Application and Other Explanatory Material
ASA 701 deals with the auditor’s responsibility to communicate key audit matters in the auditor’s report. That Auditing Standard acknowledges that, when ASA 701 applies, matters relating to going concern may be determined to be key audit matters, and explains that a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern is, by its nature, a key audit matter.
Management’s use of the going concern basis of accounting is also relevant to public sector entities. For example, Australian Accounting Standard AASB 101 addresses the issue of the ability of public sector entities to continue as going concerns. Going concern risks may arise, but are not limited to, situations where public sector entities operate on a for‑profit basis, where government support may be reduced or withdrawn, or in the case of privatisation. Events or conditions that may cast significant doubt on an entity’s ability to continue as a going concern in the public sector may include situations where the public sector entity lacks funding for its continued existence or when policy decisions are made that affect the services provided by the public sector entity.
Risk Assessment Procedures and Related Activities
Events or Conditions That May Cast Significant Doubt on the Entity’s Ability to Continue as a Going Concern (Ref: Para. 10)
The following are examples of events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern. This listing is not all‑inclusive nor does the existence of one or more of the items always signify that a material uncertainty exists.
- Net liability or net current liability position.
- Fixed‑term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short‑term borrowings to finance long‑term assets.
- Indications of withdrawal of financial support by creditors.
- Negative operating cash flows indicated by historical or prospective financial report.
- Adverse key financial ratios.
- Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.
- Arrears or discontinuance of dividends.
- Inability to pay creditors on due dates.
- Inability to comply with the terms of loan agreements.
- Change from credit to cash‑on‑delivery transactions with suppliers.
- Inability to obtain financing for essential new product development or other essential investments.
- Management intentions to liquidate the entity or to cease operations.
- Loss of key management without replacement.
- Loss of a major market, key customer(s), franchise, licence, or principal supplier(s).
- Labour difficulties.
- Shortages of important supplies.
- Emergence of a highly successful competitor.
- Non‑compliance with capital or other statutory or regulatory requirements, such as solvency or liquidity requirements for financial institutions.
- Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy.
- Changes in law or regulation or government policy expected to adversely affect the entity.
- Uninsured or underinsured catastrophes when they occur.
The significance of such events or conditions often can be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counter‑balanced by management’s plans to maintain adequate cash flows by alternative means, such as by disposing of assets, rescheduling loan repayments, or obtaining additional capital. Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply.
The risk assessment procedures required by paragraph 10 help the auditor to determine whether management’s use of the going concern basis of accounting is likely to be an important issue and its impact on planning the audit. These procedures also allow for more timely discussions with management, including a discussion of management’s plans and resolution of any identified going concern issues.
The size of an entity may affect its ability to withstand adverse conditions. Small entities may be able to respond quickly to exploit opportunities, but may lack reserves to sustain operations.
Conditions of particular relevance to small entities include the risk that banks and other lenders may cease to support the entity, as well as the possible loss of a principal supplier, major customer, key employee, or the right to operate under a licence, franchise or other legal agreement.
ASA 315 requires the auditor to revise the auditor’s risk assessment and modify the further planned audit procedures accordingly when additional audit evidence is obtained during the course of the audit that affects the auditor’s assessment of risk. If events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern are identified after the auditor’s risk assessments are made, in addition to performing the procedures in paragraph 16, the auditor’s assessment of the risks of material misstatement may need to be revised. The existence of such events or conditions may also affect the nature, timing and extent of the auditor’s further procedures in response to the assessed risks. ASA 330 establishes requirements and provides guidance on this issue.
Evaluating Management’s Assessment
Management’s Assessment and Supporting Analysis and the Auditor’s Evaluation (Ref: Para. 12)
Management’s assessment of the entity’s ability to continue as a going concern is a key part of the auditor’s consideration of management’s use of the going concern basis of accounting.
It is not the auditor’s responsibility to rectify the lack of analysis by management. In some circumstances, however, the lack of detailed analysis by management to support its assessment may not prevent the auditor from concluding whether management’s use of the going concern basis of accounting is appropriate in the circumstances. For example, when there is a history of profitable operations and a ready access to financial resources, management may make its assessment without detailed analysis. In this case, the auditor’s evaluation of the appropriateness of management’s assessment may be made without performing detailed evaluation procedures if the auditor’s other audit procedures are sufficient to enable the auditor to conclude whether management’s use of the going concern basis of accounting in the preparation of the financial report is appropriate in the circumstances.
In other circumstances, evaluating management’s assessment of the entity’s ability to continue as a going concern, as required by paragraph 12, may include an evaluation of the process management followed to make its assessment, the assumptions on which the assessment is based and management’s plans for future action and whether management’s plans are feasible in the circumstances.
In many cases, the management of smaller entities may not have prepared a detailed assessment of the entity’s ability to continue as a going concern, but instead may rely on in‑depth knowledge of the business and anticipated future prospects. Nevertheless, in accordance with the requirements, the auditor needs to evaluate management’s assessment of the entity’s ability to continue as a going concern. For smaller entities, it may be appropriate to discuss the medium and long‑term financing of the entity with management, provided that management’s contentions can be corroborated by sufficient documentary evidence and are not inconsistent with the auditor’s understanding of the entity. Therefore, the requirement in paragraph Aus 13.1 for the auditor to request management to extend its assessment may, for example, be satisfied by discussion, enquiry and inspection of supporting documentation, for example, orders received for future supply, evaluated as to their feasibility or otherwise substantiated.
Continued support by owner‑managers is often important to smaller entities’ ability to continue as a going concern. Where a small entity is largely financed by a loan from the owner‑manager, it may be important that these funds are not withdrawn. For example, the continuance of a small entity in financial difficulty may be dependent on the owner‑manager subordinating a loan to the entity in favour of banks or other creditors, or the owner‑manager supporting a loan for the entity by providing a guarantee with his or her personal assets as collateral. In such circumstances, the auditor may obtain appropriate documentary evidence of the subordination of the owner‑manager’s loan or of the guarantee. Where an entity is dependent on additional support from the owner‑manager, the auditor may evaluate the owner‑manager’s ability to meet the obligation under the support arrangement. In addition, the auditor may request written confirmation of the terms and conditions attaching to such support and the owner‑manager’s intention or understanding.
As required by paragraph 11, the auditor remains alert to the possibility that there may be known events, scheduled or otherwise, or conditions that will occur beyond the period of assessment used by management that may bring into question the appropriateness of management’s use of the going concern basis of accounting in preparing the financial report. Since the degree of uncertainty associated with the outcome of an event or condition increases as the event or condition is further into the future, in considering events or conditions further in the future, the indications of going concern issues need to be significant before the auditor needs to consider taking further action. If such events or conditions are identified, the auditor may need to request management to evaluate the potential significance of the event or condition on its assessment of the entity’s ability to continue as a going concern. In these circumstances, the procedures in paragraph 16 apply.
[Deleted by the AUASB. Refer Aus A15.1]
Other than enquiry of management, the auditor does not have a responsibility to perform any other audit procedures to identify events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern beyond the period assessed by management, which, as discussed in paragraph Aus 13.2, is approximately twelve months from the date of the auditors’ report on the current financial report.
Audit procedures that are relevant to the requirement in paragraph 16 may include the following:
- Analysing and discussing cash flow, profit and other relevant forecasts with management.
- Analysing and discussing the entity’s latest available interim financial report.
- Reading the terms of debentures and loan agreements and determining whether any have been breached.
- Reading minutes of the meetings of shareholders, those charged with governance and relevant committees for reference to financing difficulties.
- Enquiring of the entity’s legal counsel regarding the existence of litigation and claims and the reasonableness of management’s assessments of their outcome and the estimate of their financial implications.
- Confirming the existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such parties to provide additional funds.
- Evaluating the entity’s plans to deal with unfilled customer orders.
- Performing audit procedures regarding subsequent events to identify those that either mitigate or otherwise affect the entity’s ability to continue as a going concern.
- Confirming the existence, terms and adequacy of borrowing facilities.
- Obtaining and reviewing reports of regulatory actions.
- Determining the adequacy of support for any planned disposals of assets.
Evaluating management’s plans for future actions may include enquiries of management as to its plans for future action, including, for example, its plans to liquidate assets, borrow money or restructure debt, reduce or delay expenditures, or increase capital.
In addition to the procedures required in paragraph 16(c), the auditor may compare:
- The prospective financial information for recent prior periods with historical results; and
- The prospective financial information for the current period with results achieved to date.
Where management’s assumptions include continued support by third parties, whether through the subordination of loans, commitments to maintain or provide additional funding, or guarantees, and such support is important to an entity’s ability to continue as a going concern, the auditor may need to consider requesting written confirmation (including of terms and conditions) from those third parties and to obtain evidence of their ability to provide such support.
The auditor may consider it appropriate to obtain specific written representations beyond those required in paragraph 16 in support of audit evidence obtained regarding management’s plans for future actions in relation to its going concern assessment and the feasibility of those plans.
Material Uncertainty Related to Events or Conditions that May Cast Significant Doubt on the Entity’s Ability to Continue as a Going Concern (Ref: Para. 18‒19)
The phrase “material uncertainty” is used in Australian Accounting Standard AASB 101 in discussing the uncertainties related to events or conditions which may cast significant doubt on the entity’s ability to continue as a going concern that should be disclosed in the financial report. In some other financial reporting frameworks, the phrase “significant uncertainty” is used in similar circumstances.
Paragraph 18 explains that a material uncertainty exists when the magnitude of the potential impact of the events or conditions and the likelihood of occurrence is such that appropriate disclosure is necessary to achieve fair presentation (for fair presentation frameworks) or for the financial report not to be misleading (for compliance frameworks). The auditor is required by paragraph 18 to conclude whether such a material uncertainty exists regardless of whether or how the applicable financial reporting framework defines a material uncertainty.
Paragraph 19 requires the auditor to determine whether the financial statement disclosures address the matters set forth in that paragraph. This determination is in addition to the auditor determining whether disclosures about a material uncertainty, required by the applicable financial reporting framework, are adequate. Disclosures required by some financial reporting frameworks that are in addition to matters set forth in paragraph 19 may include disclosures about:
- Management’s evaluation of the significance of the events or conditions relating to the entity’s ability to meet its obligations; or
- Significant judgements made by management as part of its assessment of the entity’s ability to continue as a going concern.
Some financial reporting frameworks may provide additional guidance regarding management’s consideration of disclosures about the magnitude of the potential impact of the principal events or conditions, and the likelihood and timing of their occurrence.
Even when no material uncertainty exists, paragraph 20 requires the auditor to evaluate whether, in view of the requirements of the applicable financial reporting framework, the financial report provides adequate disclosure about events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. Some financial reporting frameworks may address disclosures about:
- Principal events or conditions;
- Management’s evaluation of the significance of those events or conditions in relation to the entity’s ability to meet its obligations;
- Management’s plans that mitigate the effect of these events or conditions; or
- Significant judgements made by management as part of its assessment of the entity’s ability to continue as a going concern.
When the financial report is prepared in accordance with a fair presentation framework, the auditor’s evaluation as to whether the financial report achieves fair presentation includes the consideration of the overall presentation, structure and content of the financial report, and whether the financial report, including the related notes, represent the underlying transactions and events in a manner that achieves fair presentation. Depending on the facts and circumstances, the auditor may determine that additional disclosures are necessary to achieve fair presentation. This may be the case, for example, when events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern but, based on the audit evidence obtained, the auditor concludes that no material uncertainty exists, and no disclosures are explicitly required by the applicable financial reporting framework regarding these circumstances.
Implications for the Auditor’s Report
Use of Going Concern Basis of Accounting is Inappropriate (Ref: Para. 21)
If the financial report has been prepared using the going concern basis of accounting but, in the auditor’s judgement, management’s use of the going concern basis of accounting in the financial report is inappropriate, the requirement in paragraph 21 for the auditor to express an adverse opinion applies regardless of whether or not the financial report includes disclosure of the inappropriateness of management’s use of the going concern basis of accounting.
When the use of the going concern basis of accounting is not appropriate in the circumstances, management may be required, or may elect, to prepare the financial report on another basis (e.g., liquidation basis). The auditor may be able to perform an audit of that financial report provided that the auditor determines that the other basis of accounting is acceptable in the circumstances. The auditor may be able to express an unmodified opinion on that financial report, provided there is adequate disclosure therein about the basis of accounting on which the financial report is prepared, but may consider it appropriate or necessary to include an Emphasis of Matter paragraph in accordance with ASA 706 in the auditor’s report to draw the user’s attention to that alternative basis of accounting and the reasons for its use.
The identification of a material uncertainty is a matter that is important to users’ understanding of the financial report. The use of a separate section with a heading that includes reference to the fact that a material uncertainty related to going concern exists alerts users to this circumstance.
Appendix 2 provides illustrations of the statements that are required to be included in the auditor’s report on the financial report when Australian Accounting Standards are the applicable financial reporting framework. If an applicable financial reporting framework other than Australian Accounting Standards is used, the illustrative statements presented in Appendix 2 may need to be adapted to reflect the application of the other financial reporting framework in the circumstances.
Paragraph 22 establishes the minimum information required to be presented in the auditor’s report in each of the circumstances described. The auditor may provide additional information to supplement the required statements, for example to explain:
[Aus] Illustration 1A of Appendix 2 is an example of an auditor’s report when the auditor has obtained sufficient appropriate audit evidence regarding the appropriateness of management’s use of the going concern basis of accounting but a material uncertainty exists and disclosure is adequate in the financial report. The Appendix of ASA 700 also includes illustrative wording to be included in the auditor’s report for all entities in relation to going concern to describe the respective responsibilities of those responsible for the financial report and the auditor in relation to going concern.
[Aus] Illustrations 2A and 3A of Appendix 2 are examples of auditor’s reports containing qualified and adverse opinions, respectively, when the auditor has obtained sufficient appropriate audit evidence regarding the appropriateness of the management’s use of the going concern basis of accounting but adequate disclosure of a material uncertainty is not made in the financial report.
In situations involving multiple uncertainties that are significant to the financial report as a whole, the auditor may consider it appropriate in extremely rare cases to express a disclaimer of opinion instead of including the statements required by paragraph 22. ASA 705 provides guidance on this issue.
[Aus] Illustration 4A of Appendix 2 is an example of an auditor’s report containing a disclaimer of opinion, when the auditor has not obtained sufficient appropriate audit evidence regarding the appropriateness of the management’s use of the going concern basis of accounting.
When the auditor of a regulated entity considers that it may be necessary to include a reference to going concern matters in the auditor’s report, the auditor may have a duty to communicate with the applicable regulatory, enforcement or supervisory authorities.
In certain circumstances, the auditor may believe it necessary to request management to make or extend its assessment. If management is unwilling to do so, a qualified opinion or a disclaimer of opinion in the auditor’s report may be appropriate, because it may not be possible for the auditor to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial report, such as audit evidence regarding the existence of plans management has put in place or the existence of other mitigating factors.
An auditor is required under the Corporations Act 2001[*] (the Act) to notify the Australian Securities and Investments Commission (ASIC) if the auditor, when conducting an audit, becomes aware of certain circumstances specified in the Act. ASIC[#] provides guidance to help auditors comply with their obligations under the, such as reporting suspected insolvent trading.
For example, AASB 101, paragraph 26, defines this as a period that should be at least, but is not limited to, twelve months from the end of the reporting period.
See ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report.
See section 311 of the Corporations Act 2001.
See, for example, ASIC Regulatory Guide 34 Auditors’ obligations: Reporting to ASIC (May 2013).