Assessment of Going Concern is one of the key areas which require the attention of Auditors and Management for the audit of financial statements for the year ended 31st March 2020. However, it is the general assumption of people that assessment of going concern is only the responsibility of auditors and not that of management. However Companies Act 2013 requires directors to prepare its financial statements on a going concern basis. A few days back ICAI has come up with an advisory on going concern assumption.
The following are some points that need to be considered by management while making an assessment of going concern.
- While assessing its ability to continue as going concern, management should assess what impact COVID 19 has on its operations and forecasted Cash flows. Management should include the following considerations in their assessment:
- Regulatory considerations: What impact entity had because of various measures taken by the government, how it has impacted its access to capital because of measures taken by government/banks, its ability to meet regulatory ratios, etc.
- Operational considerations: It impact on revenue, cash flows, execution of business operations, business models, impairment of inventory, effects on existing contracts/future contracts, increase in operating cost, etc.
- Liquidity considerations: recoverability of receivables, a decline in value of investments, funding options available, covenant breaches, risk of contingent liabilities such as invoking of performance guarantees.
- In assessing the entity’s ability to continue as going concern, management should consider information about the future which is at least but not limited to twelve months.
- Assumptions used by the management for assessing its going concern assumption should be regularly updated. Management typically relies on historical information while making such assessments. However, considering the current scenario historical information will be of no use. Hence management should use industry reports, analyst reports, and data from government sources while making assumptions. Because of new factors and complexity as a result of COVID 19, assessment of going concern assumption requires specialized knowledge.
- If management has significant doubt about the entity's ability to continue as going concern, it should disclose this fact even if it has concluded that no materiality uncertainty exists. However, were material uncertainty exists the fact should be made clear to the readers of financial statements the entity’s going concern assumption is subject to material uncertainty.
The following are some points which auditors should consider while making an assessment of an entity's ability to continue as going concern.
- The auditor should consider mitigating factors that may mitigate the risk areas identified by the management i.e. mitigating actions taken by the management such as a reduction in dividends, suspension of non-performance based bonus, cost reductions, government funding, reduction in capital expenditure, etc. The auditor should examine that impact of mitigating factors is reflected in the forecasted cash flows.
- Due to new factors and complexity as a result of COVID 19, assessment of going concern assumption requires specialised knowledge. The auditor should discuss with management whether any expert is involved in forecasting and accordingly plan its response while assessing the going concern assumptions.
- Auditors should evaluate management’s future plans in relation to going concern assessment and whether such plans are feasible and are likely to improve the situation of the entity. The auditor should discuss with management its plan to borrow money, raise equity, reduce or defer expenditures. Further, it should evaluate the management’s intentions to carry out its plan such as reviewing the status and approvals of plans in board meetings, etc.
- Auditors should ensure that management has made qualitative disclosures of underlying events or conditions related to going concern, such as enhanced disclosure in financial statements, Board of Directors reports, annual reports, disclosures about changes in financial risks, changes in policies and processes for managing the risks, disclosure about liquidity risks.
- When auditors conclude that use of going concern assumption is appropriate but material uncertainty exists and adequate disclosures are made by the management along with its plan to deal with the event or situation that gives rise to material uncertainty, the auditor can give an unmodified opinion, however, the description about material uncertainties should be disclosed under a separate paragraph “Material Uncertainty Related to going concern” and not under Emphasis of matter paragraph. However, where adequate disclosure is not made, auditors should express and qualified or adverse opinion.
- When auditors conclude that the use of going concern assumption is appropriate and no material uncertainty exists and disclosures are adequate, the auditor may consider disclosing this under Key audit matters as this is the matter which requires significant auditor’s attention.
- Auditors should not rely only on the ‘Support Letter’ issued by the parent company/investor. When Post COVID financial statements of parent are not available, it should enquire further about the financial position of the parent through evaluating publicly available information or through enquiring with the auditors of the parent company. If such information is not available auditors should accordingly evaluate its impact on auditors report.
The year 2020 is a unique year that will require unique approaches and hence management and auditors should be more vigilant and embrace new ways while performing their responsibilities.