Going Concern Assessment Under Financial Stress

1. Facts

A listed company engaged in manufacturing operations is experiencing significant financial stress during the current financial year. The following conditions exist as of the reporting date:

The company has incurred negative operating cash flows during the year and in the immediately preceding year.
The entity is in a net current liability position, with current liabilities exceeding current assets.
There are significant loan repayments falling due within the next 12 months, including term loans and working capital borrowings.
The company has defaulted in repayment of certain borrowings, resulting in lenders initiating recovery discussions.
Access to fresh external financing is restricted, and negotiations with lenders for restructuring are still at a preliminary stage.

Despite the above conditions, management has prepared the financial statements on a going concern basis, primarily relying on the following:

Letters of financial support from promoters, stating their intention to provide funding as and when required.
Proposed restructuring plans, including cost rationalisation and disposal of non-core assets.
Projected improvement in operations, based on expected recovery in demand.

Suggest, whether in the given circumstances, the use of the going concern basis appropriate, and what should be the auditor’s reporting implication?

2. Relevant Provisions under SA 570, Going Concern

Para 6. The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements, and to conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity’s ability to continue as a going concern. These responsibilities exist even if the financial reporting framework used in the preparation of the financial statements does not include an explicit requirement for management to make a specific assessment of the entity’s ability to continue as a going concern.

Para 10. When performing risk assessment procedures as required by SA 315, the auditor shall consider whether events or conditions exist that may cast significant doubt on the entity’s ability to continue as a going concern. In so doing, the auditor shall determine whether management has already performed a preliminary assessment of the entity’s ability to continue as a going concern, and:

(a) If such an assessment has been performed, the auditor shall discuss the assessment with management and determine whether management has identified events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern and, if so, management’s plans to address them; or

(b) If such an assessment has not yet been performed, the auditor shall discuss with management the basis for the intended use of the going concern basis of accounting, and inquire of management whether events or conditions exist that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern.

Para 12. The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern.

Para 16. If events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern (hereinafter referred to as “material uncertainty”) through performing additional audit procedures, including consideration of mitigating factors. These procedures shall include: (Ref: Para. A16)

(a) Where management has not yet performed an assessment of the entity’s ability to continue as a going concern, requesting management to make its assessment.

(b) Evaluating management’s plans for future actions in relation to its going concern assessment, whether the outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the circumstances. (Ref: Para. A17)

(c) Where the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in considering the future outcome of events or conditions in the evaluation of management’s plans for future actions: (Ref: Para. A18–A19)

(i) Evaluating the reliability of the underlying data generated to prepare the forecast; and

(ii) Determining whether there is adequate support for the assumptions underlying the forecast.

(d) Considering whether any additional facts or information have become available since the date on which management made its assessment.

(e) Requesting written representations from management and, where appropriate, those charged with governance, regarding their plans for future actions and the feasibility of these plans. (Ref: Para. A20)

Para 22. If adequate disclosure about the material uncertainty is made in the financial statements, the auditor shall express an unmodified opinion and the auditor’s report shall include a separate section under the heading “Material Uncertainty Related to Going Concern” to: (Ref: Para. A28–A31, A34)

(a) Draw attention to the note in the financial statements that discloses the matters set out in paragraph 19; and

(b) State that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of the matter.

Para 21. If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the preparation of the financial statements is inappropriate, the auditor shall express an adverse opinion.

Para 23. If adequate disclosure about the material uncertainty is not made in the financial statements, the auditor shall: (Ref: Para. A32–A34)

(a) Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705 (Revised)4; and

(b) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the financial statements do not adequately disclose this matter.

Para A3. 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.

Financial

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 statements.
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.