Accounting standards recognize that it is the responsibility of management to make an assessment of an entity’s ability to continue as a going concern. When management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, management is required to disclose those uncertainties in the financial statements. Also, in assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the end of the reporting period.
The consequences of COVID-19 (operational disruption/shutdowns, reduced customer demand, higher debt levels, debt covenant breaches, reduced access to additional credit etc.) may significantly impact management’s forecasted operating results and cash flow projections. COVID-19 may create new going concern issues or exacerbate existing ones.
Even entities with a history of profitable operations who have not previously found the need to prepare a detailed analysis in support of the going concern assumption may need to give the matter further consideration in light of the current circumstances.
Each entity may be affected differently by COVID-19 and the degree of consideration depends on the facts in each case.
The auditor's responsibility
The auditor is required to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements and to conclude whether a material uncertainty exists.
CAS 570, Going Concern, requires the auditor to evaluate management’s assessment, covering the same period as that used by management. Auditors also consider whether there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
In the current environment, auditors would benefit from early discussion with management regarding the nature of the assessment management will make to evidence compliance with the financial reporting framework.
CAS 570 sets out examples of events or conditions that the auditor may identify that may cast significant doubt about the entity’s ability to continue as a going concern. If such events or conditions are identified, the auditor is required to obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists through performing additional audit procedures, including consideration of mitigating factors.
Such procedures might include but are not limited to:
- evaluating management’s plans for future actions in relation to its going concern assessment, whether the outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the circumstances
- reviewing the cash flow forecasts produced by management and assessing reliability of underlying data and support for key assumptions
- reviewing management’s sensitivity analysis
- consideration of emergency funding and other government support mechanisms available to the entity and its employees
- consideration of credit facilities and repayment terms
- assessing expected covenant compliance under different scenarios and management’s actions in case of potential breach
requesting written representations from management and, where appropriate, those charged with governance regarding their plans for future action and the feasibility of these plans
Significant judgment and continual updates to the going concern assessments may be required, given the evolving situation.
If the auditor concludes that the use of the going concern assumption is appropriate in the circumstances but a material uncertainty exists, CAS 570 requires the auditor to 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 and management’s plans to deal with these events or conditions
- disclose clearly 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 realize its assets and discharge its liabilities in the normal course of business
If adequate disclosure is made in the financial statements, the auditor would express an unmodified opinion and include a separate section under the heading “Material Uncertainty Related to Going Concern” in the auditor’s report.
If adequate disclosure about the material uncertainty is not made by management, the auditor is required to express a qualified or adverse opinion.
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The views and opinions expressed in this article are those of the author and do not necessarily reflect that of CPA Canada.