Question

You have been conducting an audit of the financial reports of Rainbow Forest Ltd (Rainbow Forest). Rainbow Forest Ltd is a publishing company, specialising in books and other promotional material for special industry sectors and professional bodies. Over the last three years Rainbow Forest has been experiencing difficult trading conditions resulting in operating losses and deferred dividends. In particular, Rainbow Forest has had difficulty managing its cash flow. Book sales are down on the prior year and longstanding customers are no longer making bulk purchases, but instead they are producing e-books which are emailed to members on the mailing list. Whilst Rainbow Forest can still provide online technical support services and web design advice, they have lost a major source of revenue and 20% of employees have been made redundant. You have been told by different sources that Senior Management is under a lot of pressure to turn this difficult situation around and improve both sales and profitability. You note that some of the reports you have been provided are either incomplete or are not consistent with what you have been told. Based on your initial understanding of the entity and its environment, you have concluded that Rainbow Forest Ltd is a going concern risk.

Answer 1

A going concern is a business that is assumed will meet its financial obligations when they fall due. It functions without the threat for liquidation for the foreseeable future. As an auditor, it is the responsibility of the auditor to obtain sufficient and appropriate audit evidence regarding , and conclude in , the management's use of the going concern basis of accounting , and to conclude, whether a material uncertainty exists about the entity's ability to continue as a going concern.

In the current situation , Rainbow Forest Ltd is a publishing company specialising in books and other promotional material for special industry sector and professional bodies . It has been three years since the company is not able to produce profits and pay dividends. Moreover even the oldest of the customers are not making purchases. The major operation of the business that is publishing of books and printing material has been stopped. The sales have dropped so down that even the employees have to be laid down. To continue , it has shifted to online support services and web design services from its main business. So we can see that the main business of the company has not been profitable for a prolonged period of time. Cash flows are running negative. The company has deferred it's dividend payments for 3 long years. Also there are no plans for betterment of the situation. The reports are inconsistent and incomplete. Hence there is a risk regarding how long will the company be able to continue with continuous losses. The company is not paying dividends . The investors will resist. No one would be ready to lend funds to the company. There is no action plan. The old customers are leaving . Employees are laid off because of reduction in demnad of products. Hence there is a going concern risk.