Navigating the Going Concern Assessment: A Dual Responsibility of Management and Auditors
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The going concern assumption is a cornerstone of financial reporting, underpinning the preparation of financial statements with the expectation that an entity will continue its operations into the foreseeable future. This article explores the shared responsibilities of management and auditors in assessing and reporting on going concern, as outlined in ISA 570 ‘Going Concern’ and IAS 1 ‘Preparation of Financial Statements’.
Understanding the Going Concern Assumption
Under the going concern basis, financial statements are prepared with the presumption that the entity will not liquidate or cease operations. IAS 1 mandates this assumption unless management intends to liquidate the entity or has no realistic alternative but to do so. ISA 570 further guides auditors in evaluating the appropriateness of this assumption and ensuring that any material uncertainties are adequately disclosed.
Who Is Responsible?
A common misconception is that auditors are solely responsible for assessing going concern. In reality, the primary responsibility lies with management who must conduct the assessment, make appropriate disclosures, and justify the use of the going concern basis. Auditors, on the other hand, evaluate the process followed by management, assess the adequacy of disclosures, and determine the impact on the audit opinion.
ISA 570 clarifies that the going concern assessment is a two-step process involving both management and auditors. Management must assess the company’s ability to continue operating and disclose any uncertainties. Auditors must then evaluate this assessment and determine whether it is reasonable and adequately supported.
Management’s Role and Procedures
Management must consider all relevant facts and circumstances for at least 12 months from the reporting date. Key procedures include:
- Preparing budgets and cash flow forecasts
- Analysing borrowing facilities and financial performance
- Assessing business risks and subsequent events
The complexity of the assessment depends on the size and nature of the entity. Larger, more complex entities may require more formal and detailed assessments, while smaller entities may rely on simpler methods. Regardless of size, all entities must ensure that their assessments are integrated with their ongoing business planning and risk management processes.
If management identifies substantial doubt about the entity’s ability to continue, they must develop mitigation plans. These may include cost-cutting measures, raising capital, restructuring debt, or seeking strategic partnerships. The effectiveness of these plans must be evaluated in terms of timing and magnitude relative to the identified risks.
Disclosure Scenarios
Management’s disclosures vary depending on the outcome of the assessment:
- No Going Concern Issues: No specific disclosures are required beyond stating that the financial statements are prepared on a going concern basis.
- Close Call Situations: Management must disclose the uncertainties and explain why they do not constitute a material uncertainty.
- Material Uncertainty Exists: Detailed disclosures are required, including the nature of the uncertainty and management’s mitigation plans.
- Going Concern Not Assumed: Financial statements must be prepared on a break-up basis, with appropriate disclosures explaining the rationale.
These scenarios help stakeholders understand the financial health of the entity and the assumptions underlying the financial statements.
Auditor’s Responsibilities
Auditors must assess going concern throughout all audit stages:
- Planning: Identify risks and evaluate management’s assessment
- Execution: Gather evidence, test assumptions, and assess disclosures
- Conclusion: Determine the impact on the audit opinion
ISA 570 outlines indicators that may cast doubt on going concern, including financial stress, operational disruptions, and legal or regulatory challenges. Auditors must also consider post-reporting period events under IAS 10, which may affect the going concern status.
Auditors are required to obtain sufficient appropriate audit evidence to support their conclusions. This includes evaluating management’s forecasts, assumptions, and mitigation plans. Auditors must also consider whether management’s assessment covers the appropriate period and includes all relevant information.
Impact on the Audit Report
The audit opinion depends on the presence and adequacy of disclosures:
- Unmodified Opinion: Issued when no material uncertainty exists or when it exists but is adequately disclosed.
- Qualified Opinion: Issued when a material uncertainty exists but disclosures are inadequate.
- Adverse Opinion: Issued when the financial statements are materially misstated due to the going concern issue.
- Emphasis of Matter: Used when financial statements are prepared on a break-up basis, to highlight the alternative accounting basis.
These opinions provide transparency to users of the financial statements and help maintain trust in the audit process.
Conclusion
The going concern assessment is a complex, judgment-driven process that requires close collaboration between management and auditors. In practice, the going concern assessment is influenced by both internal and external factors. For example, the COVID-19 pandemic highlighted the importance of robust going concern assessments, as many businesses faced unprecedented challenges. Entities must be proactive in identifying risks and developing contingency plans.
Auditors must remain vigilant and exercise professional skepticism, especially when management’s assumptions appear overly optimistic. They must also ensure that their conclusions are well-documented and supported by evidence. Transparent disclosures and robust procedures are essential to uphold the integrity of financial reporting and maintain stakeholder confidence. By understanding their respective roles and responsibilities, both parties can contribute to more reliable and informative financial statements.
