COVID-19 and going concern: increased risk of material uncertainties
1 May 2020: In these unprecedented times, the audit of going concern assessments and reporting on material uncertainty related to going concerns are key for auditors. The Audit and Assurance Faculty has produced two guides on the topic.
The first guide covers the assessment of going concern and the second the reporting of material uncertainty related to going concern, both of which build on the FRC’s March 2020 Bulletin. You can access the full guides by clicking on this link and switching between the two tabs.
Assessing and auditing going concern
When preparing accounts, management assess whether an entity is a ‘going concern’. There is a high bar to depart from a going concern basis; accounts will be prepared on a going concern basis unless the business’s management either intends to liquidate the entity or cease trading (or has no realistic alternative but to do so). Where there are material uncertainties that cast significant doubt on going concern, most accounting frameworks require disclosure.
Auditors must follow the requirements of ISA 570 Going concern. The UK ISA was revised in September 2019 and although the new version is not yet mandatory it provides additional detail.
The pandemic has heightened going concern risks for many and gathering evidence may be more challenging. It’s vital the auditor maintains their professional scepticism throughout.
The issues which ICAEW’s guide covers in more depth are as follows:
- How has the business been impacted by COVID-19 and how might it be impacted? Supply chains, staff, contracts, bad debts and cash flow may all be issues.
- Does the nature of the business indicate additional risks, e.g. it is in the travel/hospitality sector, or expanding very rapidly risking over-trading?
- What government support is available?
- What timelines for lifting restrictions are factored into forecasts and what assumptions are made about the “new normal”?
- How liquid is the business and what finance is available? Are there covenant breaches or additional costs, such as redundancies?
- How have management stress tested their projections? Reverse stress testing, where management consider what would need to happen to make a business model unworkable, can be useful for the auditor and guidance on this will be issued soon.
- Has the forecast model been thoroughly tested? Spreadsheets can easily contain errors and the auditor must test the mechanics as well as the assumptions made.
Concluding on going concern
The auditor will need to obtain sufficient appropriate audit evidence to determine whether management’s use of the going concern basis continues to be appropriate. Judgment will be needed in concluding on this and on any material uncertainty disclosures required. The period considered must be at least 12 months from the date of approval of the accounts.
Reporting on material uncertainty related to going concern
Where there are material uncertainties related to going concern the auditor must check whether the financial statements:
- adequately disclose the relevant events or conditions, and management’s plan to deal with them; and,
- clearly disclose that there is a material uncertainty that may cast significant doubt on the entity’s ability to continue as a going concern.
The auditor will also check that disclosures in the “other information” are consistent. If disclosures are adequate, the auditor will issue an unmodified report including a “Material uncertainty relating to going concern” section. If the audit report includes Key Audit Matters (KAMs), then a material uncertainty related to going concern would by its nature be a KAM. A qualified or adverse opinion may be needed where disclosures of material uncertainties are inadequate.
Where there are no material uncertainties related to going concern, it may still be helpful to users for management to set out how this conclusion has been reached in the annual report, given the current circumstances. If the audit report includes KAMs, the auditor may conclude that there are no material uncertainties related to going concern, but still determine that there are matters relating to this conclusion that are KAMs.
- Coronavirus (COVID-19): Considering going concern – a guide for auditors
- Coronavirus (COVID-19): How to report on material uncertainty related to going concern – a guide for auditors
- Going concern – material uncertainty relating to going concern (reporting)
- Preparing an adverse opinion audit report
- Preparing a qualified audit report – disagreement
- Going concern – basis other than going concern
- Audit coronavirus hub