Enquiry:
Technical advice is sought on the following matters:
(1) A company ceased its operations since last three years due to adverse economic conditions. The company did not obtain any loan from the financial institutions or otherwise. Liquid funds available with the company cover 73.00 times of current liability. The financial statements of the company show the positive equity although there is accumulated loss. Further, the management has no intention to liquidate the company.
In the perspective of the aforesaid facts, what is the auditors’ responsibility as per International Standard on Auditing– 570?
(2) A company was incorporated four years back. The company did not commence its operations due to adverse economic conditions. The company has no long and short term liabilities except immaterial balance payable to the directors against payments made during the last three years for government fee (SECP and miscellaneous) and auditors remuneration etc. Further, the management has no intention to liquidate the company.
In the perspective of the aforesaid facts, what is the responsibility of auditors as per International Standard on Auditing?
Opinion:
The Committee would like to draw your attention to the following: (underline is ours)
Conceptual framework of financial reporting defines “Going Concern” assumption as:
4.1 The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed.
IAS 1 ‘Presentation of Financial Statements’ provides the following requirements of Going Concern:
25 When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.
26 In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the end of the reporting period. The degree of consideration depends on the facts in each case. When an entity has a history of profitable operations and ready access to financial resources, the entity may reach a conclusion that the going concern basis of accounting is appropriate without detailed analysis. In other cases, management may need to consider a wide range of factors relating to current and expected profitability, debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate.
The Committee would also like to draw your attention to the following para of the ISA 570 ‘Going Concern’: (underline is ours)
2. Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future. General purpose financial statements are prepared on a going concern basis, unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so. Special purpose financial statements may or may not be prepared in accordance with a financial reporting framework for which the going concern basis is relevant (for example, the going concern basis is not relevant for some financial statements prepared on a tax basis in particular jurisdictions). When the use of the going concern assumption is appropriate, assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business. (Ref: Para. A1)
6. The auditor’s responsibility is to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation of financial statements and to conclude whether there is material uncertainty about the entity’s ability to continue as a going concern… ….
12. The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern.
17. Based on the audit evidence obtained, the auditor shall conclude whether, in the auditor’s judgment, a material uncertainty exists related to events or conditions that, individually or collectively, may cast doubt on the entity’s ability to continue as a going concern. A material uncertainty exists when the magnitude of its potential impact and likelihood of occurrence is such that, in the auditor’s judgment, appropriate disclosure of the nature and implications of the uncertainty is necessary for:
a) In the case of a fair presentation financial reporting framework, the fair presentation of the financial statements……..
18. If the auditor concludes that the use of going concern assumption is appropriate in the circumstances but a material uncertainty exists, the auditor shall determine whether the financial statements:
a) Adequately describe the principal events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and management’s plans to deal with these events or conditions; and
b) Disclose clearly that there is a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business.
19. If adequate disclosure is made in the financial statements, the auditor shall express an unmodified opinion and include an Emphasis of Matter paragraph……”
20. If adequate disclosure is not made in the financial statements, the auditor shall express a qualified opinion or adverse opinion, as appropriate, in accordance with ISA 705.
It is apparent from a reading of the above that management has to make an assessment that the entity will continue as a going concern. The entity may make this assessment without detailed analysis where the entity has a history of profitable operations and ready access to financial resources. In other cases, management may need to consider a wider range of factors.
The auditor’s responsibility is to obtain sufficient appropriate audit evidence about the appropriateness of management’s assessment of the going concern assumption and to conclude whether there is material uncertainty about the entity’s ability to continue as a going concern, or not. Where conditions or events have been identified that may cast a significant doubt, the auditor may perform additional audit procedures illustrated in para 16 of the ISA 570 ‘Going Concern’ to obtain sufficient and appropriate audit evidence.
The Committee is of the view that the going concern assessment by management is required where the company ceases its operations or does not commence its operations, both due to adverse economic conditions. Although the company has sufficient liquid assets to settle its liabilities without incurring losses, ceasing or not starting operations are an indication that a material uncertainty is present. In both these cases, the auditor’s responsibility is to obtain sufficient appropriate audit evidence and to conclude whether there is material uncertainty, or not. In case where auditor’s conclusion is different from the management’s assessment, appropriate reference in the opinion is required as illustrated in ISA 570 ‘Going Concern’.
In view of above opinion, the ICAP Selected Opinion No. 2.5 of Volume IX earlier issued by the Committee on ‘Qualification of Going Concern assumption for a Dormant Company’ stands withdrawn.
(July 4, 2013)