Going concern - Procedures for reviews

Learning Outcomes

After reading this article, you will be able to explain the purpose of a going concern review, identify key indicators of going concern issues, outline the audit procedures required, and describe how the auditor should respond and report in cases of significant concern. You will be prepared to answer ACCA-style exam questions on going concern review procedures.

ACCA Foundations in Audit (FAU) Syllabus

For ACCA Foundations in Audit (FAU), you are required to understand the key elements of reviewing going concern as part of audit completion. Revision should ensure you are able to:

• Define and explain the significance of the going concern principle
• Recognise financial and operational indicators suggesting going concern difficulties
• Describe audit procedures to assess management’s going concern conclusions
• Explain how the auditor should respond when significant doubt exists about going concern
• Identify required disclosures and reporting implications when material uncertainties are present

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following would NOT usually be considered an indicator of going concern problems?
   1. Overdue loan repayments
   2. Loss of a key supplier
   3. Consistent profit growth
   4. Outstanding unpaid tax liabilities
2. When reviewing going concern, what period must management consider?
   1. At least 6 months from the reporting date
   2. At least 12 months from the reporting date
   3. No fixed period required
   4. Until the next reporting date
3. What is the auditor’s duty if a significant material uncertainty relating to going concern exists and adequate disclosure is included in the financial statements?
   1. Issue an unmodified opinion with a material uncertainty paragraph
   2. Refuse to issue any report
   3. Automatically express an adverse opinion
   4. Ignore the uncertainty

4. List three procedures an auditor should perform when assessing going concern.

Introduction

Auditors are required to evaluate whether financial statements are prepared on the appropriate basis. The going concern basis—assuming the entity will continue operations for the foreseeable future—is fundamental. However, if events or conditions cast doubt on the entity’s ability to continue, auditors must take specific steps at the review stage. A clear, robust approach to going concern helps ensure confidence in published financial statements and is a frequent topic in ACCA exams.

Key Term: going concern
The assumption that an entity will continue its operations for at least twelve months from the reporting date and will not liquidate or cease trading.

Indicators of Going Concern Problems

Auditors must remain alert to warning signs that may call the going concern basis into question. These can arise at any time during the engagement but are formally reviewed near completion.

Common financial indicators include:

• Net current liabilities (more short-term debts than short-term assets)
• Overdue loan repayments or breaches of borrowing covenants
• Severe or recurring operating losses
• Reliance on short-term finance without clear renewal
• Negative operating cash flows and inability to pay debts as they fall due

Operational and other warning signs include:

• Loss of a major customer, market, or supplier
• Intentions to cease trading, restructuring, or liquidate
• Pending legal or regulatory action that threatens viability
• Difficulty renewing key insurance or credit arrangements

Worked Example 1.1

A company’s year-end accounts show significant net losses, negative cash flows, and a demand from its main lender for immediate loan repayment. What should the auditor do?

Answer:

• Note these as significant going concern indicators.
• Perform specific procedures (see next section) to assess management’s plans for resolving the position and confirm the viability of the going concern basis.
• Evaluate disclosures and discuss with management the impact on the financial statements.

Audit Procedures for Going Concern Reviews

If indicators of going concern risk exist, the auditor must perform targeted procedures to obtain sufficient, appropriate evidence about the entity’s ability to continue in operation.

Key audit steps include:

• Enquire of management about their assessment, future plans, and intended actions
• Review latest budgets, forecasts, and future cash flow projections, considering their assumptions
• Read minutes of directors’ and management meetings for evidence of financial or operational plans and risks
• Examine terms of loan agreements, checking for breaches, and correspondence with lenders regarding extensions or support
• Review events occurring after the reporting date such as asset sales, new borrowings, or financing
• Obtain written representations from management regarding plans and intentions

Key Term: material uncertainty
A situation where events or conditions create significant doubt about the entity’s ability to continue as a going concern, and their outcome cannot be predicted with reasonable certainty.

Auditor’s Response if Significant Uncertainty Exists

When the review indicates that a material uncertainty exists, the auditor must:

• Assess whether management’s use of the going concern basis is still appropriate given the facts
• Confirm that disclosures describing the uncertainty are adequate and not misleading
• Consider the effect on the auditor’s report

If, after the review:

• The going concern basis is still appropriate and disclosures in the financial statements clearly set out the risks and uncertainties, the auditor issues an unmodified opinion but includes a “Material Uncertainty Related to Going Concern” paragraph.
• Disclosures are inadequate, the auditor must issue a qualified (‘except for’) or adverse opinion, as failure to disclose is a material misstatement.
• The going concern basis is not appropriate, the auditor should express an adverse opinion due to misapplication of the financial reporting framework.

Worked Example 1.2

Management has prepared cash flow forecasts supporting going concern, but there is a high risk that customers will not pay and a major loan is due for renewal with no commitment from the bank. Management discloses these risks in the notes. What should the auditor do?

Answer:

• Evaluate the reasonableness of management’s cash flow assumptions and plans.
• Confirm that uncertainties are clearly disclosed in the notes.
• Add a Material Uncertainty Related to Going Concern paragraph in the auditor’s report, drawing attention to the relevant disclosures.

Exam Warning

It is not correct to state that the auditor decides whether the entity is a going concern. The auditor only assesses whether management’s use of the going concern basis is appropriate and whether adequate disclosure has been made.

Revision Tip

Prepare a concise checklist of common going concern indicators and the core audit procedures to verify management’s plans.

Summary

Auditors must evaluate going concern by identifying warning indicators, applying relevant review procedures, and assessing management’s plans and disclosures. Where significant uncertainty remains, the auditor should ensure transparent disclosure and reflect this in the audit report as required.

Key Point Checklist

This article has covered the following key knowledge points:

• Define the going concern concept and explain its importance in audit
• Identify typical financial and operational indicators of going concern problems
• List and describe audit procedures for reviewing going concern
• Explain the actions an auditor must take where significant uncertainty exists
• Describe the reporting implications of inadequate or adequate going concern disclosures

Key Terms and Concepts

• going concern
• material uncertainty