Audit of going concern assumption

 Going concern basis of accounting

Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future.

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. The financial statements should be prepared on a going concern basis unless management either intends to liquidate the entity or has no realistic alternative but to do so.

When management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it shall disclose the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.

The objectives of the auditor regarding the going concern basis of accounting are:

· To obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements.

· To conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern; and

· To report in accordance with the appropriate ISA.

 Responsibilities of the management

Some financial reporting frameworks contain a requirement for management to make a specific assessment of the entity’s ability to continue as a going concern.

Management’s assessment of the entity’s ability to continue as a going concern involves making a judgment, at a particular point in time, about inherently uncertain future outcomes of events or conditions. The following factors are relevant to that judgment:

·     The degree of uncertainty which increases further into the future an event/condition/outcome occurs.

·      Size and complexity of the entity.

·      Nature and condition of the business.

·     Judgement about the future is based on information available at the time the judgement is made but subsequent events may result in inconsistent outcomes.

If, during their assessment, management become aware of material uncertainties related to events or conditions that may cast significant doubt on the entity's ability to continue as a going concern, then those uncertainties must be disclosed in the financial statements.

Responsibilities of the auditors

The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements, and to conclude based on the audit evidence obtained whether a material uncertainty exists about the entity’s ability to continue as a going concern.

 Audit procedures applied in performing going concern reviews.

Specific audit procedures the auditor might carry out to test going concern principle could include the following:

·        Analyze the entity`s cash flow, profit.

·     Perform the ratio analysis to compare the current year results with the similar results of the previous periods.

·     Analyze and discuss the entity's latest available interim financial statements (or management. accounts).

·     Review the terms of debentures and loan agreements and determine whether they have been breached.

·       Read minutes of the meetings of shareholders, the board of directors and important committees for reference to financing difficulties.

·       Enquiry of the entity's lawyer regarding litigation and claims.

·      Confirm the existence, legality, and enforceability of arrangements to provide or maintain financial support with related and third parties.

·        Assess the financial ability of such parties to provide additional funds.

·        Consider the entity's position concerning unfulfilled customer orders.

·       Review events after the period end for items affecting the entity's ability to continue as a going concern.

·        Confirm the existence, terms, and adequacy of borrowing facilities.

·        Obtaining and reviewing reports of regulatory actions.

·        Determining the adequacy of support for any planned disposals of assets.

·        Calculate the entity net assets value.

·      Obtain a written representations in support of audit evidence obtained regarding management’s plans for future actions in relation to its going concern assessment.

   Events or conditions that may cast doubt about the going concern assumption (potential indicators that an entity is not a going concern)

There exist some examples of events or conditions that may cast doubt about the going concern

assumption. These events or conditions are sometimes referred to as going concern indicators and fall under three headings: 'financial', 'operating' and 'other'.

Financial

• Net liability or net current liability position.

• Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short-term borrowings to finance long-term assets.

 • Indications of withdrawal of financial support by creditors.

• Negative operating cash flows indicated by historical or prospective financial statements.

• Adverse key financial ratios.

• Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.

• Arrears or discontinuance of dividends.

• Inability to pay creditors on due dates.

• Inability to comply with the terms of loan agreements.

• Change from credit to cash-on-delivery transactions with suppliers.

• Inability to obtain financing for essential new product development or other essential investments

 Operating

·        Management intentions to liquidate the entity or to cease operations.

·        Loss of key management without replacement.

·        Loss of a major market, key customer(s), franchise, license, or principal supplier(s).

·        Labor difficulties.

·        Shortages of important supplies.

·        Emergence of a highly successful competitor.

 Other

·       Non-compliance with capital or other statutory or regulatory requirements, such as solvency or liquidity requirements for financial institutions.

·        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.

Additional audit procedures when events or conditions that may cast doubt about the going concern assumption are identified.

If events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, the auditor should obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists related to these events or conditions. Audit evidence may be obtained by performing following procedures:

·        Requesting management to make its assessment where this has not been done.

·        Evaluating management's plans for future action.

·        Evaluating the reliability of underlying data used to prepare a cash flow forecast and considering the assumptions used to make the forecast.

·      Considering whether any additional facts or information have become available since the date management made its assessment.

·      Requesting written representations from management and those charged with governance about plans for future action and the feasibility of these plans.

 Material uncertainty in the context of going concern assumption.

The term “material uncertainty” is used in IAS 1 in discussing the uncertainties related to events or conditions which may cast significant doubt on the entity’s ability to continue as a going concern that should be disclosed in the financial statements. In some other financial reporting frameworks, the phrase “significant uncertainty” is used in the same situations.

The auditor shall conclude whether a material uncertainty exists related to events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern. A material uncertainty exists when the magnitude of its potential impact and likelihood of occurrence is such that, in the auditor’s judgment, appropriate disclosure of the nature and implications of the uncertainty is necessary for the fair presentation of the financial statements or the financial statements not to be misleading.

Risk of material misstatement of the financial statements relating to going concern assumption

The risk of material misstatement relating to going concern assumption is the risk that the financial statements may be materially misstated due to:

·        Management’s use of the going concern basis of accounting in the preparation of the financial statements is inappropriate, or

·      Inadequate disclosure in the financial statements of material uncertainty related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, or

·       Omission of disclosure in the financial statements of a material uncertainty related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, or

·        Omission of disclosure of the basis on which the financial statements are prepared and the reason the entity is not regarded as a going concern (if the entity is not going concern and management prepared the financial statements on another basis (e.g., liquidation basis)).

Implications for the auditor’s report relating to going concern.

 The possible scenarios that could arise following the auditor's review of going concern are presented below:

(a)   Management’s use of the going concern basis of accounting in the preparation of the financial statements is inappropriate.

If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the financial statements is inappropriate the auditor expresses an adverse opinion.

(b)   The use of the going concern basis of accounting is not appropriate in the circumstances and management prepares the financial statements on another basis (e.g., liquidation basis).

In this situation the auditor expresses an unmodified opinion and includes an Emphasis of Matter paragraph in audit report provided there is adequate disclosure about the basis of accounting on which the financial statements are prepared.

(c)    Material uncertainty exists and disclosure in the financial statements is adequate.

If Material uncertainty exists and disclosure in the financial statements is adequate, an auditor’s report containing an unmodified opinion and a separate section under the heading “Material Uncertainty Related to Going Concern.”

(d)   Material uncertainty exists and that the financial statements are materially misstated due to inadequate disclosure.

An auditor’s report containing a qualified opinion when the auditor has concluded that a material uncertainty exists and that the financial statements are materially misstated due to inadequate disclosure.

(e)    Material uncertainty exists and the financial statements omit the required disclosures relating to material uncertainty.

An auditor’s report containing an adverse opinion when the auditor has concluded that a material uncertainty exists, and the financial statements omit the required disclosures relating to a material uncertainty.

(f)    Management unwilling to make or extend Its assessment.

In certain circumstances, the auditor may request management to make or extend its assessment of the entity’s ability to continue as a going concern. If management is unwilling to do so, a qualified opinion or a disclaimer of opinion in the auditor’s report may be appropriate.