How to report on material uncertainty related to going concern - a guide for auditors
The impact of COVID-19, including the effects of government restrictions, in many cases will result in events or conditions that may cast significant doubt on a reporting entity’s ability to continue as a going concern. If such events or conditions exist, it is the responsibility of management to ascertain whether or not the entity is a going concern, and, if it is considered to be a going concern, whether there is, nonetheless, a related material uncertainty.
This Audit and Assurance Faculty guidance sets out the steps auditors need to take to ascertain whether material uncertainty disclosures in relation to going concern in the financial statements are adequate, and how these disclosures will then impact the audit report. It supplements the guidance in the faculty’s audit report guides.
Paragraph 9-2 (b) of ISA (UK) 570 (Revised September 2019) includes a definition of a material uncertainty related to going concern as follows:
An uncertainty related to events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern, where the magnitude of its potential impact and likelihood of occurrence is such that appropriate disclosure of the nature and implications of the uncertainty is necessary for:
i. In the case of a fair presentation financial reporting framework, the fair presentation of the financial statements; or
ii. In the case of a compliance framework, the financial statements not to be misleading.
While the extraordinary nature of COVID-19 means that a material uncertainty seems likely to exist for a large number of businesses, any automatic assumption that COVID-19 has led to a material uncertainty, or to the need for any standard reference to COVID-19 in the audit report, regardless of circumstances, is open to challenge. The individual circumstances of the entity (or group) should always be considered.
It seems likely that some businesses, will benefit as a result of COVID-19 and that others that are adversely affected will not be affected to the extent that there is a material uncertainty. Some firms may decide as a matter of policy to establish a rebuttable presumption that material uncertainties exist, or that some reference will be made in the audit report to COVID-19, for all or a particular category of audits. In such circumstances, clarity regarding the circumstances in which the presumption would be rebutted, and specific examples thereof, are likely to be helpful in dealing with any subsequent challenge.
While specific reporting requirements vary, depending on the accounting standards applied, typically management would be expected to disclose when financial statements have not been prepared on a going concern basis, as well as details of any material uncertainty related to going concern.
For the purposes of this guidance, it has been presumed that there is sufficient appropriate audit evidence to enable the auditor to conclude that management’s use of the going concern basis of accounting is appropriate in the circumstances, but a material uncertainty related to going concern exists. However, this guidance also discusses the situation where there is no material uncertainty, but an auditor reports on key audit matters (KAMs) and includes one or more KAMs relating to going concern.
Determining whether there are material uncertainties
The auditor will need to obtain sufficient appropriate audit evidence in order to determine whether management’s use of the going concern basis continues to be appropriate, and, whether management has identified and appropriately disclosed any material uncertainties.
Paragraph 18-1 of ISA (UK) 570 (Revised September 2019) includes a new stand back requirement. This requires the auditor to take into account all relevant audit evidence obtained, whether corroborative or contradictory, before concluding on the appropriateness of management’s use of the going concern basis or whether a material uncertainty related to going concern exists.
It is possible that the auditor identifies a different material uncertainty related to going concern to that identified and disclosed by management.
Where management has concluded that there is no material uncertainty related to going concern, the auditor will need to determine whether that is appropriate and any resulting impact on the audit report. In this situation, management might still explain in the disclosures why, having considered the effects of COVID-19, there is no material uncertainty related to going concern. Concluding on whether or not there is a material uncertainty related to going concern is explored in the Audit and Assurance Faculty guide Considering going concern - a guide for auditors.
Where management has concluded that a material uncertainty related to going concern exists, the auditor will also need to conclude on whether disclosures made by management in the financial statements are adequate. This will also have an impact on the audit report.
The various circumstances that can arise (assuming the auditor obtains sufficient evidence to conclude on whether the use of the going concern basis of accounting is appropriate), together with the impact on the audit report, are set out in the following flow chart.
Determining whether disclosures are adequate
The auditor must determine whether the material uncertainty relating to the COVID-19 pandemic is adequately disclosed in the financial statements.
The auditor must determine whether the financial statements:
- adequately disclose the principal events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern;
- adequately disclose management’s plans to deal with these events or conditions; and
- clearly disclose 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 realise its assets and discharge its liabilities in the normal course of business. If the disclosures do not specifically refer to ‘material uncertainty’ and to ‘significant doubt on the entity’s ability to continue as a going concern’, then it may be more likely the auditor will issue a modified opinion.
How auditors should approach disclosures included within other information
The auditor should also read the other information accompanying the financial statements, such as the strategic report or directors’ report, and determine whether disclosure of the material uncertainty within that other information is consistent with the disclosures in the financial statements, or whether instead any of the information is ‘incorrectly stated or otherwise misleading’.
The auditor should ascertain whether the disclosures within the other information are presented in a way that is fair and balanced, reflecting the entity’s individual circumstances in their true light. The disclosures might be expected to be included in the ‘Business review’ section of a strategic report, or the ‘Future developments’ section of a directors’ report. Indications that the disclosures are not fair and balanced would include situations where disclosures do not refer to ‘material uncertainty’, or if it is mentioned, it is not part of the sections mentioned above, but inconspicuously in a different section.
How to make the necessary changes to the auditor’s report
If adequate disclosure about the material uncertainty related to going concern is made in the financial statements, the auditor’s report should include a new section of the audit report with the heading “Material uncertainty related to going concern”.
The location for this section is not specified in ISA (UK) 570, but commonly it is included directly after the ‘Basis for opinion’ section.
The auditor should give a brief description of the circumstances that led to the material uncertainty and then draw attention to the note in the financial statements that discloses this matter and state that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern. It will also state that the auditor’s opinion is not modified in respect of the matter.
For periods commencing on or after 15 December 2019, a new, 'positive’ statement on going concern is required:
In auditing the financial statements, we have concluded that the directors’ use of the going concern basis of accounting in the preparation of the financial statements is appropriate.
For Public Interest Entities (‘PIEs’), other listed entities, those entities applying the UK Corporate Governance Code and entities subject to the governance requirements of the Companies (Miscellaneous Reporting) Regulations 2018 , the auditor is also now required to explain how they evaluated management’s assessment of the entity’s ability to continue as a going concern, and, where relevant, key observations arising with respect to that evaluation.
The conclusion on the directors’ use of the going concern basis and the explanations noted above for PIEs and the other entities identified above can either be included in the Conclusions relating to going concern section, or this section can be deleted and they can be included in the Material uncertainty related to going concern section, following the description of the circumstances that led to the material uncertainty.
See Appendix 4 of the FRC’s Bulletin: Illustrative Auditor’s Reports On United Kingdom Private Sector Financial Statements for an illustration of the standard wording, together with the wording required for PIEs and the other entities identified above.
The faculty’s guide, 'Going concern - Material uncertainty relating to going concern', provides more detail on wording for situations where the auditor concludes that a material uncertainty related to going concern is adequately disclosed. It includes an example “Material uncertainty related to going concern” section, as well as guidance on whether other sections of the auditor’s report require changes as a result.
How to report on key audit matters
If the audit report includes KAMs, then a material uncertainty related to going concern would by its nature be a KAM. However, ISA 701 requires that the matter be discussed in the separate ‘Material uncertainty related to going concern’ section rather than in the KAMs section of the audit report. It would be expected that the auditor includes a similar level of detail as if it were reported in the KAM section, including the audit response. The auditor needs to include a reference in the KAMs section to the “Material uncertainty related to going concern” section, for example by including the following wording before the KAMs themselves:
"In addition to the matter described in the material uncertainty related to going concern section, we have determined the matters described below to be the key audit matters to be communicated in our report."
The auditor could conclude that no material uncertainty exists relating to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern, but still determine that there are matters relating to this conclusion that are KAMs. Where this is the case, the auditor’s description of such KAMs could include aspects of the identified events or conditions disclosed in the financial statements, as well as the audit work performed that led the auditor to conclude that there was no material uncertainty and, as with any KAM, significant judgments made by the engagement team with respect to the matter. In such cases, the "Conclusions relating to going concern" section could refer to the KAM for the explanation of how the auditor evaluated management's assessment of the entity's ability to continue as a going concern.
The FRC’s COVID-19 Bulletin March 2020 also refers to other situations where the auditor might consider reporting COVID-19 as a KAM in its own right.
What to do if the auditor concludes that disclosures are not adequate
Practically, if the auditor does not consider that material uncertainties related to going concern are adequately disclosed, the auditor will determine which aspects of the required disclosures are missing, and communicate this to the entity’s management, with a view to management enhancing the disclosures.
If the auditor still concludes that material uncertainties related to going concern are not adequately disclosed, reference should be made to the Audit and Assurance Faculty’s guides Preparing a qualified audit report - disagreement or Preparing an adverse opinion audit report.
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 The qualifying conditions are laid out in the Department for Business, Energy & Industrial Strategy’s The Companies (Miscellaneous Reporting) Regulations 2018 Q&A.