EXAMPLES OF INDICATIONS WHERE GOING CONCERN ASSUMPTIONS MAY NOT BE APPROPRIATE
It is recognized that a business generally does not cease to continue without prior indications. The seriousness of such indication may vary depending upon the circumstances.
The possible indications include:
a) Excess of liabilities over current assets or excess of excess of current liabilities over current assets.
b) Inability to repay debentures and long term loans at scheduled dates without any possibility of rescheduling of debts.
c) Acquisition of fixed assets ‘being financed through short term borrowings.
A sound financial policy is to finance fixed assets with shareholders funds, Many companies resort to long term loans to partially finance fixed assets. However, if increasing reliance is placed on short term borrowings to finance long term assets, it is clearly an indication that the company has going concern problem. This is because the short-term will have to be settled more promptly than the return form use of fixed assets.
d) Adverse key financial ratios. The examples are:
– Low liquidity ratios
– Decrease in margins
– Decrease in return on investment
– Increase in debt to equity ratio
e) Net cash out flow from operating activities.
f) Substantial accumulation of preference dividends and non-payment f dividend to ordinary shareholders for a prolonged period.
g) Inability to pay suppliers’ invoices in time.
h) Default on compliance of loan terms.
i) Refusal of suppliers to deliver goods on credit basis.
j) .Non availability of funds to finance new business.
k) Resignation of key management or staff, for example production manager.
l) Loss of major suppliers or customers.
m) Strikes and other labour problems.
n) Non compliance with statutory capital requirements.
o) Legal proceedings that may jeopardize entity’s ability to continue the business.
p) Imposition of new taxes by Government that may not render the entity to be commercially viable.
2. MITIGATING FACTORS
The effect of certain indications that the entity may not continue as a going concern can be mitigated (counter balanced) by management’s plans. For example:
– Leasing assets rather than purchasing them outright.
– Ability to dispose off assets or to postpone replacement assets.
– Renewing or extending loans.
– Raising additional capital.
– Obtaining financial support from other group companies.
– Availability of appropriate key personnel.
– Possibility of developing alternative source of supplies.
– Likelihood of finding alternative sales market.
3. AUDIT PROCEDURES
At the planning stage, the auditor should consider whether any of the indications described above exist.
This should be noted that the procedures applied by the auditor would not usually cover any specific additional procedures as the matters discussed above would normally be known to the auditor as a result of other audit procedures. However, certain significant procedures as regards the ability of an entity to continue in operations for foreseeable future include:
a) Review of interim accounts.
b Discuss with directors and staff current and future workings entity.
c) Consider forecast and budgets.
d) Study the terms of long term loan to ascertain non-compliance, if any.
e) Study minutes of the meeting of Board and shareholders.
f) Obtain letter from company’s lawyers
g) Consider volume of order backlog and entity’s ability to goods on scheduled dates
h) If the company is an affiliate of a group, the auditor should.
Consider the implications of any obligations or guarantees, which exist tween the company and the group. A proper understanding of the agreements may require a legal advice. When considering whether to place reliance on such agreements the auditor has to judge enforceability of the agreements. He should also obtain enforceability of the agreements and obtain financial statements of the parent to ascertain Whether parent company itself has a going concern problem.
The auditor should perform above procedures to the date of audit report.
4. REPORTING RESPONSIBILITIES
ISA 570 requires issuance of an adverse or a qualified opinion on the grounds of disagreement with management as regards certain non disclosures relating to going concern problem. The choice of issuing qualified or adverse opinion will depend upon auditor’s professional judgment as to the effect of non-disclosure on the financial statements.
Both the companies are in net liability and net current liability situations. However, in the case of Company A the auditor may decide to issue an adverse opinion; in case of Company B, he may conclude that a qualified report will be adequate.
The reason is that in the case of Company A, if a forced liquidation takes place, the realizable value of fixed assets could be significantly lower than the book value; in case of company B even if the fixed assets realize zero, the impact of the required adjustment will be maximum Rs. 50,000. Also, as the long term liabilities of the company will have to be settled within a year, the deficit to meet such obligations in case of Company A will be much higher than that of Company B.
A summary of impact on auditor’s report is set out in diagrammatic form on the next page.
If auditor believes that management plans and other factors need to be disclosed and if adequate disclosure is not made, on the grounds of non- disclosure a qualified or adverse report will be issued.
column is “going concern appropriate”. ISA 570 give a list of of risk that continuance, as a going concern may be Where the auditor finds existence of one or more of such he may still have reasons to conclude that going concern is appropriate. The first column relates to such circumstances.
Assume that at year end current liabilities exceed current assets. The auditor only conclude, on the basis of subsequent events, that it was only temporary phase, and therefore in his judgment, the going concern assumption was appropriate.