Question

Read the case and answer the questions that follow.

Oftentimes, especially in challenging economic times, companies may not have positive financial results. The professional standards require that auditors evaluate whether there is substantial doubt about the company's ability to continue as a going concern for a reasonable period of time--a year from the balance sheet date.

CONCEPT REVIEW: Tremendous judgment is involved in this phase of the audit. It should be noted that while auditors are not required to perform procedures to test the going concern assumption, they must evaluate the assumption in relation to the results of the audit procedures performed relative to the other components of the audit.

Read the case and answer the questions that follow.

BACKGROUND:

Due to a variety of reasons, such as current economic conditions and individual operating results, companies may not have the ability to continue as a going concern. This assumption is of great interest to users of financial statements, as GAAP financial statements make the assumption the company will continue. Assets, for example, may be carried at a cost that is higher than liquidation value. Audit standards require that auditors consider whether the company under audit will be able to continue as a going concern. Auditors do not need to perform specific procedures, but they do need to use judgment in making an assessment. Items like the ability to pay debt, negative cash flow issues, legal situations, etc. all come into play.

Dillon CPA is the auditor for Sunshine Industries, a manufacturer of widgets. Sunshine's cash flow has cash used in operations of an amount twice that from last year, a net loss and current liabilities exceed current assets by about 25 percent. Company management insists they are spending lots of money investing in new product development and expect to see profits from these new products in the next year. Additionally, according to the CEO of Sunshine Industries, a lawsuit from a former supplier is expected to be settled in the next year.

1.	What procedures should the Dillon CPA audit team consider based on these facts?

2.	What should the audit team include in its report if the auditors cannot get comfortable with Sunshine management's optimistic attitude?

3.	What specific items could Dillon CPA include in an emphasis-of-matter paragraph?

Answer 1

1. According to ISA 570 - Going concern stresses that the going concern assessment is made at the date of financial statements and takes into account the relevant facts and circumstances known at that date which can affect the going concern status.

CPA Dillion should follow the below procedures :-

a. The auditor should first perform the Risk Assessment procedures as laid down in ISA 315 :-

• Inquiry of Management and others within and outside the entity for the events or conditions which can cast significant doubts about going concern assumption.
• Consider Management's assessment (if any), determine whether management has identified events or conditions which can cast significant doubts about going concern assumption and its plans to address them.
• Evaluation of the basis on which management has made its assumption of going concern.
• The auditor must remain alert throughout the audit.

b. Look for events / conditions that may cast significant doubt on going concern :

• Financial Indicators
  • Adverse Key Financial Ratios  
  • Inability to pay creditors on due dates
  • Arrears or discontinuance of dividends
  • Net liability position
• Operating Indicators
  • Labor difficulties
  • Shortages of important supplies
• Other Indicators
  • Pending legal proceedings
  • Uninsured / under insured catastrophes

c. Additional Audit Procedures to obtain sufficient and appropriate audit evidence that company is a going concern.

2. If the audit team does not get comfortable with the optimistic attitude of Sunshine Management it has following options:-​​​​​​​

• Going Concern Assumption being questionable and resolved by management explanation - Issue unmodified opinion but with Emphasis of Matter Paragraph
• Going Concern Assumption being questionable and management explanation is found to be inadequate - Issue Qualified Opinion
• Going Concern Assumption being inappropriate - Issue adverse opinion

3. Specific items that the auditor should include in an Emphasis of Matter Paragraph :-

• An uncertainty relating to the future outcome of exceptional litigation or regulatory action.
• A major catastrophe that has had or continues to have a significant effect on entity's financial position.