The Going Concern Assumption

Going concern is a term that appears repeatedly in every section of an audit file. The planning phase will ask the auditor if they have done a preliminary assessment on going concern.

The fieldwork section will have procedures specifically relating to going concern.

Completion has even more focus on whether the entity is a going concern or not. On a holistic level the question of going concern appears in every single aspect of an audit file.

Going Concern Queries

For a company undergoing an audit this can be confusing. The auditor often receives enquiries as to why the same requests are repeated. Surely the answer from the planning phase hasn’t changed three weeks later during completion?

In this article we will delve more deeply into why the auditor appears so concerned about a seemingly innocuous concept.

Auditor’s Mandate

The key to the riddle lies int the auditor’s mandate. As auditors, the mandate is not to report to the management-team of an entity but to provide an independent opinion to the shareholders/stakeholders of a company.

A key aspect of this audit opinion is commentary as to the soundness of the financial position of the company at the date that the audit opinion is provided.  

The auditor needs to give an audit opinion, taking into account the materiality level and the work performed, that in their opinion, the entity has both the ability and intent to continue to operate for the 12 months following the date of the audit report.

Assessing Historical Information as Opposed to the Going Concern Assumption

There is a difference between testing a trial balance as opposed to assessing going concern. A good way of understanding  this difference is that going concern is a forward looking metric, whereas testing a trial balance is an historical check of the fair presentation of financial information.

When assessing going concern, the auditor is attempting to obtain a level of reliability of a future outcome. This differs from standard audit work where the auditor is testing events and transactions that have already occurred.

To assess this forward looking nature, the auditor must look at various inputs including budgeting, forecasting, financing and cash flow requirements. The auditor will consider the company’s future expenses, revenues and cash flow expectations. Broadly speaking, If the future cash inflows can cover operating and finance costs for the next twelve months, then, on a rudimentary level, the auditor would prima facie consider a company to be a going concern. (In the absence of other pertinent information)

Assessment and Considerations

The challenge when assessing going concern is that the expected costs and net cash flows have not yet occurred, and therefore it is not as straight forward to test the accuracy of a future transaction as it is to test transactions that have already occurred.  

To navigate this challenge, an auditor will need to assess historical accuracy in budgeting and attempt to verify that cash balances as of the date of audit report are sufficient to cover future expected outflows (cash is usually a stronger indicator as it less easily malleable than other indicators).

Other useful information may include customer contracts. In addition the auditor may consider key Supplier contracts which will give rise to future costs, rentals and leases, financial obligations (Such as loans, both intercompany and external as well commitments and provisions)  as well as legal confirmations from the attorney on record which provides comfort that there are no unexpected pervasive legal issues that may cause the going concern assumption to be incorrect. The mix of debt, in terms of current and non-current composition, is also critical as well as debt covenants and breach thereof.

The auditor should also consider qualitative measures such as the company’s strategy for growth, and processes and controls that are in place to ensure consistent cash flow and limit the risk of misappropriation of funds.

The consequence of not assessing going concern appropriately can be pervasive. Getting this assumption incorrect does not only result in inaccurate accounting (In terms of the relevant IFRS/GAAP framework) but may also result in misguided decisions being made by shareholders. These consequences can be far reaching and the auditor needs to focus on making sure that the going concern assumption is valid and appropriate. 

In conclusion, when your auditor asks for budgets and forecasts, consider the context and aid the process by helping the auditor better understand your future strategy. Let them assess how and where the future incomes and costs will be generated and allow them to provide a more robust audit opinion.

This may even provide some additional strategy insight for the company. May the collaboration be a going concern!