Going Concern Auditing - Essay Example

Going Concern Auditing Introduction Auditors issue normal audit report unless they have substantial doubt about the going concern concept of the entity. Going concern is a concept “where the entity is assumed to continue in existence for the foreseeable future, the extent of which varies from entity to entity influenced by the nature of entity’s business, its business risk, and external influences.”(Lain Gray and Stuart Manson, page 674)i This concept is related with continuation of activities in the normal and regular course of business activities. That does not means that seasonal business that is periodically interrupted is not a going concern. In fact seasonal interruption are routine and regular and even after such interruptions business continue in normal course and thus entities pursuing seasonal business may be called going concern despite periodic seasonal interruption In this write up the issues relating auditors’ responsibility to assess the substantial doubt arising out of normal auditing procedures is considered in order to produce independent and effective reporting to the stakeholders. Contents Introduction Contents The going concern concept Auditor’s responsibility Substantial doubt Reporting the substantial doubt Conclusion Word Count References The going concern concept The assumption under the concept of going concern is continuity in normal course and such “continuity of entity operations is usually assumed in financial accounting in the absence to contrary” (Michael J Ramos, page 285)ii Auditors assess the going concern concept whenever substantial doubt is created while following regular and normal audit procedures.”If there are no doubt neither directors nor auditor need refer specifically to going concern in the financial statements or audit report. However, the Combines Code states that directors should report that the business is a going concern with supporting assumptions and qualifications as necessary. “(Lain Gray and Stuart Manson, page 674)iii Going concern concept assumes an atmosphere of normalcy. Under the going concern concept “the enterprise will continue in operational existence for a foreseeable future.” (Nexia International, page 137)ivWhenever auditors have substantial doubts about the going concern concept it underlies that financial statements have not been prepared under normal circumstances. This is because “the going concern concept is unlikely to be compatible with the intention or necessity to enter into a scheme of rearrangement with the company’s creditors, or make an application for an administrative order, or place the company in administrative receivership or liquidation.”(Saleem Sheikh and William Rees, page 349)v In other words results or status shown by concern that is not working under going concern concept need appropriate disclosures in financial statements and reporting by the auditors. Auditor’s Responsibility Auditing standards world over put an obligation on the auditor to assess the client is a going concern. The important thing is that auditors are not required to follow special procedures to assess the going concern attribute. The assessment should be based on conditions or events resulting from normal auditing procedures. The auditing techniques should not be guided specifically to search for going concern attribute but the transactional circumstances may indicate that entity is or isn’t a going concern. The procedures or techniques that are being followed for other auditing purposes may indicate the going concern attribute. The assessment of the auditor has to be indirect and not specific for this assessment. The auditor has to act whenever there is substantial doubt while following normal auditing procedures. For example during the course assessment of working capital adequacy of an entity an auditor assesses that the entity is not suitably equipped with working capital to meet its current obligations and this is happening on a continuous basis. While searching for the reason for such inadequacy of working capital, the auditor may come across that one of the manufacturing plants is lying idle for longer period than usual because of reasons that are not commercial. Such situations indicate that the entity is not carrying on its business on regular or continuous basis as a going concern. Substantial Doubt Existence of substantial doubt about going concern is a matter of evaluation by the auditor of the circumstances and disclosures made by the management in the financial statements. The substantial doubt has to be about the conclusion that entity will not be able to continue as a going concern for a reasonable period of time. “The reasonable period of time is defined as a period not to exceed one year beyond the date of financial statements being audited.” (Luis Puncel, page 21.61)vi As stated above auditor need not design procedures to evaluate such a condition, but regular audit procedures should be used by the auditor. Regular audit procedures that help the auditor in indicating substantial doubt about going concern include the following- “Analytical procedures indicating negative trends, slow moving inventory, receivable collectability problems, liquidity and solvency problems Review of subsequent events like collapse of market price of entity’s inventory, withdrawal of line of credit by bank, expropriation of entity’s assets Review of compliance with the terms of debts and loan agreements Reading of minutes of meetings of stockholders, board of directors, and board committees Confirmation with related parties and third parties of the details of arrangements to provide or maintain financial support.” (Steven M Bragg, page 296)vii Reporting the substantial doubt “An auditor has to assess whether a company is a going concern before an unqualified report can be issued.”(Andrew Higson, page 145)viii Normal audit report seeks modifications only for a material uncertainty and when there are material uncertainties about going concern attributes, the report is qualified by adding a paragraph following opinion paragraph. In fact as per SAS 34 “the decision to modify the report hinges on uncertainty about recoverability and uncertainty. Under this section, continued existence has a separate status. There could be substantial doubt about continuous existence even when there is no question about recoverability and classification.” (Michael J Ramos, page 285)ix There lies the responsibility of the auditor. The auditor has to obtain sufficient circumstantial evidences that create substantial doubt. The entity may be solvent and meeting its obligations but audit evidences may indicate substantial doubt about the going concern attributes. But the auditor is not required to design procedures to obtain such substantial doubt. In other words substantial doubts about the going concern attributes should be circumstantial. Once a paragraph about going concern is added in an audit report it keeps on affecting the coming audit reports. In fact the “going concern paragraph should be included in subsequent auditor’s reports as long as substantial doubt about the entity’s existence continues. If the substantial doubt condition ceases in a future period, there is no need to include the substantial doubt explanatory paragraph for reports that cover previous periods in which the substantial doubt conditions was originally applicable.”(Mark s Beasley and Joseph V Carcello, page 389)x It is obligatory on part of auditor to document his findings in order to protect such findings and strengthen the qualification of report. Whenever an auditor is of the opinion that that there exists substantial doubt about the going concern concept for an entity, the auditor/s file should be documented with following information- “Conditions or events that are the basis for the going concern substantial doubt. Elements of management’s plans that have significant effect on overcoming the adverse effects of the conditions or events identified above Audit procedure performed and evidence gathered related to significant elements of management’s plans The auditor’s conclusion about the ability of the client to continue as a going concern. Possible effects on the financial statements. If the auditor concludes that substantial doubt issue has been alleviated, document the conclusion regarding the need for disclosure of the conditions or events. If the disclosures in financial statements about the going concern are inadequate, document the conclusion regarding whether the audit report should be qualified or an adverse opinion should be expressed.” (Mark s Beasley and Joseph V Carcello, page 389-390)xi It is important for the auditor to note that IAS 1 seeks that uncertainties that create a doubt on the going concern attributes of an entity must be disclosed. That means it is the basic responsibility of the management to consider circumstances and a number of factor that cast a doubt about the going concern of the entity. Auditor has to comment upon the stand already taken by the management. Going concern attributes are positive unless indications to the contrary exist. This is the basic assumption for the auditor to understand because “if it is believed that a business is not a going concern in the long term, and then accounts must be drawn up on the basis of current or exist values of assets and liabilities. Exist values when applied to assets, are the values that would be obtained from the forced sales of those assets. In respect of liabilities, exist values are those that would apply if immediate settlement were to be made. This would probably give very different results than if the going concern concept is used.” (Henry Lunt, Margret Weaver, page 277)xii Conclusion Going concern is first an issue with the management and they have to make appropriate disclosures in financial statements when doubt about entity not being a going concern exists. Auditors have to act when a substantial doubt about the entity’s going concern for a reasonable period is created while following regular auditing procedures. Auditor’s responsibility of reporting develops with the occurrence of such substantial doubt. Word Count- 1755 References Read More