The accounting term going concern refers to the assumption that an entity will continue its operations for the foreseeable future. General purpose financial statements are prepared using the going concern basis of accounting unless management either intends to liquidate the entity or cease operations or has no realistic alternative but to do so (ISA 570.2). The auditors at GCS Malta discuss the concept of going concern and the auditor’s responsibilities in this article.

Who is responsible for determining whether a company is going concern?

While many would assume that determining whether a company is going concern or not is the auditor’s responsibility, in actual fact, it is management’s responsibility to assess the company’s ability to move forward as a going concern. ISA 570 states 3 factors that management must consider to determine whether or not an entity can prepare its financial statements on the going concern basis of accounting:

  1. The degree of uncertainty associated with the outcome of an event/condition increases significantly the further into the future an event or condition or the outcome occurs.
  2. The entity’s size, complexity, nature and condition of its business and the degree to which it is affected by external factors affect the judgement regarding the outcome of events or conditions.
  3. Any judgement about the future is based on information available at which the judgement is made.

What are the responsibilities of the auditor?

Under ISA 570, the auditor’s responsibility is to obtain sufficient and appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. In addition, auditors need to report in accordance with ISA 570 (revised) when issuing the auditor’s report.

Here are some indicators of going concern risk that auditors should look out for during a company’s  financial statement audit:

  • Strategic conditions – such as a company’s lack of a clear strategic plan or reliance on a small number of customers/suppliers
  • Liquidity conditions – such as the trend of declining cash and negative cash flows
  • Financial reporting conditions – such as the inability to provide a short-term cash forecast or providing financial information which is not considered consistent with historical or industry information
  • Adverse changes in the environment, market position or operation conditions – such as the emergence of highly successful competitors or the shortage of important suppliers

Potential implications of going concern on the auditor’s report

There are various potential implications to the auditor’s report that auditors must consider depending on which one of the following scenarios the auditor encounters:

  • Where the use of the going concern basis by management is deemed inappropriate– that is, management has prepared the financial statements on a going concern basis when in reality these should have been prepared on an alternative basis, and therefore the auditor shall issue an adverse opinion
  • Where the use of the going concern basis is appropriate, but there exists a material uncertainty – the auditor shall express an unmodified opinion and include a separate section under ‘Material uncertainty related to going concern’ within the auditor’s report; this shall include the events or conditions that may cast doubt on the entity’s ability to continue as a going concern
  • Where a material uncertainty exists and the financial statements are materially misstated due to inadequate disclosure – the auditor shall express a qualified opinion/adverse opinion (as appropriate) in accordance with ISA 705 (revised) and state that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern.
  • Management unwilling to make or extend its assessment – The auditor may express a qualified opinion/disclaimer of opinion in the auditor’s report, as appropriate.

Why GCS Malta?

At GCS Malta, our team of professional auditors can assist you with various auditing services tailored to your needs. Contact us today for more information.

Article by Sarah Jane Gauci