This article provides an overview of the responsibilities of the auditor in terms of going concern, including reporting a matter relating to going concern as a KAM
In the current economic climate, the ability of an entity to continue in business for the foreseeable future is receiving more attention than ever before. In terms of the International Standards on Auditing (ISAs), the auditor is tasked with assessing the appropriateness of management’s use of the going concern basis of accounting in preparing the financial statements. The introduction of a key audit matter (KAM) has brought a new dimension to the auditor’s report and the auditor’s consideration of the going concern assumption with the question being ask about whether going concern can be reported by the auditor as a KAM.
Introduction
ISA 570 (Revised) Going Concern sets out three main scenarios regarding going concern:
The use of the going basis of accounting by management in preparing the financial statements is appropriate. However, although the audit evidence indicates that no material uncertainty exists, events or conditions have been identified that cast significant doubt on the entity’s ability to continue as a going concern.1
The use of the going concern basis of accounting by management in preparing the financial statements is inappropriate.2
The use of the going concern basis of accounting is appropriate but a material uncertainty exists. Here, the auditor is faced with two scenarios to consider: either management has adequately disclosed the material uncertainty in the financial statements or not.3
Once the auditor has concluded on going concern, the implications on the auditor’s report are clearly set out in ISA 570 (Revised).
Implications for the auditor’s report
Events or conditions have been identified but no material uncertainty exists
If events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern but based on the evidence obtained the auditor concludes that no material uncertainty exists, the auditor should evaluate, in view of the requirements of the applicable financial reporting framework, whether the financial statements provide adequate disclosures about these events or conditions.4 The International Financial Reporting Standards (IFRS) contain the requirement for management to include disclosures about the events or conditions that cast significant doubt on the ability of the entity to continue in business for the foreseeable future, as follows: ‘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.ʼ5
Use of going concern basis of accounting is inappropriate
When management have prepared the financial statements using the going concern basis of accounting but the auditor is of the view that this is inappropriate, the audit opinion must indicate that the financial statements do not fairly present the state of the affairs of the entity. In such cases, the auditor shall express an adverse opinion.6
Use of going concern basis of accounting is appropriate but a material uncertainty exists
Where there is material uncertainty in relation to the going concern basis of accounting but management has adequately disclosed this in the financial statements, ISA 570 (Revised) requires the auditor to include a separate section in the auditor’s report titled ‘Material uncertainty related to going concern’.7 This is intended to draw the user’s attention to the note in the financial statements that discloses the principal events or conditions that cause the significant doubt and clearly discloses that a material uncertainty exists, which may result in the entity not being able to realise its assets or discharge the liabilities in the normal course of business.
If the auditor is not satisfied that the financial statements adequately disclose the material uncertainty, the auditor must modify the audit opinion, as considered appropriate in accordance with ISA 705 (Revised) Modifications to the Opinion in the Independent Auditor’s Report (ISA 705 (Revised)).8
The introduction of the concept of KAMs has brought a new dimension to the auditor’s report. This has also resulted in a new angle to the auditor’s consideration of the going concern assumption, in terms of whether the auditor can and/or should report going concern as a KAM in some cases.
Key audit matter considerations
KAMs are defined as those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period. KAMs are selected from matters communicated with those charged with governance.9
ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report (ISA 701) provides guidance to the auditor in determining which matters are considered to be KAMs. This includes matters that require significant auditor attention in performing the audit, as well as areas of higher assessed risk of material misstatement (RoMM), significant auditor judgements, and significant events or transactions that occurred during the period.10
ISA 701 recognises that a matter giving rise to a modified opinion in accordance with ISA 705 (Revised), or a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern in accordance with ISA 570 (Revised), are by their nature KAMs. However, ISA 701 states that these matters must not be described in the KAMs section of the auditor’s report, but rather reported in accordance with ISA 570 (Revised),11 as outlined above.
ISA 701 does, however, not make mention of the situation where the auditor has identified events of conditions that may cast significant doubt on the entity’s ability to continue as a going concern but the audit evidence indicates that no material uncertainty exists and therefore management’s use of the going concern basis of accounting is appropriately applied in preparing the financial statements. This situation is likely to be a KAM because of the significant auditor attention required, the higher the assessed RoMM, as well as the significant auditor judgement involved in reaching the conclusion.
Reporting going concern as a kam
ISA 701 states that communicating KAMs provides additional information to intended users of the financial statements to assist them in understanding those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period. Communicating KAMs may also assist intended users in understanding the entity and areas of significant management judgement in the audited financial statements.
Although the auditor may have concluded that no material uncertainty relating to going concern exists, in reaching this conclusion, a number of matters may have been identified that would provide the intended users of financial statements with useful information about the entity. ISA 570 (Revised) provides examples of events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. The auditor may want to communicate some of these events or conditions as KAMs to the intended users of the financial statements as they provide insight into the state of the entity.
ISA 701 only mentions two scenarios where KAMs may not be reported in the auditor’s report:12
Where law or regulation precludes public disclosure about the matter, or
In extremely rare circumstances, where the auditor determines that the matter should not be communicated in the auditor’s report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. This shall not apply if the entity has publicly disclosed information about the matter.
ISA 701 further explains that it will be extremely rare for a matter determined to be a KAM not to be communicated in the auditor’s report. This is because there is presumed to be a public interest benefit in providing greater transparency about the audit for intended users. Accordingly, the judgement not to communicate a KAM is appropriate only in cases when the adverse consequences to the entity or the public as a result of such communication are viewed as so significant that they would reasonably be expected to outweigh the public interest benefits of communicating about the matter.13
Conclusion
In cases where some events and conditions cast doubt over the entity’s ability to continue as a going concern but the evidence gathered by the auditor in accordance with the ISA requirements leads to a conclusion that no material uncertainty exists, one or more of the events and conditions identified by the auditor may be disclosed in line with ISA 701 as a KAM. Such communication is likely to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed.
Notes
1 ISA 570 (Revised), para 20.
2 ISA 570 (Revised), para 21.
3 ISA 570 (Revised), paras 22 and 23.
4 ISA 570 (Revised), para 20.
5 International Accounting Standard (IAS) 1, para 25; International Financial Reporting Standards.
6 ISA 570 (Revised), para 21.
7 ISA 570 (Revised), para 22.
8 ISA 570 (Revised), para 23(a).
9 ISA 701, para 8.
10 ISA 701, para 9(a)−(c).
11 ISA 701, para 15.
12 ISA 701, para 14.
13 ISA 701, para A53.
AUTHORS | Thandokuhle Myoli CA(SA) is Project Director: Assurance and Hayley Barker Hoogwerf CA(SA): Project Director: Assurance and Audit