AUDIT CONSIDERATIONS IN RESPECT OF GOING CONCERN IN THE CURRENT ECONOMIC ENVIRONMENT This Staff Alert references the pre-clarified ISAs. The clarified ISAs are effective for audits of financial statements for periods beginning on or after December 15, 2009. The clarified standards can be accessed at:www.ifac.org/auditing-assurance/clarity-center/clarified-standards This alert is issued by staff of the International Auditing and Assurance Standards Board (IAASB) Key Messages within This Alert to raise auditors’ awareness about matters relevant • The going concern assumption is a fundamental to the consideration of the use of the going concern principle in the preparation of financial state- assumption in the preparation of the financial ments. statements in the current environment. In particular, • The assessment of an entity’s ability to con- management, those charged with governance and tinue as a going concern is the responsibility of auditors alike will be faced with the challenge of the entity’s management. evaluating the effect of the credit crisis and economic • The appropriateness of the use of the going downturn on an entity’s ability to continue as a going concern assumption is a matter for the auditor concern and whether these effects on the entity ought to consider on every audit engagement. to be described, or otherwise reflected, in the financial statements. • International Standard on Auditing (ISA) 570, “Going Concern,” establishes the relevant While the Staff Audit Practice Alert, “Challenges requirements and guidance with regard to the in Auditing Fair Value Accounting Estimates in auditor’s consideration of the appropriateness the Current Market Environment [October 2008],” of management’s use of the going concern as- refers to going concern in the context of the effects sumption and auditor reporting. of valuation in illiquid markets, this alert addresses • The credit crisis and economic downturn have wider issues that are likely to be relevant to auditors led to a lack of available credit to entities of of entities in all industries and of all sizes. While all sizes, which may affect an entity’s ability this alert refers principally to ISA 570, other ISAs to continue as a going concern; this and other contain requirements and guidance to assist the auditor factors may be relevant in the auditor’s evalu- in dealing with other issues that may also require ation of forecasts prepared by management to particular attention in the current environment, such support its going concern assessment. as inventory valuation and allowances for doubtful receivables. • The extent of disclosures in the financial state- ments is driven by management’s assessment This alert does not take account of matters specific of an entity’s ability to continue as a going con- to industries or jurisdictions, both of which will be cern, coupled with the disclosure requirements relevant to the issues discussed below. Government of the applicable financial reporting framework. responses to the crises have been substantial, but • Consideration of the need for an emphasis of varied. Thus in some jurisdictions certain aspects matter paragraph in the auditor’s report will be of credit availability may have been resolved while a difficult matter of judgment to be made in the others continue to cause difficulties; and the particular context of the entity’s circumstances; the mere matters tackled by governments may differ as between existence of the credit crisis, though referred jurisdictions. Similarly, governments have been to in the financial statements, does not of itself considering assistance to certain industries, the nature create the need for an emphasis. of which may have a material effect on the matters discussed in this alert. Further, the effect of the credit crisis and economic downturn varies both as to its severity and timing depending on the industry and the jurisdiction. 1 This alert does not amend or override the ISAs that management either intends to liquidate the are currently effective, the texts of which alone are entity or to cease trading, or has no realistic authoritative. Reading the alert is not a substitute for alternative but to do so. When management reading the ISAs, relevant accounting standards or is aware, in making its assessment, of other authoritative material. The alert is not meant to material uncertainties related to events or be exhaustive and reference to the ISAs themselves conditions that may cast significant doubt should always be made. In conducting an audit upon the entity’s ability to continue as a in accordance with ISAs, auditors are required to going concern, those uncertainties shall be comply with all the ISAs that are relevant to the disclosed. When financial statements are engagement.1 not prepared on a going concern basis, that fact shall be disclosed, together with the Background basis on which the financial statements are The going concern assumption is a fundamental prepared and the reasons why the entity is principle in the preparation of financial statements. not regarded as a going concern. Under the going concern assumption, an entity is In assessing whether the going concern ordinarily viewed as continuing in business for assumption is appropriate, management the foreseeable future with neither the intention takes into account all available information nor the necessity of liquidation, ceasing trading or about the future, which is at least, but is not seeking protection from creditors pursuant to laws or limited to, twelve months from the balance regulations. Accordingly, unless the going concern sheet date. The degree of consideration assumption is inappropriate in the circumstances of depends on the facts in each case. When the entity, assets and liabilities are recorded on the an entity has a history of profitable basis that the entity will be able to realize its assets, operations and ready access to financial discharge its liabilities, and obtain refinancing (if resources, a conclusion that the going necessary) in the normal course of business. concern basis of accounting is appropriate The assessment of an entity’s ability to continue may be reached without detailed analysis. as a going concern is the responsibility of the In other cases, management may need to entity’s management; and the appropriateness of consider a wide range of factors relating management’s use of the going concern assumption to current and expected profitability, debt is a matter for the auditor to consider on every audit repayment schedules and potential sources engagement. Some financial reporting frameworks of replacement financing before it can satisfy itself that the going concern basis is contain an explicit requirement for management to 2 make a specific assessment of the entity’s ability to appropriate.” continue as a going concern, and standards regarding The detailed requirements regarding management’s matters to be considered and disclosures to be made responsibility to assess the entity’s ability to continue in connection with going concern. For example, as a going concern and related financial statement within International Financial Reporting Standards disclosures may also be set out in law or regulation. (IFRS), International Accounting Standard (IAS) 1, “Presentation of Financial Statements,” requires Other standards and guidance may also be management to make an assessment of an entity’s relevant, such as those relating to disclosures ability to continue as a going concern: of risks and uncertainties or to supplementary “When preparing financial statements, statements such as management discussion and management shall make an assessment of analysis or similar. an entity’s ability to continue as a going concern. Financial statements shall be Relevant Auditing Standards prepared on a going concern basis unless International Standard on Auditing (ISA) 570, 1 The complete set of ISAs that are currently effective are available for download at http://www.ifac.org/members/DownLoads/2008_IAASB_Handbook_ Part_I-Compliation.pdf. 2 IAS 1 as at 1 January 2007, paragraphs 23-24. 2 considering the effect of any plans of manage- “Going Concern,” establishes the relevant ment and other mitigating factors; and requirements and guidance and is discussed in more detail below. Management’s assessment of the c. Seek written representations from manage- 7 entity’s ability to continue as a going concern is a ment regarding its plans for future action. key part of the auditor’s consideration of the going The credit crisis and the economic downturn are concern assumption. likely to result in events or conditions being identified The auditor’s responsibility is to consider, when that will give rise to the auditor performing the audit 8 planning and performing audit procedures and procedures described in paragraph 26 of ISA 570. evaluating their results, the appropriateness of On the basis of the evidence obtained, ISA 570 management’s use of the going concern assumption requires the auditor to determine if, in the auditor’s 3 in the preparation of the financial statements. judgment, a material uncertainty exists related to The auditor considers the appropriateness of events or conditions that, alone or in aggregate, management’s use of the going concern assumption may cast significant doubt on the entity’s ability to even if the financial reporting framework used in continue as a going concern.9 A material uncertainty the preparation of the financial statements does not exists when the magnitude of its potential