Question

Evaluate why the accounting assumption of “going concern” is of interest to auditors. Are there specific audit procedures that must be performed related to the going concern assumption? Why or why not?

Answer 1

Ans. : * The auditor evaluates an entity’s ability to continue as a going concern for a period not greater than one year following the date of the financial statements being audited. The auditor considers (among other issues) the following items in deciding if there is a 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 company

• Denial of trade credit to the company by its suppliers

• Uneconomical long-term commitments to which the company is subjected

• Legal proceedings against the company

If there is an issue, the audit firm must qualify its audit report with a statement about the problem.

It is possible for a company to mitigate an auditor's view of its going concern status by having a third party guarantee the debts of the business or agree to provide additional funds as needed. By doing so, the auditor is reasonably assured that the business will remain functional during the one-year period stipulated by GAAS.

* Specific audit procedures that must be performed related to the going concern assumption are as follows :

1.Analytical procedures – Analytical procedures used as a substantive test or used in the planning and overall review stages of the audit may indicate: (a) negative trends; (b) slow-moving inventory; (c) Receivable collectibility problems; (d) liquidity and solvency problems.

2. Review of subsequent events – Subsequent events, such as the bankruptcy of a major customer, confirm adverse conditions that existed at the balance sheet date. Other subsequent events that indicate a possible going concern problem include: (a) collapse of the market price of the entity’s inventory; (b) withdrawal of line of credit by bank; and (c) expropriation of entity’s assets.

3. Review of compliance with the terms of debt and loan agreements – Violation of debt covenants results in debt default.

4. Reading of minutes – Minutes of meetings of stockholders, board of directors, and board committees may indicate (a) potentially expensive litigation; (b) loss of lines of credit; (c) loss of a major supplier; and (d) changes in the operation of the business that could result in significant losses.

5. Inquiry of legal counsel – Responses to inquiries of the entity’s legal counsel about litigation, claims, and assessments could indicate possible significant losses because of product liability claims, copyright or patent infringement, contract violations, and illegal acts.

6. Confirmations concerning financial support – Confirmation with related parties and third parties of the details of arrangements to provide or maintain financial support may indicate loss of bank lines of credit or loss of third-party guarantees of entity indebtedness.