The Auditor’s Report 2: Going concern

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1 Going concern

If a material uncertainty exists which is adequately disclosed in the financial statements, the auditor is required to draw attention to the related disclosure in a separate section of the auditor's reported headed ‘Material Uncertainty Related to Going Concern’.

For example:

Generally if the directors or the auditors think the company might not survive into the foreseeable future there is a going concern problem. ‘Foreseeable future’ is not defined but under IFRS it should not be less than 12 months from the end of the accounting period. UK GAAP (FRS 102) specifies that is should not be less than 12 months from the date of approval of the financial statements.

Remember: It is for management to make an assessment of an entity’s ability to continue as a going concern. The auditor’s responsibilities are to obtain sufficient appropriate audit evidence, conclude and report.

If the notes do not disclose the going concern uncertainty, the auditor must express a modified opinion because inadequate disclosure means that there is an element of the financial statements that is not 'presented fairly'.

If there is no realistic possibility of the company surviving the financial statements should be drawn up on a break-up basis and, if not, the audit opinion will most likely be adverse (see Illustration in the last section of the next chapter).

2 Indicators of going concern uncertainty

Signs that the company may have going concern difficulties include the following:

• Negative operating cash flows.
  

• An inability to pay suppliers when due (and auditors are usually rather sensitive if the company is borrowing more from its suppliers).
  

• Operating losses. These do not mean that the company is going to fail immediately; going concern tends to be rather more concerned with cash. An operating loss can be sustained for a number of years provided that cash doesn’t run out. In the longer term, losses usually result in cash flow problems.
  

• If the borrowing facilities are coming to an end and the new ones haven’t been agreed, what’s the company going to do to repay the loan, when no cash is available?
  

• The loss of key staff or key customers can mean the company is unable to trade or unable to sell its products.
  

• Technology changes can render the company’s purpose and main product redundant.
  

• Legislative changes may mean that the company’s operations become illegal or the company has to go through some sort of regulatory requirements before it can continue trading and that this is going to be difficult for it.
  

• Non-compliance with regulations may mean a business loses its right or license to trade and in such a case the company may simply have to be wound up. Non-compliance can also result in crippling penalties and harmful damage to the organisation’s reputation.
  

3 Audit work on going concern uncertainty

This can consist of:

• Evaluating management’s plans for future actions in relation to its going concern and whether the outcome of these plans are feasible and likely to improve the situation.
  

• Where the entity has prepared a cash flow forecast:
  

  • Evaluating the reliability of the underlying data generated to prepare the forecast; and
    

  • Determining whether there is adequate support for the assumptions underlying the forecast.
    

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

• Requesting written representations from management and, where appropriate, those charged with governance, regarding their plans for future actions and the feasibility of these plans.

4 Interaction between KAMs, MURGC and EoM

• Inevitably, if there are going concern doubts then dealing with these will have been a key audit matter for the auditor, but it is very important to realise that going concern issues are reported only ONCE in the auditor’s report. The rules are:
  

  • If the auditor concludes that there is material uncertainty with regard to going concern which is adequately disclosed, a MURGC section must be included in the auditor’s report but will NOT be referred to again in the KAM section.
    

  • If the auditor had been worried about going concern but concludes that in fact, no material uncertainty exists , there will clearly be no MURGC section, but it may be included as a KAM, if it meets the definition of a KAM.
    

• If what is regarded as a key audit matter is disclosed in the notes to the financial statements, the KAM does not need to repeat that information but must refer to the relevant note.
  

• If an item is communicated in the KAM paragraph, the auditor does not also include it in an EoM paragraph.
  

Remember: A KAM is a key AUDIT matter. So it is possible that there could be some matter which is fundamental to users’ understanding of the financial statements, which was not a KAM. In this case, an EoM paragraph refers the user to an issue that is adequately disclosed in the financial statements. (If not adequately disclosed, the audit opinion must be qualified.)

Here is an example of an emphasis of matter:

Note that the financial statements do contain a note explaining the effects of the fire. The financial statements are therefore as comprehensive and as open as they can be. But obviously, the fire has operational and financial implications and to understand the company's position (e.g. its ability to pay dividends next year), the users of the financial statements need to be aware of this.

5 Conclusion

This is easy: matters that might give rise to a KAM, a material uncertainty as to going concern or to an emphasis of matter paragraph appear once and once only in any auditor’s report.