It is essential that candidates preparing for the Advanced Audit and Assurance exam have a thorough understanding of the respective responsibilities of auditors and management regarding going concern. The going concern review can require significant judgement to be applied and the impact of external factors, such as significant global events, can make the assessment of management’s going concern review challenging. Further, recent corporate failures have brought the auditor’s review of going concern back into focus.
This article discusses the auditor’s responsibilities, as well as the indicators which could highlight where an entity may not be a going concern and the reporting aspects relating to going concern.
ISA 570 (Revised) Going Concern, contains well-established guidance on going concern, including the following objectives for the auditor:
All audits should involve an assessment of the appropriateness of management’s use of the going concern basis of accounting, and it is obvious to say that the auditor may well have to perform additional procedures when there are heightened risks relating to going concern, caused by difficult economic and market conditions or specific industry considerations affecting the company. But going concern should be considered at all stages of the audit, not just in terms of specific procedures, and the auditor is required to remain alert to events or conditions which may cast significant doubt on the company’s ability to continue as a going concern. This requires the auditor to exercise high levels of professional judgement.
In the exam it is important to remember that going concern is therefore not just something considered at a particular stage in the audit cycle, but should be an issue that permeates the whole performance and review of an audit.
Auditors should consider going concern indicators and their impact on a particular audit when:
Paragraph A3 of ISA 570 provides good examples of financial, operational and other indicators which may individually or collectively cast significant doubt on the entity’s ability to carry on as a going concern. This is where the auditor’s judgement is critical as it is not conclusive that one or more of these items always signifies that a material uncertainty exists.
Auditors are required by ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment, to gain an understanding of the audit client's business and the economic environment in which it operates. This understanding should then lead to the identification of business risks, which are then evaluated in terms of any risks of material misstatement in the financial statements.
Business risks include risks that could reduce the company's profit and/or cash inflows, and could ultimately mean that either a company is not a going concern, or that there are significant doubts over its ability to continue as a going concern. Identification of this heightened risk at this initial stage in the audit cycle means that additional audit procedures can be planned as a response to the specific risks identified.
All of this means that the auditor must gain a detailed understanding of the environment in which a company is operating, and more specifically, an understanding of the particular market conditions affecting its operations. Risks can arise from many factors, including reduced demand for goods and services, customers' inability to pay for goods and services already provided, an inability to raise necessary finance and the need and renewal of specific operating licences. Such factors must be assessed for their specific impact on a company's operations. It is important to remember that difficult economic or market conditions do not automatically mean that a material uncertainty exists about a company's ability to continue as a going concern but these must be considered by the auditor in order to gain a full understanding.
The evaluation of business risks should lead to the assessment of specific financial statement risks. For a company facing going concern difficulties, the fundamental financial statement risk is whether the financial statements have been prepared on the correct basis of accounting, or whether any significant uncertainties have been disclosed in the financial statements. However, there are more specific financial statement risks including:
Where risks, such as the ones mentioned above, have been identified, the auditor must respond to the risks by designing and performing appropriate audit procedures. Clearly the procedures should address the specific risks identified, and so extra procedures may be needed on many balances and transactions such as the ones outlined above.
More generally, audit procedures are necessary in order to evaluate how the key management personnel have satisfied themselves that it is appropriate to adopt the going concern basis in preparing the financial statements. Procedures should include:
Paragraph A16 of ISA 570 contains examples of additional procedures that may be used.
Analysis of cash flow is usually a key feature of any going concern evaluation. In this evaluation the auditor should pay particular attention to the reliability of the company's systems for generating the cash flow information, and whether the assumptions underlying the cash flow appear reasonable, applying professional scepticism and challenging those assumptions where needed.
In evaluating going concern, the auditor will consider whether necessary borrowing facilities are in place and in doing so will attempt to obtain confirmations from the company's bankers. However, the bankers may be reluctant to confirm whether the borrowing facilities will be available, in which case the auditor should consider the significance of this to the entity's ability to continue as a going concern, and also consider, through discussion with management, whether there are other strategies or sources of finance available.
In forming the audit opinion, the auditor should consider two issues: have the financial statements been prepared using the appropriate basis of accounting and is there adequate disclosure of any material uncertainty regarding going concern.
First, the auditor may conclude that management's use of the going concern basis is inappropriate. This means that the financial statements are effectively rendered meaningless, and ISA 570 requires the auditor to express an adverse opinion on the financial statements.
In rare circumstances, where the financial statements have not been prepared under the going concern basis of accounting (for example, using a liquidation basis), and the auditor agrees with the use of this alternative basis for the preparation of the financial statements, the audit opinion may be unmodified. This is so long as the auditor has also concluded that there is adequate disclosure in the financial statements regarding the basis of accounting. However, the auditor may consider it necessary to include an Emphasis of Matter paragraph in accordance with ISA 706 (Revised) Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report, to draw the user’s attention to the alternative basis of accounting and the reasons for its use.
It is much more likely that the auditor concludes that the level of disclosure in relation to material uncertainties is inadequate rather than concluding that the going concern basis of accounting is wholly inappropriate. ISA 570 contains detailed guidance in this area, which is briefly summarised below:
In situations where entity’s are facing significant economic or operational pressure, auditors may find themselves being asked by audit clients to perform non-audit services which may create self-review or advocacy threats to objectivity or which would involve assuming management responsibilities For example for a client who is suffering financial pressure and is seeking to raise additional or alternative finance or restructure, the audit firm may be asked to perform:
The problem created is that the audit firm may not be able to objectively assess going concern factors when in addition becoming involved with non-audit services pertaining to the going concern status of the company. The audit firm should carefully consider the appropriateness of providing such non-audit services in these circumstances.
Safeguards may be able to reduce the threats to objectivity and independence to an acceptable level. Safeguards may include:
Auditors must be extra vigilant in relation to the audit of going concern matters, and should also remember the possible ethical implications of being involved in non-audit services relevant to going concern. Going concern is an area which should be front and centre of every audit and evidence must be challenged with the appropriate level of professional scepticism.
Written by a member of the AAA examining team