OVERVIEW
Objective
¾
To explain the auditor’s responsibilities for the going concern assumption used in preparation of financial statements.¾ Essential procedure
¾ Indicators of significant doubt ¾ Mitigating factors
¾ Throughout the audit
PLANNING CONSIDERATIONS
AUDIT EVIDENCE
¾ Essential procedure ¾ IAS 1 definition
¾ Management’s responsibility ¾ Auditor’s responsibility
¾ Evaluating management’s
assessment
¾ Sources of information ¾ Beyond the assessment period ¾ Additional procedures
RESPONSIBILITIES
CONCLUSIONS
¾ Basic principle ¾ Disclosure
REPORTING
1
RESPONSIBILITIES
1.1
Essential procedure
The auditor should consider the appropriateness of management’s use of the going concern assumption .
1.2
IAS 1
Presentation of Financial Statements
Definition
. . . enterprise will continue in
operation for the future Generally a period of at least 12 months from the end of the reporting period
. . . assume neither intention nor necessity (eg no realistic
alternative) to liquidate or cease trading
Management must assess entity’s ability to continue as a going concern
If assumption justified If unjustified
¾ Assets will be realised and liabilities discharged in normal course of business
¾ Amounts recorded in respect of assets may not be realised ¾ Amounts and maturity dates of
liabilities may need adjustment.
Accounting requirements
¾
Financial statements should be prepared on a going concern basis unless that basis is inappropriate.¾
Material uncertainties which cast significant doubt on the appropriateness of the going concern basis should be disclosed.¾
When the going concern basis is not used the financial statements should disclose: that fact;
the basis of preparation;
why the enterprise considered not to be a going concern.
1.3
Management’s responsibility
1.4
Auditor’s responsibility
¾
To consider: management’s use of the going concern assumption; whether material uncertainties require disclosure.
2
PLANNING CONSIDERATIONS
2.1
Essential procedure
Events or conditions which may cast doubt on the enterprise’s ability to continue as a going concern should be considered when planning the audit.
¾
Management may have already made a preliminary assessment of going concern issues and plans to address them. For example: raise capital;
increase borrowings; restructure debt;
defer capital expenditure; liquidate assets.
¾
If not, management should be asked to make an assessment, particularly if such events and conditions are apparent.¾
Management’s assessment may not require detailed analysis when the enterprise is profitable and has adequate financial resources.2.2
Indicators of significant doubt
Example 1
Give examples of financial, operational and other events or conditions which, individually or collectively, may indicate significant doubt about the going concern assumption.
Solution
Financial
Operational
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¾
¾
Other
¾
¾
¾
2.3
Mitigating factors
¾
Management’s plans to maintain adequate cash flows by alternative means Disposal of assets
Rescheduling of loan repayments Obtaining additional capital.
¾
Availability of a suitable alternative source of supply.2.4
Throughout the audit
The auditor should keep alert to such events and conditions and, if identified:
¾
perform additional procedures¾
re-assess components of audit risk (as necessary ).3
AUDIT EVIDENCE
3.1
Evaluating management’s assessment
Management’s assessment should be evaluated for the same period as required by the financial reporting framework. This should be extended to at least 12 months from the end of the reporting period (if greater).
3.2
Sources of information
¾
Client’s system for timely identification of warnings of risks/uncertainties.¾
Budgets, forecast information, etc.¾
Obligations, undertakings, guarantees with lenders, suppliers, etc.¾
Bank borrowing facilities and suppliers’ credit.3.3
Beyond the assessment period
The auditor should inquire of management if they have knowledge of indicators of
significant doubt beyond the period of assessment (i.e. at least 12 months from the end of the reporting period).
¾
This is the only audit procedure required in respect of this period. It provides a good example of a “certain instance” in which it is appropriate to obtain written management representation.3.4
Additional procedures
When there are indicators of significant doubts, the auditor should:
¾
review management’s plans for future actions and obtain written representation thereon;¾
gather sufficient appropriate evidence to determine whether or not a material uncertainty exists.3.4.1
Material uncertainty
A material uncertainty exists when the magnitude of its potential impact is such that its disclosure is necessary for the fair presentation of the financial statements.
3.4.2
Cash flow forecasts
¾
When analysing and discussing cash flow and profit forecasts with management, consider: reliability of the entity’s system for generating such information appropriateness of underlying assumptions
comparison of prospective financial information
−
for recent prior periods with historical results−
for current period with results achieved to date.3.4.3
Other relevant procedures
¾
Review subsequent events for items affecting going concern assumption.¾
Analyse and discuss latest available interim financial statements.¾
Confirm existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assess the financial ability of such parties to provide additional funds.¾
Consider unfilled customer orders.¾
Discuss management’s plans for future action : to liquidate assets
to borrow money or restructure debt to reduce or delay expenditures to increase capital.
¾
Seek written management representations regarding plans that might have a significant effect on solvency within the foreseeable future.4
CONCLUSIONS
4.1
Basic principle
The auditor should judge whether material uncertainty exists.
4.2
Disclosure requirements where material uncertainty exists
¾
Description of principal events or conditions raising substantial doubt; management’s plans.
¾
Statement that there is material uncertainty, therefore entity may be unable to realize assets and discharge liabilities in normal course of business.5
REPORTING
Example 2
For each of the six situations set out below:
(a) suggest an appropriate audit report modification (if any); and (b) state the grounds for such a modification.
Situations
(1) Based on the audit evidence obtained there is no material uncertainty. (2) The going concern assumption is appropriate but material uncertainty
exists which is adequately disclosed.
(3) As for (2) but adequate disclosure is not made.
(4) The going concern assumption is inappropriate but the financial statements have been prepared on a going concern basis.
(5) The going concern assumption is inappropriate and the financial statements have been prepared on an alternative basis, which is adequately disclosed.
(6) Management does not make an assessment for a period of at least 12 months from the end of the reporting period when asked to do so.
Solution
Audit report modification
Grounds
(1)
(2)
(3)
(4)
(5)
¾
The circumstances set out in (1) to (5) can be summarised as follows:5.1 Basis appropriate 5.2 Material
uncertainty
5.3 Basis inappropriate
¾
Sufficient evidence to support theassumption
¾
Disclosure required(see 4.2)
¾
Basis used is:⇒ do not modify report (assuming any
mitigating factors adequately disclosed)
Adequate
⇒ unqualified with EMPHASIS
OF MATTER
Illustration 1
Inadequate
⇒ qualified or adverse
opinion
Illustration 2
Going concern
⇒ Adverse opinion Alternative ⇒ unqualified with EMPHASIS OF MATTER
Standards in ISA 570 specifically address situations (2) – (6).
Illustration 1
“Without qualifying our opinion we draw attention to Note X in the financial statements which states that the Company incurred a net loss of xxx during the reporting period ended December 31 20X1 and, as of that date, the Company's current liabilities exceeded its total assets by xxx. These conditions, along with other matters as set out in Note X, indicate the existence of a material uncertainty which may cast significant doubt about the Company’s ability to continue as a going concern.”
Illustration 2 Inadequate disclosure
⇒
Qualified opinion
“The Company’s financing arrangements expire and amounts outstanding are payable on [date]. The Company has been unable to re-negotiate or obtain replacement financing. This situation indicates the existence of a material
uncertainly which may cast significant doubt on the Company’s ability to continue as a going concern and therefore it may be unable to realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do not disclose this fact.
¾
An adverse opinion should be expressed when the financial statements as a whole do not give a true and fair view (or fairly present) the financial position (e.g. ifmanagement were considering ceasing to trade or filing for bankruptcy).
¾
Note that if a company is not a going concern, an adverse opinion should be expressed if the financial statements are prepared on a going concern. This is irrespective of any disclosure made.Commentary
“Inappropriate accounting treatments are not rectified by disclosure of the accounting policies used or by notes or explanatory materials” IAS 1 Presentation of Financial Statements.
FOCUS
You should now be able to:
¾
define and discuss the significance of the concept of going concern;¾
explain the importance of and the need for going concern reviews;¾
explain the respective responsibilities of auditors and management regarding going concern;EXAMPLE SOLUTION
Solution 1 — Indicators of significant doubt
Financial
¾
Net liability/net current liability position¾
Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment¾
Withdrawal of financial support¾
Negative operating cash flows¾
Excessive reliance on short-term borrowings to finance long-term assets¾
Adverse key financial ratios¾
Substantial operating losses¾
Arrears or discontinuance of dividends¾
Inability to pay creditors on due dates¾
Difficulty in complying with the terms of loan agreements¾
Change from credit to cash-on-delivery transactions with suppliers¾
Inability to obtain financing for essential new product development or other essential investments.Operational
¾
Loss of key management without replacement¾
Loss of a major market, franchise, license, or principal supplier¾
Labour difficulties or shortages of important supplies.Other
¾
Non-compliance with capital or other statutory requirements¾
Pending legal proceedings against the entity that may, if successful, result in judgments that could not be metSolution 2 — Audit report modifications
Audit report modification
Grounds
(1) Unmodified (i.e. unqualified without
emphasis of matter) None
(2) Unqualified with emphasis of matter Significant uncertainty
(3) Qualified “except for” or
Adverse (if matter is pervasive)
Disagreement
(4) Adverse Disagreement
(5) Unmodified or
Unqualified with emphasis of matter
None for qualification
(6) Qualified “except for” or
Disclaimer (if matter is pervasive)
