Going Concern, Subsequent Events and the Audit Report
You are completing the audit of Calder Retail Ltd for the year ended 31 March. The company has a bank loan of £2m repayable in June, and the bank has indicated it will not renew the facility unless the company provides a credible refinancing plan. At the date of the audit report (20 June), management has produced a cash flow forecast showing the company can meet its liabilities for 12 months only if a new investor injects £500,000 by August. The investor has signed a non-binding letter of intent. The forecast assumes a 15% increase in sales, although sales have fallen 8% in the year. The company made a loss of £300,000 and has net current liabilities of £800,000. Management has prepared the financial statements on a going concern basis and disclosed the uncertainty in a note. The directors refuse to adjust the sales assumption.
1. Evaluate whether the going concern basis is appropriate and what audit evidence you need before concluding.
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Assessment. The indicators are adverse: net current liabilities of £800,000, a £300,000 loss, a loan repayable in June that the bank will not renew, and a forecast that depends on a non-binding letter of intent and an optimistic 15% sales growth assumption when actual sales fell 8%. On the evidence, a material uncertainty exists. The going concern basis may still be appropriate if management's plans are feasible, but the forecast is not credible as it stands.
Evidence needed:
- The cash flow forecast and the assumptions, tested for arithmetical accuracy and reasonableness; challenge the 15% growth assumption against recent trading and market data.
- The letter of intent: confirm its terms, whether it is binding, the identity and financial standing of the investor, and whether conditions precedent exist.
- Correspondence with the bank confirming the position on the loan and any covenant waivers.
- Post year-end management accounts and cash balances to the date of the report.
- Minutes of board meetings and any correspondence with other lenders or shareholders.
- A written representation from management confirming the completeness of their going concern assessment and their plans.
If the material uncertainty remains but is adequately disclosed, issue an unmodified opinion with a separate 'Material Uncertainty Related to Going Concern' section. If the basis is not appropriate, the financial statements are materially misstated and a qualified or adverse opinion is required.
2. Management refuses to revise the sales assumption. Draft the reporting implications and explain how the subsequent events standard affects your treatment of the letter of intent.
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Reporting implications.
- The refusal to revise an assumption that is contradicted by evidence is a limitation on the evidence available and indicates management bias. If the effect is material but not pervasive, qualify the opinion ('except for'); if pervasive, disclaim.
- If the going concern basis is inappropriate, the financial statements should be prepared on a break-up basis; failure to do so is a material misstatement. Given net current liabilities and the loan position, the misstatement could be pervasive - consider an adverse opinion.
- Even if an unmodified opinion is given, the material uncertainty must be highlighted in a separate section headed 'Material Uncertainty Related to Going Concern', and the note must be adequate. If disclosure is inadequate, qualify the opinion.
- Report the matter to those charged with governance and document the discussion.
Subsequent events. The letter of intent is dated after the year end. Under IAS 10 it is a non-adjusting event: it does not change conditions at 31 March, so no adjustment is made to the figures. However, it is relevant to the going concern assessment because it affects the entity's ability to continue for at least 12 months from the date of approval of the financial statements. It should therefore be considered in the going concern evaluation and, if material, disclosed. The auditor must obtain sufficient evidence about the event up to the date of the audit report and consider whether it indicates a condition that existed at the year end.