The Going Concern That Management Won't Discuss
You are auditing a retail chain with three stores in Baku and Ganja. At year-end, current liabilities exceed current assets by AZN 2.1 million, and the company has a term loan of AZN 4 million due in nine months. The loan covenant requires a debt-service coverage ratio of 1.2; the company's ratio at year-end is 1.05. Management has prepared the financial statements on a going-concern basis and states that it expects to refinance the loan and that a shareholder will inject AZN 1.5 million, but provides no signed commitment for either. The finance director says the covenant breach 'will be waived' but has no written waiver. The audit report is due in three weeks. The company has no formal cash-flow forecast.
1. Evaluate the appropriateness of the going-concern assumption and identify the audit evidence you need.
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Assessment (ISA 570): Indicators of doubt exist: net current liability position of AZN 2.1m, a AZN 4m loan due within nine months, and a covenant breach (1.05 vs 1.2). Management's mitigation depends on two events - refinancing and a shareholder injection - neither of which is supported by a signed commitment or written waiver.
Evidence required:
- A written loan waiver or amendment from the lender, or a signed refinancing term sheet.
- A signed shareholder commitment or evidence of funds (bank statement, board resolution).
- A cash-flow forecast covering at least 12 months from the date of the financial statements, with the auditor testing the reasonableness of assumptions.
- Sensitivity analysis: what happens if refinancing fails or the injection does not occur.
- Subsequent-events review up to the date of the audit report (ISA 560) to see whether any of these events have occurred.
Conclusion: Without corroborating evidence, the going-concern assumption is not adequately supported. The auditor should treat this as a significant risk and consider whether a material uncertainty exists that requires disclosure under ISA 570.
2. If management refuses to provide a forecast or commitments, what is the effect on your report?
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Scope limitation: The absence of a cash-flow forecast and of signed commitments means the auditor cannot obtain sufficient appropriate evidence about the entity's ability to continue as a going concern. This is a limitation on the scope of the audit.
Effect on opinion:
- If the possible effects are material but not pervasive (the rest of the financial statements can still be audited), issue a qualified opinion for the scope limitation.
- If the going-concern matter is pervasive - because the financial statements as a whole may not be prepared on a valid basis - issue a disclaimer of opinion.
If a material uncertainty exists but is adequately disclosed: Issue an unmodified opinion with a Material Uncertainty Related to Going Concern paragraph (ISA 570), placed immediately after the Basis for Opinion.
If the uncertainty is not disclosed: Issue a qualified or adverse opinion for material misstatement of disclosure.
Deadline: The three-week deadline does not change the evidence requirement. Document the refusal, communicate with those charged with governance, and consider the implications for the engagement.