AUDITING

Going Concern
 GOING CONCERN
• Under the going concern assumption, an entity is
viewed as continuing in business for the foreseeable
future.
• General purpose financial statements are prepared
on a going concern basis, unless (a) management
either intends to liquidate the entity or (b) to cease
operations, or (c) has no realistic alternative but to do
so.
• “Going concern” may not be relevant for “special
purpose frameworks” i.e. tax framework.
Going concern concept is one of the accounting principles that states that a business entity
will continue running its operations in the foreseeable future and will not be liquidated or
forced to discontinue operations for any reason
• When the use of the going concern assumption is
appropriate, assets and liabilities are recorded on the
basis that the entity will be able to realize its assets
and discharge its liabilities in the normal course of
business.
• Public sector entities: (a) lacks funding for continued
existence or (b) when policy decisions are made that
affect the services provided by the public sector entity
Advantages and Disadvantages of Going Concern Concept
Advantages:
• Businesses buy assets with expectations of reaping benefits from them for a very
long time. In line with this objective, the going concern concept will allow to correctly
record the value of such assets.
• This concept serves as the basis for recording the profits and losses for an
accounting period.
• It also facilitates the identification and splitting of all the assets and liabilities into
short and long-term.
Disadvantages:
• Financial reports show the assets at cost and not at the current market rate due to
the going concern concept. But, in the case of liquidation, the financial statements
are on the basis of their current market value. However, these numbers would be
very different from the ones at cost.
• Any sudden change in the law could affect the going concern status of a firm. In such
a case, the business would have to drastically change its accounting.
Ques: Who is responsible for determining whether a company is going concern?
• While many would assume that determining whether a company is going concern or
not is the auditor’s responsibility, in actual fact, it is management’s responsibility to
assess the company’s ability to move forward as a going concern.
• ISA 570 states 3 factors that management must consider to determine whether or not
an entity can prepare its financial statements on the going concern basis of accounting:
1. The degree of uncertainty associated with the outcome of an event/condition increases
significantly the further into the future an event or condition or the outcome occurs.
2. The entity’s size, complexity, nature and condition of its business and the degree to
which it is affected by external factors affect the judgement regarding the outcome of
events or conditions.
3. Any judgement about the future is based on information available at which the
judgement is made.
What are the responsibilities of the auditor?
• Under ISA 570, the auditor’s responsibility is to obtain sufficient and appropriate audit
evidence regarding management’s use of the going concern basis of accounting in the
preparation of the financial statements. In addition, auditors need to report in accordance
with ISA 570 (revised) when issuing the auditor’s report.
• Here are some indicators of going concern risk that auditors should look out for during a
company’s financial statement audit:
• Strategic conditions – such as a company’s lack of a clear strategic plan or reliance on a
small number of customers/suppliers
• Liquidity conditions – such as the trend of declining cash and negative cash flows
• Financial reporting conditions – such as the inability to provide a short-term cash
forecast or providing financial information which is not considered consistent with
historical or industry information
• Adverse changes in the environment, market position or operation conditions – such as
the emergence of highly successful competitors or the shortage of important suppliers
• Potential implications of going concern on the auditor’s report
• There are various potential implications to the auditor’s report that auditors must
consider depending on which one of the following scenarios the auditor encounters:
• Where the use of the going concern basis by management is deemed
inappropriate– that is, management has prepared the financial statements on a
going concern basis when in reality these should have been prepared on an
alternative basis, and therefore the auditor shall issue an adverse opinion
• Where the use of the going concern basis is appropriate, but there exists a material
uncertainty – the auditor shall express an unmodified opinion and include a
separate section under ‘Material uncertainty related to going concern’ within the
auditor’s report; this shall include the events or conditions that may cast doubt on
the entity’s ability to continue as a going concern
• Where a material uncertainty exists and the financial statements are materially
misstated due to inadequate disclosure – the auditor shall express a qualified
opinion/adverse opinion (as appropriate) in accordance with ISA 705 (revised) and
state that a material uncertainty exists that may cast significant doubt on the entity’s
ability to continue as a going concern.
• Management unwilling to make or extend its assessment – The auditor may express
a qualified opinion/disclaimer of opinion in the auditor’s report, as appropriate.
 ASSESSMENT
• International Accounting Standard (IAS) 1 requires
management to make an assessment of an entity’s
ability to continue as a going concern.
• Management will make a judgment (professional
judgment), at a particular point in time (year end),
about inherently uncertain future outcomes (next 12
months) of events or conditions.
• Subsequent events may result in outcomes that are
inconsistent with judgments that were reasonable at
the time they were made (going concern assessment
may change).
 AUDITOR’S RESPONSIBILITY
When performing risk assessment procedures the
auditor shall consider whether there are events or
conditions that may cast significant doubt on the entity’s
ability to continue as a going concern.
• The auditor shall determine whether management
has already performed a preliminary assessment.
• If assessment has been made, auditor will discuss
with management what are the doubts to continue as
going concern, and how these will be addressed.
• If an assessment has not been made, auditor will ask
management to do so (if there is any doubt)
 EVENTS CREATING DOUBT
• Net liability or net current liability position.
• Fixed-term borrowings approaching maturity
• excessive reliance on short-term borrowings to finance
long-term assets.
• Negative operating cash flows
• Adverse key financial ratios.
• Substantial operating losses or significant
deterioration in value of assets
• Inability to pay creditors on due dates.
• Inability to comply with the terms of loan agreements.
 DOUBTS (2)
• Change from credit to cash-on-delivery with suppliers.
• Inability to obtain financing for essential new product
development or other essential investments
• Non-compliance with capital / statutory requirements.
• Pending legal or regulatory proceedings against the
entity that may, if successful, result in claims that the
entity is unlikely to be able to satisfy.
• Changes in law or regulation or government policy
expected to adversely affect the entity.
• Uninsured or underinsured catastrophes when they occur
 ASSESSMENT
• The auditor shall determine whether management has
already performed a preliminary assessment of the
entity’s ability to continue as a going concern.
• If not, the auditor will request management to make the
assessment
• The ‘doubts’ can be mitigated. i.e., unable to make normal
debt repayments may be counter-balanced by alternative
means, i.e. by disposing of assets, rescheduling loan
repayments, or obtaining additional capital.
• Similarly, the loss of a principal supplier may be mitigated
by the availability of a suitable alternative source of
 CONCLUSION
DOUBT ASESSMENT

Material Uncertainty
No
Mitigate
mitigation

Matter of Emphasis Adverse Opinion