It is essential that candidates preparing for the Audit and Assurance (AA) exam understand the respective responsibilities of auditors and management regarding going concern. This article discusses these responsibilities, as well as the indicators that could highlight where an entity may not be a going concern, and the reporting aspects relating to going concern.
Among other syllabus requirements, candidates must ensure they are aware of the respective responsibilities of auditors and management regarding going concern. The provisions in ISA 570, Going Concern deal with the auditor’s responsibilities in relation to management’s use of the going concern basis of accounting in the preparation of the financial statements.
An entity prepares financial statements on a going concern basis when, under the going concern assumption, the entity is viewed as continuing in business for the foreseeable future. The term ‘foreseeable future’ is not defined within ISA 570, but IAS 1®, Presentation of Financial Statements deems the foreseeable future to be a period of at least 12 months from the end of the reporting period.
The concept of going concern is an underlying assumption in the preparation of financial statements, hence it is assumed that the entity has neither the intention, nor the need, to liquidate or curtail materially the scale of its operations. If management conclude that the entity has no alternative but to liquidate or curtail materially the scale of its operations, the going concern basis cannot be used and the financial statements must be prepared on a different basis (such as the ‘break-up’ basis).
The concept of going concern is particularly relevant in times of economic difficulties and in some situations management may determine that a profitable company ple because of significant cash flow difficulties. It is important that candidates understand that it is the responsibility of management to make an assessment of whether the use of the going concern basis of accounting is appropriate, or not, when they are preparing the financial statements.
In order to conclude as to whether, or not, an entity is able to continue in business for the foreseeable future, management will have to make judgments on various uncertain future outcomes of events or conditions. ISA 570 outlines three factors that are relevant and which management must take into consideration when determining whether, or not, an entity can prepare the financial statements on the going concern basis:
The degree of uncertainty associated with the outcome of an event or condition increases significantly the further into the future an event or condition or the outcome occurs. For that reason, most financial reporting frameworks that require an explicit management assessment specify the period for which management is required to take into account all available information.
The size and complexity of the entity, the nature and condition of its business and the degree to which it is affected by external factors affect the judgment regarding the outcome of events or conditions.
A past exam question, for eight marks, required candidates to: ‘Identify any potential indicators that the company is not a going concern and describe why these could impact upon the ability of the company to continue trading on a going concern basis.’
The scenario presented to candidates gave an abundance of warning signals that management’s assessment of going concern may not be appropriate in the circumstances. These warnings signals were: