ACCA Paper F8

AUDIT AND INTERNAL REVIEW INTERNATIONAL STREAM

Autumn 2008 Lecture 6

Application of the Going Concern Concept to Audits.

DATE: Spring 2008

TUTOR:

ISA 570 GOING CONCERN

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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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2 Continued Trading loss

1 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

1 Inability to pay debts as and when due

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1 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.

1 Examine orders received and contracts signed

1 Holding company or bank support.

Directors support.

Audit Procedures (Tests) For Going Concern:

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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.

1 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.

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– 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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2 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.

1 If in the auditor’s judgement the entity will not be able to continue as a going
concern, the auditor should express an adverse opinion if the financial statements
have been prepared on a going concern basis.

1 If disclosure in the financial statement regarding going concern is inadequate

then issue a qualified audit opinion based on disagreement.

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 London School of Business and Finance 2007 Page of 7 7