Risk assessment procedures and related activities
Risk assessment procedures performed during the planning phase of the audit include enquiries, analytical procedures, internal control assessment, observation and inspection. When performing these risk assessment procedures, and throughout the audit, auditors consider whether events or conditions exist which may cast doubt on the entity’s ability to continue as a going concern. This requires proper knowledge of the business, the business model, the legal requirements, and the industry. These considerations need to be documented in the audit file.
The auditor considers management’s assessment of going concern and discusses the events and conditions, which may individually or collectively cast significant doubt on the entity’s ability to continue as a going concern. Their assessment should include a cash flow forecast where the other information does not provide an appropriate picture of the prospects of the entity.
If they have not performed such an assessment yet, the auditor discusses the reasons for the intended use of the going concern basis with management. All these discussions need to be documented in the audit file.
For these discussions with management to be fruitful, results from the following risk assessment procedures are considered:
- Going concern ratios calculated during the preliminary analytical review
- Overall controls assessed, specifically business risk assessment procedures, which will mostly include budgets and cash flow forecasts
- Knowledge of the business and industry
- Overall risk and fraud risk assessment, e.g., management applying for additional finance.
The auditor demonstrates professional scepticism by addressing events not considered by management, from knowledge of the business and industry, and analytical review. As an example, management may want to paint a glowing picture of the business, rather than discuss potential solvency or liquidity issues with the auditor.
Evaluating management’s assessment
When evaluating management’s going concern assessment, the auditor considers the period covered by the assessment, and whether the period complies with the applicable financial reporting framework. Both IFRS and IFRS for SMEs require management to take all available information about the future, which is at least 12 months from the reporting date, into consideration when making an assessment. Therefore, if management’s going concern assessment does not cover at least 12 months from the reporting date, the auditor asks management to extend their assessment. The period covered by management’s going concern assessment should be clearly documented in the audit file. If management refuses to extend their assessment, the auditor needs to report this deficiency and consider its impact on the audit report.
The auditor needs to further enquire of management whether they are aware of any events or conditions beyond the period of their assessment which may cast significant doubt on the entity’s ability to continue as a going concern.
Another aspect to consider when evaluating management’s assessment is whether it includes all relevant information the auditor is aware of based on audit work performed. Auditors need to consider the impact of new developments on the entity, for example, significant subsequent events that could have an impact on going concern. Expiring agreements, pending lawsuits, natural disasters, wars, and the outbreak of a pandemic could have an impact on the business. These considerations need to be documented.
When events or conditions are identified that may have an impact on the entity’s ability to continue as a going concern, it is important that the auditor performs additional procedures to determine whether there is sufficient evidence to support the going concern basis and related disclosures in the financial statements. These procedures include more in-depth evaluation of the feasibility of management’s plans and future actions, and whether the likely outcome of these plans will improve the situation.
Concluding on going concern
The auditor needs to conclude on:
1. The appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements
2. Whether a material uncertainty exists that may cast doubt on the entity’s ability to continue as a going concern
3. Whether events or conditions and/or material uncertainties identified are adequately disclosed in the financial statements.
The audit report needs to be modified according to the conclusions drawn on each of these considerations. This may range from:
Expressing an unmodified opinion
- Expressing an unmodified opinion and including a separate section in the audit report to highlight a material uncertainty related to going concern
- Qualifying or disclaiming the opinion due it not being possible for the auditor to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements
- Qualifying the opinion where, for example, inadequate disclosure was made of a material uncertainty in the financial statements
- Expressing an adverse opinion, which is required when the use of the going concern basis of accounting is inappropriate, in the auditor’s judgement.
ISA 570 (Revised) provides clear guidance on the appropriate treatment of matters identified relating to going concern in the audit report. It is important that the auditor documents the thought process applied and reasons for the conclusions and opinion expressed.
Auditors need to ensure that sufficient appropriate audit evidence is obtained and documented, for disclosures made and the basis of accounting used, in support of their conclusions on going concern. Reaching an incorrect conclusion could result in an inappropriate opinion being expressed on the financial statements.
LEAF can assist firms with assessing engagement performance through monitoring file reviews; engagement quality reviews; methodology design reviews; attendance on engagements; and training staff on the relevant requirements and procedures.
1. IAASB: ISA 570 (Revised), Going concern