C2: AUDITING AND ASSURANCE

Topic: Going Concern

ISA 570

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 Introduction to GC
• Going concern (GC) is the fundamental
accounting assumption that the entity will be
able to continue in the foreseeable future.
• It is the ability of the business entity to continue
without the threat of liquidation in the
foreseeable future…
.. (12 month from date of FS approval)
• General purpose FS should be prepared on a GC
basis, unless:
1. management intends to liquidate the entity or
2. to cease operations, or
3. has no realistic alternative but to do so.
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 Responsibility on GC
Management
i. To make assessment on entity’s ability to continue as a GC
ii. If mgt becomes aware of material uncertainty relating to
GC, should properly disclose the uncertainty
iii. If FS are not prepared on CG basis then mgt should
disclose that fact, the basis used and reasons.
Auditor
1. To consider the appropriateness of mgt’s use of the GC
assumption
2. To conclude whether there exists a material uncertainty
that might affect the GC
3. To determine the implication of the GC status on the
auditor’s report.
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Factors affecting mgt’s assessment of
CG status
i. Size, nature and complexity of the entity
ii. Availability of the information at the time of
judgment making
iii. Period under consideration
• Note: Any judgment made about going concern
should be based on…
… the available information at the time when the
judgment was made.
• Subsequent events (SEs) may prove this judgment
to be wrong.

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 implication of the going concern
status on the auditor’s report
Situation Impact on Impact on
audit opinion auditors report
No material Unmodified-
uncertainty FS give a true Unmodified
exists and fair view
regarding GC
Material Modified with a
uncertainty exists
Unmodified- section headed
FS give a true Material
and adequately uncertainty related
disclosed by mgt and fair view to GC
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Situation Impact on audit Impact on
opinion auditors report
Modified. Basis for
Material uncertanty Modified- qualified or adverse
exists which is not
adequately disclosed Qualified or opinion explaining the
GC issues mgt have
or is ommitted adverse failed to disclose

Coy is not a GC and has Unmodified- Modified-with

prepared FS on a
break-up basis and FS give a true EoM
made adequate and fair view paragraph
disclosures
Modified. Basis for
Coy is not a GC adverse o’
and has Modified- adverse .pinion explaining CG
prepared FS on opinion issues and hom mgt
have failed to account
a CG basis Compiled by IMACRIS for
Situation Impact on audit Impact on
opinion auditors report
Modified-Qualified Modified. Basis for
GC period assessed
or disclaimer due qualified/disclaimer
by mgt is < 12
to an inability to expl that SAAE on GC
months and mgt is
obtain SAAE on the was not obtained to
unwilling to extend form conclusion
use of CG

Indicators of the going concern basis being in

doubt
(a) Financial indicators
i. Adverse key financial ratios
ii. Negative operating cash flows as indicated
from historical or PFI
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iii. Inability to pay account payables on due dates
iv. Change from credit to cash on delivery
transactions with suppliers
v. Inability to comply with loan agreements
vi. Fixed term borrowings approaching maturity
without any intention of renewal
vii. Short term borrowings used to finance tangible
assets
viii. Large arrears of dividends payable
ix. Consistent substantial operating losses
x. Material deterioration in assets used primarily
for the purpose of generating cash flows
xi. Inability to obtain finance to develop key new
products
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 (b) Operating indicators
i. Loss of key management personnel (and no
replacements)
ii. Loss of a major market or franchisee
iii. Shortages or loss of key suppliers or
customers
iv. Difficulties with labour unions
v. Loss of licence or changes in law that may
adversely affect the entity
vi. Management intentions to liquidate the
entity or to cease operations.
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 (c) Other indicators
i. Non-compliance with capital or other
statutory legal requirements
ii. Pending legal proceedings against the entity
which, if successful, may result in claims that
the entity is unlikely to be able to satisfy.
iii. Changes in law or regulation or government
policy expected to affect the entity adversely.
iv. Uninsured or underinsured catastrophes
occur.
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 Audit procedures for GC
1. A review of the management’s plans for future
actions in respect of going concern,
2. If the entity has prepared cash flow forecasts the
auditor shall evaluate the reliability of the
underlying data used in the forecasts.
3. Consideration of whether any additional facts or
information have become available since the
date of the management’s assessment.
4. Obtain written representations from
management regarding their future action plans
and the feasibility of the plans.
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 Audit procedures for GC
6. Analyzing and discussing the entity’s latest
available interim financial statements.
7. Reading the terms of debentures and loan
agreements and see if they are breached.
8. Performing audit procedures regarding
subsequent events with impact on GC.
9. Obtaining and reviewing reports of
regulatory actions.

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THE END

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 Going Concern Case
• Malevich & Co is a Public Certified Accountants in
practice offering audit and assurance services to a
large portfolio of clients.
• You are a manager in the audit department
responsible for the audit of Kandinsky Co which
have a financial year ended 31 July 2015.
• The audit is being completed and you are
reviewing issues which have been raised by the
audit seniors.
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 Going Concern Case..
• Kandinsky Co is a manufacturer of luxury food items
including chocolate and other confectionery which
are often sold as gift items individually or in
hampers containing a selection of expensive items
from the range of products.
• Due to an economic recession sales of products
have fallen sharply this year, and measures have
been implemented to support the company’s cash
flow. You are aware that the company only has
$150,000 in cash at the year end.
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 Going Concern Case..
• Extracts from the draft financial statements
and other relevant information are given
below.

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 Note July 2015 July 2014
(Draft) (Actual)
$’000 $’000
Revenue 2,440 3,950
Operating expenses (2,100) (2,800)
Finance charge (520) (500)
––––––– –––––––

(Loss)/profit before tax (180) 650

––––––– –––––––

Total assets 10,400 13,500

Long-term liabilities – bank loan 1 3,500 3,000
Short-term liabilities – trade payables 2 900 650
Disclosed in notes to financial statements:
Undrawn borrowing facilities 3 500 1,000
Contingent liability 4 120 –
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 Going Concern Case..
• Notes:
i. The bank loan was extended in March 2015 by
drawing on the borrowing facilities offered by
the bank.
The loan carries a fixed interest rate and is
secured on the company’s property including
the head office and manufacturing site.
The first repayment of loan capital is due on 30
June 2016 when $350,000 is due to be paid.
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 Going Concern Case..
ii. Kandinsky Co renegotiated its terms of trade with its
main supplier of cocoa beans, and extended payment
terms from 50 days to 80 days in order to improve
working capital.
iii. The borrowing facilities are due to be reviewed by
the bank in April 2016 and contain covenants
including that interest cover is maintained at 2, and
the ratio of bank loan to operating profit does not
exceed 4:1.
iv. The contingent liability relates to a letter of support
which Kandinsky Co has provided to its main supplier
of cane sugar which is facing difficult trading
conditions.
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 Going Concern Case..
• Required:
In respect of the audit of Kandinsky Co:
a. Identify and explain the matters which may
cast significant doubt on the company’s
ability to continue as a going concern; and
(9 marks)
b. Recommend the audit procedures to be
performed in relation to the going concern
matters identified. (6 marks)
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 Answer to the case
a. Going concern matters
i. Revenue and profitability
- revenue has fallen by 38·2%.
- Operating margins have fallen from 29·1% to 13·9%
- loss-making position does not in itself mean that the company is
not a going concern, however, the trend is extremely worrying
i. Bank loan
- bank loan is significant i.e. 33.7% of TA and increased by 500,000
during the year
- The company appears to be supporting operations using long-term
finance
- The loan is secured on the company’s properties so the bank has right to
seize the assets in June 2016

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 Answer to the case
i. Trade payables
- payables balance has increased by 38·5%
- An extension to the payable payment period indicates that the co is
struggling to manage its CCC
- if Kandinsky Co cannot make payments on time suppliers could stop
supplying
i. Borrowing facility
- Kandinsky Co has $500,000 available in an undrawn borrowing
facility
- somewhat easing the going concern pressures which the company is
facing
- Interest cover (1150/500 = 2·3 in 2014 ) and (340/520 = 0·65 in 2015)
and borrowings to operating profit (3,000/1,150 = 2·6:1 in 2014 ) and
(3,500/340 = 10·3:1 in 2014 and shows that covenants have now been
breached

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 Answer to the case
i. Contingent liability
- Possible cash outflow of 120,000
- If it happens that this will be paid, 80% of their current
cash reserve will be used
- it is not certain that Kandinsky Co would have the means
to make the cash available to its supplier and this creates GC
issues
- There may also be legal implications for Kandinsky Co if
the cash could not be made

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 Answer to the case
b. Audit procedures….
• Same just link to the case!!

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THANK YOU!
THE END.

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C2: AUDITING AND ASSURANCE

Topic: GOING CONCERN

ISA 570

Compiled by IMACRIS
 To be covered
• Introduction to GC
• Responsibility on GC
• Factors affecting mgt’s assessment of CG
status
• Implication of GC status on Auditors report
• Indicators of GC basis being in doubt
• Audit procedures for GC
• Case

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 Introduction to GC
• Going concern (GC) is the fundamental
accounting assumption that the entity will be
able to continue in the foreseeable future.
• It is the ability of the business entity to continue
without the threat of liquidation in the
foreseeable future…
.. (12 month from date of FS approval)
• General purpose FS should be prepared on a GC
basis, unless:
1. management intends to liquidate the entity or
2. to cease operations, or
3. has no realistic alternative but to do so.
Compiled by IMACRIS
 Responsibility on GC
Management
i. To make assessment on entity’s ability to continue as a GC
ii. If mgt becomes aware of material uncertainty relating to
GC, should properly disclose the uncertainty
iii. If FS are not prepared on CG basis then mgt should
disclose that fact, the basis used and reasons.
Auditor
1. To consider the appropriateness of mgt’s use of the GC
assumption
2. To conclude whether there exists a material uncertainty
that might affect the GC
3. To determine the implication of the GC status on the
auditor’s report.
Compiled by IMACRIS
Factors affecting mgt’s assessment of
CG status
i. Size, nature and complexity of the entity
ii. Availability of the information at the time of
judgment making
iii. Period under consideration
• Note: Any judgment made about going concern
should be based on…
… the available information at the time when the
judgment was made.
• Subsequent events (SEs) may prove this judgment
to be wrong.

Compiled by IMACRIS
 implication of the going concern
status on the auditor’s report
Situation Impact on Impact on
audit opinion auditors report
No material Unmodified-
uncertainty FS give a true Unmodified
exists and fair view
regarding GC
Material Modified with a
uncertainty exists
Unmodified- section headed
FS give a true Material
and adequately uncertainty related
disclosed by mgt and fair view to GC
Compiled by IMACRIS
Situation Impact on audit Impact on
opinion auditors report
Modified. Basis for
Material uncertanty Modified- qualified or adverse
exists which is not
adequately disclosed Qualified or opinion explaining the
GC issues mgt have
or is ommitted adverse failed to disclose

Coy is not a GC and has Unmodified- Modified-with

prepared FS on a
break-up basis and FS give a true EoM
made adequate and fair view paragraph
disclosures
Modified. Basis for
Coy is not a GC adverse o’
and has Modified- adverse .pinion explaining CG
prepared FS on opinion issues and hom mgt
have failed to account
a CG basis Compiled by IMACRIS for
Situation Impact on audit Impact on
opinion auditors report
Modified-Qualified Modified. Basis for
GC period assessed
or disclaimer due qualified/disclaimer
by mgt is < 12
to an inability to expl that SAAE on GC
months and mgt is
obtain SAAE on the was not obtained to
unwilling to extend form conclusion
use of CG

Indicators of the going concern basis being in

doubt
(a) Financial indicators
i. Adverse key financial ratios
ii. Negative operating cash flows as indicated
from historical or PFI
Compiled by IMACRIS
iii. Inability to pay account payables on due dates
iv. Change from credit to cash on delivery
transactions with suppliers
v. Inability to comply with loan agreements
vi. Fixed term borrowings approaching maturity
without any intention of renewal
vii. Short term borrowings used to finance tangible
assets
viii. Large arrears of dividends payable
ix. Consistent substantial operating losses
x. Material deterioration in assets used primarily
for the purpose of generating cash flows
xi. Inability to obtain finance to develop key new
products
Compiled by IMACRIS
 (b) Operating indicators
i. Loss of key management personnel (and no
replacements)
ii. Loss of a major market or franchisee
iii. Shortages or loss of key suppliers or
customers
iv. Difficulties with labour unions
v. Loss of licence or changes in law that may
adversely affect the entity
vi. Management intentions to liquidate the
entity or to cease operations.
Compiled by IMACRIS
 (c) Other indicators
i. Non-compliance with capital or other
statutory legal requirements
ii. Pending legal proceedings against the entity
which, if successful, may result in claims that
the entity is unlikely to be able to satisfy.
iii. Changes in law or regulation or government
policy expected to affect the entity adversely.
iv. Uninsured or underinsured catastrophes
occur.
Compiled by IMACRIS
 Audit procedures for GC
1. A review of the management’s plans for future
actions in respect of going concern,
2. If the entity has prepared cash flow forecasts the
auditor shall evaluate the reliability of the
underlying data used in the forecasts.
3. Consideration of whether any additional facts or
information have become available since the
date of the management’s assessment.
4. Obtain written representations from
management regarding their future action plans
and the feasibility of the plans.
Compiled by IMACRIS
 Audit procedures for GC
6. Analyzing and discussing the entity’s latest
available interim financial statements.
7. Reading the terms of debentures and loan
agreements and see if they are breached.
8. Performing audit procedures regarding
subsequent events with impact on GC.
9. Obtaining and reviewing reports of
regulatory actions.

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Kindly go through a case on going concern

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 Case answers
• Fall in gross profit % achieved
• While the fall in absolute revenue has ben
explained, the fall in gross profit margin is
more serious.
• This will continue to be a problem, as
expenses seem constant and interest costs are
growing.
• This will make a future return to profitability
difficult.
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 Case answers
• Losses TZS49,000,000
• Such levels of losses by comparison to2016
profit will make negotiations with the bank
difficult, especially with the loss of a major
customer.

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 Case answers
• Increased receivables balance and increased ageing
• 2016 74.8 days
• 2017 96.7 days
• Worsening debt collection is bad news when the
company is making loss and has a deteriorating
liquidity position.
• The increase in average debt collection period
• May be due to an irrecoverable receivable on the
account of the major customer lost in the year.
• An irrecoverable receivable write-off would cause
increased losses.

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 Case answers
• Worsening liquidity ratio
• 2016 1.03
• 2017 0.85
• This is a significant fall which will worsen
further if an allowance for irrecoverable
receivables is required.
• The company has loan and lease
commitments which possibly may not be met.
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 Case answers
• Increasing reliance on short-term finance
• This does not secure the future.
• With the company going through so much
change this may cause difficulties for the bank
overdraft facility negotiations.

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 Case answers
• Increasing reliance on short-term finance
• This does not secure the future.
• With the company going through so much
change this may cause difficulties for the bank
overdraft facility negotiations.

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 Case answers
• Gearing will have increased
• This leads to an interest commitment which is
a drain on future profits.
• This may also cause a problem in negotiating
new finance arrangements.

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 Case answers
• Loss of major customer to competitor
• Risk of unallowed-for irrecoverable
receivables in the financial statements.
• Other customers could follow suit, worsening
the company’s future prospects.
• Loss of commercial customers
• Commercial customers normally provide
regular income which is important for a
company with repayment commitments.
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 Case answers
• Draft accounts – final adjustments are outstanding
• The company’s net asset position could be worsened
considerably if non-current assets are written down to
their recoverable amount, and the repairs inventory is
written down to net realisable value.
• As mentioned before further allowances for
irrecoverable receivables may be necessary.
• The closure may necessitate redundancy provisions.
• All of these factors could increase losses considerably.

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 Case answers
• Overdraft facility to be reviewed three months
after the year end
• This time period is probably not long enough to
see a real improvement in the company’s
fortunes.
• As auditors we will be reporting when faced with
fundamental uncertainty.
• Trying to anticipate the bank’s likely reaction to
the financial statements would be a high risk.
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 Case answers
• Future return to profits anticipated at a time
when competitors are achieving success
• The concern should be whether this is over
optimistic. If so, too much reliance being
placed upon written representations would be
a high risk strategy.

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 Case answers
• Summary. If the company is not a going
concern, then the financial statements would
be truer and fairer if prepared on a liquidation
basis. Material adjustments may then be
required to the financial statements.

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 Case answers
• Audit work to be performed in respect of going
concern at Crash Bang – (Any 5 @ 2 marks)
• Analyse sale proceeds for non-current assets, inventory
and cash received from customers occurring after the
end of the reporting period.
• Review the debt ageing and cash recovery lists. Ask
directors if outstanding amounts from lost customer
are recoverable.
• Discuss the optimistic view of likely future contracts wit
h the MD. Orders received after the end of the
reporting period should be reviewed to see if they
substantiate their opinion.

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 Case answers
• Obtain their opinion about future contracts in
a written representation letter.
• Review bank/loan records to assess the extent
to which the company has met its loan and
lease commitments in the period after the
end of the reporting period.
• Review sales orders/sales ledger for evidence
of additional lost custom after the year end.

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 Case answers
• Obtain cashflow and profit forecasts:
– Discuss assumptions with the directors;
– Perform sensitivity analysis flexing the key assumptions i.e.
interest rates, date of payment of payables and receipts from
customers;
– Check all commitments have been cleared in accordance with
legal agreements;
– Agree budgets to any actual results achieved after the year end;
– Assess reasonableness of assumptions in the light of the
achievement of the company’s budgets set for 2015; discuss
with the directors any targets not achieved;
– Reperform calculations;
– Ensure future budgeted profit are expected to meet likely
interest charges

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 Case answers
• Review bank records to ensure that the company is
operating within its facility after the end of the reporting
period. Review bank certificate for terms and conditions of
the facility. Review bank correspondence for any
suggestion the bank is concerned about its current
position.
• Ask management whether the new motorcycle fleet is
attracting new contracts as anticipated. Scrutinise any new
contracts obtained and check improved gross profit
margins will be achieved.
• Obtain written representations as to the likelihood of the
company operating 12 months from the date of approval of
the financial statements.

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 THE END

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