Going Concern Pressure and the Auditor's Response
You are the engagement partner on the audit of Delta Foods Ltd for the year ended 31 March. Draft financial statements show profit before tax of BDT 8,000,000 and net current liabilities of BDT 22,000,000. A term loan of BDT 60,000,000 matures in eight months and the bank has not confirmed renewal; informal discussions suggest renewal is likely but the bank requires the audited accounts first. The company has unused overdraft facilities of BDT 15,000,000 that expire in four months. The directors have prepared cash flow forecasts showing adequate headroom, but the forecasts assume a 20% growth in sales that has not been achieved in any of the last three years. The audit is due to be signed in three weeks. Management has drafted a going concern note describing the position as satisfactory.
1. Assess the appropriateness of management's going concern assessment and identify the deficiencies in the draft note.
Read the worked answer
Assessing management's assessment. The assessment period must extend at least twelve months from the date the financial statements are approved, not merely from the balance sheet date. Within that window the company faces two hard constraints: a BDT 60,000,000 loan maturing in eight months with no confirmed renewal, and overdraft facilities of BDT 15,000,000 expiring in four months. The company is already in a net current liability position of BDT 22,000,000. These are material uncertainties that could cast significant doubt on the ability to continue as a going concern.
Deficiencies in the draft note.
- It concludes that the position is satisfactory without disclosing the specific events and conditions: the loan maturity, the absence of written renewal confirmation and the facility expiry.
- It does not explain management's plans to mitigate the risks, such as the status of the bank negotiation or any planned disposals, cost reductions or shareholder support.
- It relies on a 20% sales growth assumption that is inconsistent with three years of actual performance, and gives no sensitivity analysis showing what happens if growth is not achieved.
- It does not state the material uncertainty clearly or draw the reader's attention to it.
Conclusion. The note is not adequate. Management must revise it to disclose the uncertainties, the assumptions and the sensitivities, or, if the uncertainties are not adequately disclosed, the auditor must modify the opinion.
2. Explain how the auditor should respond, including the procedures required and the effect on the audit report if the uncertainties remain unresolved.
Read the worked answer
Auditor's response.
- Challenge the forecasts: obtain the underlying model, test the 20% growth assumption against historical results and current order books, and perform sensitivity analysis on a no-growth and a declining-sales scenario.
- Obtain written confirmation from the bank of the renewal status and any covenants, and read loan agreements for default or acceleration clauses.
- Review post-year-end management accounts and cash balances for evidence of actual performance.
- Consider the availability of alternative finance and whether shareholders or the parent will provide support, supported by written commitment.
- Obtain written representations from the directors on their assessment, the assumptions and their plans.
- Evaluate whether the disclosures in the going concern note are complete and clear.
Effect on the report.
- If the going concern basis is appropriate and the material uncertainty is adequately disclosed, issue an unmodified opinion with a separate Material Uncertainty Related to Going Concern section, placed immediately after the basis for opinion.
- If the uncertainty is not adequately disclosed, issue a qualified or adverse opinion, as appropriate, because of the material misstatement in the disclosures.
- If the going concern basis is not appropriate and the financial statements are prepared on that basis, issue an adverse opinion.
- If the auditor is unable to obtain sufficient evidence to conclude on the appropriateness of the basis, issue a disclaimer of opinion.
Timing. The three-week deadline is not a reason to reduce procedures; if evidence cannot be obtained in time, the auditor should discuss a delay in signing with those charged with governance.