ISA 570 (Revised) Going Concern

ISA 570 (Revised) Going Concern

Overview of the standard:

IAS 1 Presentation of Financial Statements (requirement):

The underlying assumption of an entity’s accounts using IFRS is presumed to be a going concern, ie assets and liabilities split into current and non-current portions, with measurement according to IFRS such as historical cost, net realisable value or fair value.

However, if it is not a going concern entity, break up basis should be applied. There will be no non-current assets or liabilities, ie only current portions remain. Besides, assets are measured at liquidated value. Discontinued operations should also be presented.

Going concern is where the entity will continue in business for the foreseeable future (at least 12 months after the current Financial Statements year end), and:

1. Not intend to cease trading or liquidating; and

2. Not in a situation where the business has to cease trading or liquidating.

Responsibilities of management and auditors:

Management’s responsibility per IAS 1

Auditor’s responsibility per ISA 570

Evaluate whether the business can continue at least 12 months after the reporting date.

If the business is not a going concern entity, proper accounting treatment, presentation such as discontinued operations, and disclosures about break up basis accounting should be made correctly.

Evaluate the appropriateness of management’s assumption that the business is a going concern, ie review cash budgets prepared by client for the upcoming 12 months’ operations.

Consider auditor’s report implications.

Disclose material uncertainties in the accounts properly.

Perform audit procedures to confirm whether material uncertainties exist and whether there are events casting doubt over client’s going concern status, ie review subsequent events.

Be professionally sceptical about any events or conditions which may cast significant doubt on entity’s ability to continue as a going concern.

Audit procedures – to determine whether material uncertainty(ies) exist:

At interim audit stage

Look for conditions and events which cast doubt on client's going concern status.

Ways: Inspect board minutes; Calculate ratios; Review strategic, financial and other indicators.

At final audit stage

If those conditions and events remain, perform audit procedures to determine whether material uncertainties exist.

Strategic indicators:

Key management left;

Shortage of vital supplies or labour;

Lost major market, or a very successful competitor emerged;

Franchise or other licensing agreements can not be renewed.

Inspect board minutes for discussion of such matters, ie whether they have plans to deal with these matters.

Inspect subsequent events to look for any improved situations.

Financial indicators:

Profitability - continue to suffering from losses

Liquidity - negative cash balance; poor liquidity ratios; significant reliance on short term liability; overdraft can not be renewed; can not find the replacement loan; not comply with loan covenants; can not make loan payments on time.

Profitability:

Inspect forecasted P/L and interim accounts to confirm whether situation has improved.

Liquidity:

Inspect cash flows forecast, bank letters to confirm overdrafts which can not be renewed, or

alternative loans; loan contracts for repayment dates.

Inspect management plans (board minutes) to look for available ways to reduce or delay paying cash, ie reducing overheads, or

to extend the loan period; and plans to increase cash inflows such as additional financing options such as debt, equity issue, sale of assets such as non-core assets.

Other indicators:

Non-compliance with law;

New regulation affecting client's operations;

Pending legal cases which may have a significant impact on client;

Natural disasters

Inspect board minutes for discussion of such matters, ie whether they have plans to deal with these matters.

Inspect subsequent events to look for any improved situations.

Audit report implications:

Situation 1: Whether there is material uncertainty?

1. Yes (material uncertainty), with adequate disclosure – Unqualified opinion, with Material Uncertainty Regarding Going Concern paragraph.

2. Yes (material uncertainty), without adequate disclosure:

If this is a material uncertainty – qualified opinion

If this is a significant material uncertainty (such as where client is seriously considering filing a bankruptcy) – adverse opinion

3. No – unmodified audit report

4. Yes (material uncertainty indicators), but were subsequently resolved by management – known as ‘Close Call’, ie unqualified opinion, however, this matter shall be included in the ‘Key Audit Matter (KAM)’ paragraph.

The KAM paragraph usually includes: description of the matter; reference to management’s explanation; reasons why this is a KAM; how the matter was audited by auditors. The KAM paragraph does not mean audit opinion is qualified.

Situation 2: Client has to cease trading, ie client HAS TO prepare accounts under ‘Break up’ basis:

1. If client did not prepare accounts under ‘break up’ basis – Adverse opinion.

2. If client prepared accounts under ‘break up’ basis:

Made adequate disclosure about change in preparation basis – unqualified opinion + Emphasis of matter paragraph.

Did not make adequate disclosure – Qualified opinion.

Situation 3: There are many material uncertainties (strategic, financial and other indicators):

Disclaimer opinion – irrespective or whether adequate disclosures are made regarding material uncertainties.

Situation 4: Auditors have doubts over whether management could continue the operation in the foreseeable future (let’s say 12 months), auditors require management to extend the assessment (prepare additional budgets), however, management declines:

1. If this is only material – Qualified opinion.

2. If this is material and pervasive – Disclaimer of opinion.

Ethical considerations:

Non-audit services may be provided by audit firm to the client	Threats to objectivity
Review restructuring choices or advice on corporate finance choices (these two are Corporate Financial Services).	Advocacy threat to objectivity – audit firm is seen to promote client’s position and negotiate on behalf of client.
Prepare cash flows forecasts or profits forecasts.	Management threat to objectivity – potential lawsuit if client suffers from losses; Self review threat to objectivity – as firm may have challenges to question client that the forecasted target could not be met in the following year.
Review cash flows forecasts or profits forecasts (prospective financial information).	Self review threat to objectivity – as firm may have challenges to question client that the forecasted target could not be met in the following year.
Attend meeting together with banks to ask for additional funding for client.	Advocacy threat to objectivity – audit firm is seen to promote client’s position and negotiate on behalf of client. If client is in deep financial trouble, it is best not to attend such meetings. If attending such meetings: Audit firm is permitted to suggest different options such as negotiate with bank to lower interest rates (move group deposit in this bank; compare interest rates with other competitor banks). Audit firm is not allowed to simply promote client such as guaranteeing client has money to repay to banks.

General safeguards to reduce threats to objectivity:

Perform Engagement Quality Control Review on the engagement.

Obtain written confirmation from client that they remain responsible for any management decisions made for any non-audit services.

Use an independent audit partner to review the going concern assessment and conclusion to confirm this is reasonable.

Exam rehearsal question

Which of the following represents an indicator which may cast doubt over the going concern status of a company?

(1) A significant decrease in the gearing ratio

(2) The loss of a major customer

(3) Taking the full credit period available before paying suppliers

(4) A change from credit to cash on delivery terms by suppliers

A 1 and 2 only

B 1, 2 and 4

C 1, 3 and 4

D 2 and 4 only

Answer: D

Option 1 was an incorrect answer, if the gearing ratio had increased rather than decreased then this could be a going concern indicator. Option 2 was correct, losing a major customer could lead to reduced sales and cash flows. Option 3 was incorrect, taking the full credit period given by suppliers is sensible business practice and not an indicator of cash flow problems. Option 4 was correct, if a company is struggling to pay for its goods, suppliers can refuse to supply any further goods or require cash at the point of delivery. The correct answer was D, options 2 and 4. The most common incorrect answer given was B which included correct options 2 and 4 but also option 1.

Exam rehearsal question

Which of the following statements, relating to the auditor’s reporting responsibilities for going concern, if any, is/are correct?

(1) Where management is unwilling to make their assessment of the company’s ability to continue as a going concern, the auditor should include an emphasis of matter paragraph in the audit report

(2) Where the use of the going concern assumption is inappropriate, the auditor should include a qualified opinion in the audit report

A 1 only

B 2 only

C Both 1 and 2

D Neither 1 nor 2

Answer: D

If management are unwilling to make their assessment of going concern this would result in a modified opinion with a qualified or disclaimer opinion. If the going concern basis is not appropriate, then an adverse opinion should be provided rather than a qualified opinion as the matter is material and pervasive.

Exam rehearsal question

It is 1 July 20X5. You are an audit supervisor of Y & Co and have been assigned responsibility for completing the detailed going concern testing for Z Co for the year ended 30 April 20X5. Z Co’s audit should be finalised and the financial statements signed by 30 September 20X5. Management’s assessment of Z Co’s ability to continue as a going concern covers the period to 30 November 20X5.

Which of the following actions should Y & Co take in relation to Z Co’s going concern assessment?

A. Request that management extends the assessment period to 30 September 20X6

B. Request that management extends the assessment period to 30 April 20X6

C. Perform additional audit procedures to confirm Z Co’s going concern status

D. Review management’s assessment to 30 November 20X5 and only request that it is extended if it raises doubt that Z Co is a going concern

Answer: B

This question examines knowledge of ISA 570 Going Concern. However it also demonstrates the need to be able to apply the principles to a practical scenario. ISA 570 requires that in evaluating the entity’s ability to continue as a going concern the auditor must cover the same period as that used by management to make its assessment. If management’s assessment covers a period of less than twelve months from the date of the financial statements the auditor is required to request management to extend its assessment period. In this case the auditor must request that management extend the assessment period to 30 April 20X6. Performing additional audit procedures would not resolve the fact that the assessment period is not as required by ISA 570, therefore option C is not an appropriate response in this instance.

Exam rehearsal question

A & Co is the auditor of Z Co for the year ended 31 December 20X8. The detailed audit work is due to be completed by 30 June 20X9. The directors are planning to approve the financial statements on 31 July 20X9 and then issue them to the shareholders on 15 August 20X9. The management of Z Co has performed an assessment of the company’s ability to continue as a going concern based on a cash flow forecast prepared to 31 December 20X9.

To which date must A & Co’s assessment cover when evaluating management’s assessment of Z Co’s ability to continue as a going concern?

A. 30 June 20X9

B. 31 July 20X9

C. 15 August 20X9

D. 31 December 20X9

Answer: D

As with the previous question, this question requires detailed knowledge, in this case of ISA 570 Going Concern. However, it also demonstrates the need to be able to apply knowledge to a practical scenario. In accordance with ISA 570, the auditor is required to review the same period as that used by management to determine whether the going concern basis is appropriate. This must be at least 12 months from the end of the reporting period. The management of Z Co has used a cash flow forecast for 12 months to December 20X9. As this is at least 12 months from the end of the reporting period, this is date to which A & Co’s assessment must cover.

Exam rehearsal question

Which of the following statements summarise the auditor’s responsibilities in relation to going concern?

(1) Evaluate management’s assessment of the entity’s ability to continue as a going concern.

(2) Determine whether or not an entity can prepare its financial statements using the going concern basis of accounting.

(3) Remain alert throughout the audit for events or conditions which may cast significant doubt on the entity’s ability to continue as a going concern.

(4) Obtain evidence to determine whether a material uncertainty exists if events are identified which may cast doubt on the entity’s ability to continue as a going concern.

A 1, 3 and 4 only

B 1, 2 and 4 only

C 2 and 3 only

D 1, 2 3 and 4

Answer: A

Candidates are reminded to ensure that they understand the different between the auditor’s and management responsibilities in relation to going concern and to ensure that they understand the requirements set out in ISA 570 Going Concern. Statement 2, which relates to determining the basis on which the financial statements should be prepared, is a management responsibility.

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Categories: : Audit and Assurance (AA)