of the enterprise”
Since financial statements are prepared on the assumption of going concern, it is essential for the auditor to give positive consideration to the applicability of the going concern basis at the planning stage and throughout the audit. Risk evaluation and findings during the audit may uncover indicators of going concern problems:
Operational problems:
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Continued Trading loss1 Forced reduction in operation 1 Loss of key suppliers or customers 1 Litigation with customers and suppliers 1 Increased competitions
1 Dependence on one product.
Financial problems:
1 Net current liabilities
1 Funding operations from overdue VAT/PAYE 1 Excess borrowing to finance daily obligations 1 Loan defaults
1 Cancellation of capital projects
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Inability to pay debts as and when due1 Refusals to renew/extend overdraft limits
Personnel problems:
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2 Loss of key personnel
1 Prolonged industrial disputes
If the above indicators are detected, the auditor should seek evidence to support the going concern assumption.
The evidence includes:-
1 Profit and cash flow projection covering the period at least 12 months from the date the directors approve the financial statements.
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Examine orders received and contracts signed 1 Holding company or bank support.Directors support.
Audit Procedures (Tests) For Going Concern:
ISA 570 requires that the auditor, when forming an opinion as to whether financial statements gives a true and fair view should consider the entity’s ability to continue as a going concern and make any relevant disclosure in the financial statements.
Audit Procedures:
1 Assess the adequacy of the means by which the directors have satisfied themselves that the adoption of the going concern basis is appropriate.
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Examine all relevant evidences available to support the going concern status. 1 Review the director’s business review and their assessment of the future. 1 Assess the systems or other means by which the directors have identified warnings of future risks and uncertainties.1 Examine budgets and other future plans and assess the reliability of such budgets by references to past performances.
1 Examine management accounts and other reports of recent activities.
1 Obtain confirmation of existing bank borrowing facilities and suppliers credits. 1 Review the board minute for any discussion of going concern matters.
1 Enquire of the director’s plan for resolving any issue that may threaten the going concern of the company.
1 Consider obligations undertakings guarantee with lenders, suppliers and group companies for giving or receiving support.
2 Review management’s plans for future actions based on its going concern assessment.
– Gather additional sufficient and appropriate audit evidence to confirm whether or not a material uncertainty exists regarding the going concern concept.
– Seek written representations from management regarding its plans for future action.
– Obtain information from company bankers regarding continuance of loan facilities. – Review receivables ageing analysis to determine whether there is an increase in days – which may also indicate cash flow problems.
Audit procedures if the company is not considered to be a going concern
– Discuss the situation again with the directors. Consider whether additional disclosures are required in the financial statements or whether the financial statements should be prepared on a ‘break up’ basis.
– Explain to the directors that if additional disclosure or restatement of the financial statements is not made then the auditor will have to modify the audit report.
– Consider how the audit report should be modified. Where the directors provide adequate disclosure of the going concern situation, then an emphasis of matter paragraph is likely to be appropriate to draw attention to the going concern disclosures.
– Where the directors do not make adequate disclosure of the going concern situation then qualify the audit report making reference to the going concern problem. The qualification will be an ‘except for’ opinion or an adverse opinion depending on the auditor’s opinion of the situation.
Impact on the audit report:
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Based on the audit evidence obtained, the auditor should determine if in his judgement a material uncertainty exists related to events or conditions that alone or in aggregate may cast significant doubt on the entity’s ability to continue as a going concern.1
If there is a “significant level of concern” but company is still a going concern, then issue an unqualified audit report but with explanatory paragraph in the basis of opinion section. Highlight the existence of material uncertainty relating to the event or condition that may cast significant doubt on the entity’s ability to continue as going concern and draws attention to the note in the financial statement that discloses the matter.1 If adequate disclosure is not made in the financial statements the auditor should express a qualified or adverse opinion as appropriate. The report should include reference to the fact that there is a material uncertainty that may cast significant doubt about the entity’s ability to continue as a going concern.