Question

Question 4 [20 marks]
Going concern assumption is an important fundamental principle in the preparation of financial statements. Therefore the auditor must take particular attention of this assumption as he carries out his audit.

Required:
a. What is going concern? (5)
b. How does an auditor identify going concern factors and what is its effect on the audit on the audit report? (15)

Answer 1

a. The going concern assumption is a basic assumption for the accounting of a business entity. For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, and objectives. In other words, the company will not have to liquidate or be forced out of business. The important aspect is that there should be no intent to close down or lower down the operations in the foreseeable future. If there is uncertainty as to a company's ability to meet the going concern assumption, the facts and conditions must be disclosed in its financial statements. The disclosure is required only when there is a doubt regarding the fulfilment of going concern assumption.

b. FACTORS TO BE CONSIDERED:

The auditor must evaluate the management's assessment regarding the going concern. The assessment must include all those factors that the auditor is aware during the audit, the assessment must cover at least 12 months of the period from the date of the financial statements.

The auditor must also consider the following factors in deciding if there is substantial doubt about an entity’s ability to continue as a going concern:

• Negative trends in operating results (such as a series of losses)

• Loan defaults by the business entity

• Denied trade credit to the company by its suppliers

• Uneconomical long-term commitments to which the business entity is subjected

• Legal proceedings against the business entity

EFFECT ON AUDIT REPORT:

The auditor shall express an adverse opinion if he founds that the management’s use of the going concern basis of accounting is inappropriate.

However, in case the management’s use of Going Concern basis of accounting is appropriate but a material uncertainty exists:

1) Adequate Disclosure: If adequate disclosure about the material uncertainty is made in the financial statements then the auditor shall express an unmodified opinion. The auditor’s report shall include a separate section under the heading “Material Uncertainty Related to Going Concern” to:

(a) Draw attention to the note in the financial statements that disclose such matters; and

(b) State that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of the matter.

2) No Adequate Disclosure: If adequate disclosure about the material uncertainty is not made in the financial statements, the auditor shall:

(a) Express a qualified opinion or adverse opinion, as appropriate; and

(b) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the financial statements do not adequately disclose this matter.

If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor shall consider the implications for the auditor’s report.