Procedures for Conducting Going Concern Reviews in Auditing
Introduction
The concept of ‘going concern’ is a fundamental principle in accounting that assumes a company will continue to operate for the foreseeable future, without the intention or necessity of liquidation. Performing a going concern review is a critical aspect of auditing, as it assesses whether a business can continue to meet its obligations and sustain its operations. This article discusses the detailed procedures and methodologies auditors employ to perform these evaluations, ensuring stakeholders have a clear understanding of a company’s financial health and future prospects.
Understanding Going Concern Reviews
A going concern review is part of the auditor’s responsibility to evaluate whether there is a significant doubt about a company’s ability to continue as a going concern for a reasonable period, which is generally one year from the date the financial statements are issued. This assessment is crucial as it affects the financial statements’ valuation, presentation, and disclosures.
Procedures for Going Concern Reviews
Management Assessment
The first step in a going concern review is to evaluate management’s own assessment of the entity’s ability to continue as a going concern. Auditors review the period of management’s assessment, which should cover at least twelve months from the end of the reporting period. They analyze the procedures management used to make their assessment, including any forecasts and projections, to determine their reasonableness.
Analyzing Financial Indicators
Auditors review the financial statements for conditions or events that may raise substantial doubt about the entity’s ability to continue as a going concern. This includes analyzing trends in profitability, debt maturity schedules, financial ratios, and cash flow projections. Negative trends, such as declining sales, increasing losses, or negative operating cash flows, might indicate potential problems.
Reviewing Non-Financial Indicators
Non-financial indicators also play a crucial role in assessing a company’s viability. These may include legal proceedings, new laws or regulations, loss of a key patent or market, or severe economic downturns. Auditors need to consider these factors in their analysis to understand their impact on the company’s ability to sustain operations.
Evaluating External Factors
External factors such as market conditions, industry trends, and the overall economic environment are critical to understanding the challenges a company might face. For instance, a recession can impact a company’s ability to finance operations, acquire new business, or maintain existing revenue streams.
Checking Compliance with Financial Agreements
Auditors review loan agreements and other financing arrangements to identify any covenant breaches that could affect the entity’s ability to secure necessary funding. This involves checking debt covenants for restrictions that could potentially trigger loan repayments that the company may not be able to meet.
Considering Mitigating Factors
If there are concerns about the entity’s ability to continue as a going concern, the auditor evaluates management’s plans for dealing with these issues. This includes plans to dispose of assets, plans to obtain sufficient financing, or plans to reduce expenditures. The auditor assesses the likelihood that these plans can be effectively implemented and resolves the adverse conditions or events.
Subsequent Events Review
Auditors also review events that occur after the balance sheet date to identify any that might affect the going concern assumption. This includes obtaining information about new financing arrangements, changes in market conditions, or regulatory changes up to the date of the auditor’s report.
Preparing Audit Documentation
Documenting the findings and conclusions regarding the going concern assessment is a vital part of the audit process. This documentation should include the conditions or events that led to the concern, management’s plans and their feasibility, and the auditor’s conclusion about the entity’s ability to continue as a going concern.
Communicating with Governance
The auditor communicates relevant findings regarding the going concern assessment to those charged with governance, such as the board of directors or audit committee. This ensures that those responsible for overseeing the management are aware of potential risks.
Conclusion
Performing a thorough going concern review is vital for auditors, as it directly impacts the reliability and accuracy of financial statements. By carefully following these procedures, auditors can provide valuable insights into a company’s operational sustainability and alert stakeholders about potential financial distress. This process not only protects investors and creditors but also supports the overall market integrity by promoting transparency and accountability in financial reporting. Understanding and implementing robust going concern review procedures is therefore an essential skill for auditors in their role as protectors of public financial interests.