Hello auditors!

As the romantic rainy season is over and rosy winter season stepping in closer day by day, the festival season is all over upon us. While this is the general atmosphere for all of us, you, the company auditors have the audit season before you in full swing, thoroughly busy, and except for the listed public companies which already have finalized their accounts, declared their results in accordance with the regulatory requirements of the Securities and Exchange Board of India (hereinafter “SEBI”) and the listing agreement, and even have had conducted their annual general meetings, although mostly by video conference, all other companies and entities are getting geared up for finalising their accounts and getting the audits completed.

And yes, there, you!

Yes, you as an auditor, you are there to conclude that audit before you can celebrate the festivals of the light i.e. Deepawali yourself and allow the company accounting and finance staff also to do so.

In the above background, dear auditor, an attempt is made in this article on the concerns you should have and how to address those concerns to report on the fundamental assumption of going concern in your audit report, as required in the Independent Auditor’s report of the company you are auditing under the Companies Act 2013, in compliance with the Standard on Auditing (SA) 570 (Revised), “Going Concern.”

1. GOING CONCERN?

So you are aware about going concern? Yes, the same one, of the fundamental assumptions of accounting!

So let’s repeat it at the cost of repetition, what’s a going concern? It means that if the entity is a going concern, it will continue its operations for the foreseeable future. The foreseeable future may be a period depending on the nature of business and the circumstances and the regulatory provisions applicable to the company. However, since the financial statements are prepared on an annual basis, a minimum twelve months period is considered as a foreseeable future generally.

1.1 Management’s responsibility for the financial statements section of your audit report contains the following explicit statement:

“In preparing the financial statements:

  • management is responsible for assessing the Company’s ability to continue as a going concern,
  • disclosing, as applicable, matters related to going concern;
  • using the going concern basis of accounting; and,
  • unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so.”

So let’s begin in the beginning

1.1.1 Management is responsible for assessing the Company’s ability to continue as a going concern:

(i) Audit documentation for assessment

So while reporting, as an auditor, aren’t you supposed to take an audit evidence of such “assessment made by the management” and the basis thereof?  So what is the assessment made? Unless you have that assessment on your hands, your audit evidence, and unless you have evaluated it, can you make that bold and explicit statement, in your audit report?

Therefore there should be documentation for the evaluation and assessment made by the management for the company’s ability to continue as a going concern in foreseeable future.

(ii) Assessment:

Yes, assessment, but not one made by the Income tax or Goods and Service Tax officer! The assessment made by the management that the company/entity will continue as a going concern, which in turn, should be based on the:

    • facts prevailing at the time of finalising the accounts; and
    • assumptions /estimates made for such assessment.

(iii) So the management assessment for going concern should be in writing?

Yes and no!

As always, its always better to be in writing. In case it’s not in writing, and based on oral discussion which happens in the case of small companies, you should follow the time tested audit procedure of enquiry, discussion and making note thereof as an audit evidence for your audit documentation purpose.

Now, this assumption can be made by the management based on the facts prevailing at the time of finalising the accounts. Some of these issues, based on which the management can make an assessment for going concern assumption to be valid or not are:

    • Financial issues
    • Operational issues
    • Other issues (including Covid – 19 situation)

So a working should be obtained from the management as to how the assessment is made by them for reporting the going concern assumption to be valid and if not valid, the reason for the same.

(iv) Working by the management:

As an auditor, you should insist and obtain a documentary evidence as to the basis on which the management has made the assessment that the company is a going concern. So how the management prepares it? It could be based on financial, operational and other issues.

An illustrative list of an assessment made by the management could be as under:

Illustrative note on management’s considerations and basis for a going concern

Management’s risk assessment procedures and related activities, assumptions for the events or conditions that may cast significant doubt on the Company’s ability to continue as a Going Concern

 Particulars Management evaluation and  assumptions
   
Sr.  no. Events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern considered by the management in its evaluation. The current, estimated (at least for the next 12 months) position and status and the basis of assumptions made for the next 12 months to pay off the liabilities
1 Financial Considered based on the projected Cash flow for the financial year 2020-2021
     
1.1 Net liability or net current liability position. Based on the projected cash flow, the company has sufficient funds available to pay off its liabilities falling due during the financial year 2020-21
1.2 Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short-term borrowings to finance long-term assets. The company does not have such obligations or situations during the next financial year
1.3 Indications of withdrawal of financial support by creditors. No such indications exist for the company by its financial creditors as the company is regular in payment of its financial obligations on due dates
1.4 Negative operating cash flows indicated by historical or prospective financial statements. The company does not have negative cash flows – neither historically, nor in future based on its financial projections as evident from the projected cash flow for financial year 2020-2021
1.5 Adverse key financial ratios. The financial ratios are adequate indicating  a robust financial position
1.6 Substantial operating losses or significant deterioration in the value of assets used to generate cash flows. Due to lockdown declared by the government, the company  did not stop its operations from and it has not materially affected its business growth and the projected cash flows for the 1st quarter of the financial 2020-2021. However, this being a short term event, the management does not expect any disturbance in continuing its operations in the foreseeable future
1.7 Arrears or discontinuance of dividends. The company does not have financial constraints to pay the arrears of dividends as the sufficient cash balances earmarked separately as per the provisions of the Companies Act 2013 read with declaration of dividends is maintained.
1.8 Inability to pay creditors on due dates. Based on the projected cash flows for the financial year 2020-2021, the management is certain that no such situation would arise in the near future.
1.9 Inability to comply with the terms of loan agreements. The management does not foresee any such situation arising on the basis of the projected cash flows for the financial year 2020-2021
1.10 Change from credit to cash-on-delivery transactions with suppliers. The management has not changed its policy to change its sale policy and continues to follow the industry norms in this respect.
1.11 Inability to obtain financing for essential new product development or other essential investments. No such plans envisaged by the management at this stage
 
2 Operating Based on the current operations and the future projections, assumptions and estimates
 
2.1 Management intentions to liquidate the entity or to cease operations. Management does not see any need for such an eventuality in the near future.
2.2 Loss of key management without replacement. The key management personal are replaced by the management as a continuous procedure. No key management position remains or is allowed to remain without replacement of key managerial personnel
2.3 Loss of a major market, key customer(s), franchise, license, or principal supplier(s). No such situation is perceived by the management in the near future
2.4 Labor difficulties Due to Covid-19 and the lockdown enforced by the government, there has been considerable labour movement from the cities to the rural areas. However, considering the employment opportunities, this issue will not affect the operations of the management
2.5 Shortages of important supplies. There may be some disturbances due to the lock down and labour issues in some pockets. However, the management is capable of arranging alternate sources for such supplies
2.6 Emergence of a highly successful competitor The possibility exists, but the management assumes that, based on its evaluation and past experience in the industry, no competitor can challenge or force or create a threat so as to affect its operations.
 
3 Impact of  Covid- 19 on company and industry Based on the market, economic and industry outlook and conditions
 
  There has not been any significant disruption to the business due to Covid-19 as we were able to carry out our operations remotely.
 
4 Other issues  
 
4.1 Non-compliance with capital or other statutory or regulatory requirements, such as solvency or liquidity requirements for financial institutions. Presently the management does not see any such threats as all the capital, statutory or regulatory requirements are being complied with.
4.2 Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy. There are no pending legal or regulatory cases against the company which are likely to affect the operations of the company
4.3 Changes in law or regulation or government policy expected to adversely affect the entity. The management does not foresee any such situation arriving during the next financial year
4.4 Uninsured or underinsured catastrophes when they occur. All the plant, properties and equipment, working capital assets and even key managerial personnel are adequately insured by the company. Therefore management is confident that even in such an event, there will not be any effect.

In support of the above assumption, you must also take on the record, the working and evidence on the basis of which the above assessment is made.

(v) Assumptions /estimates made for the above assessment

Its possible that certain assumptions/estimates are made by the management in making the above assessment. So these assumptions/estimates should also be taken on record as an audit evidence. These assumptions can be such as (i) management will raise finance by way of capital, loans, sale of investments is hand (ii) increasing marketing budget (iii) increase in sales force, labour (iv) Investment in new technology, machinery (v) timely recovery of trade receivables (vi) moratorium request for loans etc

All the above should be taken on record

1.1.2 Management is responsible for disclosing, as applicable, matters related to going concern:

Based on the management assessment as above, the management is required to disclose any matter related to going concern assumption in the financial statements.

As an auditor, you should be concerned and therefore verify and check if the proper disclosure is made in the financial statements based on the assessment made by the management

1.1.3 Using the going concern basis of accounting:

There is a fundamental assumption that the accounts are prepared on a going basis. Based on the assessment as discussed as above only, the management can categorically state that the accounts are and can be prepared on a going concern basis. This assumption should be tested for a foreseeable future. A reasonable period for this foreseeable future is considered a period of twelve months, as per Standard on Auditing (SA) 570 (Revised), “Going Concern.”

So, as an auditor, its paramount for you that the going concern assumption by the management is proved beyond reasonable doubt, with audit evidence.

1.1.4 Management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so:

In case, the fundamental assumption of going concern does not hold true, based on the assessment made by the management as evident from the working provide to you, Mr. Auditor, the fact should be stated in the financial statements and the accounts should not be prepared as a going concern.

1.2 Auditor’s responsibilities for the audit of the financial statements section of your audit report contains the following explicit statement:

“As part of an audit in accordance with SAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also conclude:

  • on the appropriateness of management’s use of the going concern basis of accounting
  • based on the audit evidence obtained,
  • whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern.
  • if we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or,
  • if such disclosures are inadequate, to modify our opinion.
  • Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern.

So let’s go again and visit the above statement!

1.2.1 The appropriateness of management’s use of the going concern basis of accounting:

Based on the working provided by the management for making an assessment, and on the assumptions and estimates made by them and taken on record, as an auditor, you should evaluate if the same is appropriate in the given circumstances. If not, then further inquiry should be conducted, discussion and  verification should be made so as to ensure that the basis of working provided by the management for GOING CONCERN assumption is appropriate. Then only conclusion should be made.

1.2.2 The audit evidence obtained:

The working for the assessment, the assumption and estimates considered by the management for making such assessment, its appropriateness can form the audit evidence based on which you are concluding if the company is a going concern.

1.2.3 If there any material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern.

Based on the audit evidence so gathered, it would be possible to arrive at a conclusion whether uncertainty exists related to any event or the conditions which are prevalent which may cast or not cast significant doubt on the company’s ability to continue as a going concern. So making a conclusion will, now be easier and documented evidence will be available on the records.

1.2.4 If a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements:

So based on your evaluation of the management’s assessment, which is again supported by the working and assumptions and estimates made by the management, it would be easier now to report if any material uncertainty exists. If yes, then you should draw attention that a material uncertainty exists. But still if you are convinced that Going Concern assumption can be made, then drawing the attention would be adequate while reporting. If not, then you may have to modify your opinion.

1.2.5 If such disclosures are inadequate, to modify our opinion:

If there is a disclosure made in the financial statements about the going concern assumption, which in your opinion, is not adequate, then you must modify your opinion.

1.2.6 Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern.

As the evidence is collected, its appropriateness is tested, disclosure is made in the financial stat If there is a disclosure made in the financial statements about the going concern assumption, which in your opinion, is not adequate, then you must modify your opinion. If adequate, your conclusions can be that the going concern assumption is met by the company.

2. AREN’T YOU CONCERNED?

So, there you are!

Aren’t you concerned?

Yes, you are very much!

  • Have you been taking any such records on the audit file as documentary audit evidence?
  • Unless you do not want to have audit evidence and document for the same to arrive at the conclusion!

So aren’t you concerned?

You should be, unless you have the basis of the management assessment, duly evaluate it, check the appropriateness of the assessment, assumptions and estimates made by the management and then only make an audit conclusion, as per your report!

3. OBSERVE CLOSELY!

Now it is in fitness of things to explicitly make a statement to conclude that you observed closely before making that conclusion in your audit report as to, whether:

  • going concern assumption assessment made by the management was proper?
  • you have evaluated the assessment made by the management and whether it was proper?
  • appropriate evidence was made available for the purpose of arriving at the conclusion in the audit report?
  • a modified opinion is required based on the audit evidence collected and documented?
  • reporting conclusion is proper and adequate?

So observe closely and conclude properly before rushing to celebrate, that relishing  Deepawali.

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