Audit completion

1 Introduction

Until the auditor’s report is signed, the auditors have an active duty to look for evidence or events that might alter their opinion on the financial statements

This chapter deals with:

• Subsequent events
  

• Going concern
  

• Written representations
  

2 Subsequent events

2.1 Introduction

Imagine that a set of financial statements has been produced for the year to 31/12/20X4 and then on 15/1/20X5, the company has a really bad day:

• A customer who owed $250,000 as at 31/12/20X4, and who has paid nothing subsequently, goes into liquidation with little chance of creditors receiving anything;
  

• The company’s factory burns down.
  

How should these events be treated in the financial statements?

2.2 Adjusting and non-adjusting events

The rule is that if the event provides evidence about the state of affairs that existed at the period end date, then the event is an adjusting event: the amounts in the statement of profit or loss and statement of financial position must be changed to take account of the event.

Otherwise the event is a non-adjusting event. No adjustments are made to the statement of profit or loss and statement of financial position, but if material the matter should be disclosed in notes to the financial statements.

Therefore the treatment of the two incidents outlined above will be:

• The customer who went into liquidation must have been in a poor state at the year end and the debt was to all intents and purposes irrecoverable then. Going into liquidation gives evidence about the debt’s valuation as at 31/12/20X4. Therefore, write down the debt as at 31/12/20X4.
  

• The factory destruction happened 15/1/20X5, but the factory was perfectly ‘fine’ and existed on 31/12/20X4. This is a non-adjusting event. Because it is so serious, a note would be added to the financial statements disclosing the fire and its financial impact.
  

2.3 Auditor’s responsibility

Until the auditor’s report is signed (ie the auditor has fulfilled his duty to report) the auditor has an ‘active’ duty to consider subsequent events. The auditor must obtain sufficient appropriate audit evidence to ensure that events after the reporting date have been:

• Identified (both adjusting and non-adjusting)
  

• Appropriately reflected in the financial statements (adjusted or disclosed).
  

Audit procedures must include:

• Inquiring of management whether any such events have occurred
  

• Reading minutes of board meetings
  

• Obtaining written representation that all such events have been adjusted or disclosed.
  

Additional procedures may be considered necessary. For example, making specific inquiry of the client’s lawyer about developments in a legal case since the year end.

3 Going concern

Financial statements are normally prepared on a going concern basis: the entity is expected to continue operating, rather than liquidate or cease trading. Under examinable ISA 570 (Revised 2024), the auditor evaluates management’s assessment and asks management to extend it if it covers less than twelve months from the date the financial statements are approved. This audit assessment horizon can be longer than twelve months from the year end.

If there is doubt about whether the going concern assumption is valid, then this should be disclosed in a note in the financial statements.

If it looks inevitable that the organisation will soon fail, then the financial statements should be drawn up on a break-up basis.

Indicators of going concern problems include:

• Negative operating cash flows
  

• Operating losses
  

• Borrowing facilities not renewed or extended
  

• Poor liquidity ratios (such as a low current ratio)
  

• High gearing
  

• Taking longer to pay suppliers
  

• Loss of key personnel
  

• Loss of key customers
  

• Technological advances
  

• Legal and regulatory changes
  

• Bad publicity
  

It is management’s responsibility when preparing the financial statements to review the company’s going concern position and the auditor must audit management’s conclusions.

Audit work will include:

• Evaluate management’s assessment, including the method, assumptions, data and any changes from the previous period.

• Obtain forecasts covering at least twelve months from approval of the financial statements, check their calculations and challenge sales, costs, cash receipts, funding and other assumptions. Compare forecasts with later actual performance and consider plausible downside scenarios.

• Review cash flows, liquidity, interest cover and gearing; inspect loan terms, maturities, covenant compliance and correspondence with bankers.

• Evaluate whether management’s plans to raise finance, sell assets or reduce expenditure are feasible, whether management intends to implement them and whether it has the ability to do so.

• Ask about events beyond the assessment period that may cast significant doubt; discuss significant matters with those charged with governance and evaluate disclosures.

• Obtain written representations supporting management’s use of the basis, the assessment and related disclosures, and any plans for future action. They support but cannot replace other evidence.

4 Written representation

This is a letter sent by management to the auditor, just before the auditor signs the auditor’s report. It is an essential piece of audit evidence.

The auditor must obtain written representations to confirm the responsibilities of management (and those charged with governance):

• That they have properly prepared and presented the financial statements
  

• That they have provided complete information to the auditor.
  

• That all transactions have been recorded.
  

Other representations may be required to support other audit evidence. But they cannot substitute for other audit evidence. For example:

• All knowledge or suspicion of fraud has been disclosed to the auditor.
  

• All known actual or possible litigation and claims have been disclosed to the auditor and properly accounted for.
  

• All subsequent events have been adjusted or disclosed as required.
  

• Plans for future actions relevant to management’s assessment that the entity is a going concern.
  

These examples illustrate how written representations support the assertion of completeness.