Going Concern Judgement When the Bank Covenant Is Tight
Ardent Retail Ltd has a 31 December year end. At 31 December 2024 it has net current liabilities of £1.8m and a term loan of £5m repayable in June 2025. The loan covenant requires EBITDA of at least £1.2m; draft accounts show EBITDA of £1.28m, but this includes £150,000 of one-off supplier rebates recognised on the basis of a verbal agreement not yet documented. The company has £300,000 of undrawn overdraft facilities, expiring 31 March 2025. The directors have prepared a cash flow forecast to December 2025 showing headroom of £40,000 in the worst case, which assumes a 4% sales growth; actual sales fell 6% in the last quarter. The bank has indicated it is 'supportive' but has not issued a formal renewal letter. The directors propose to prepare the accounts on a going concern basis and to disclose the material uncertainty.
1. Evaluate the adequacy of management's going concern assessment and identify the audit procedures needed to conclude on the appropriateness of the going concern basis.
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The assessment is not adequate as it stands. The forecast's worst case assumes 4% sales growth when the last quarter showed a 6% decline - a 10 percentage point gap that undermines the reliability of the whole model. Headroom of £40,000 is trivial against a £5m repayment and £300,000 of facilities expiring 31 March 2025, so the forecast does not cover the twelve-month period from the date the accounts are approved without a clear refinancing assumption. The £150,000 of supplier rebates is supported only by a verbal agreement; if it is not recognised, EBITDA falls to £1.13m and the covenant is breached, which would make the loan repayable on demand. The auditor should: obtain the rebate documentation or treat the rebate as unrecognised and quantify the covenant breach; obtain the bank's formal facility letter and any waiver; test the reasonableness of the sales growth assumption against post-year-end management accounts; perform sensitivity analysis on the forecast; obtain a written representation from the directors; and consider whether a material uncertainty exists that requires disclosure under IAS 1. If the bank has not confirmed the renewal, the auditor cannot assume it.
2. Assuming the auditor concludes a material uncertainty exists but the going concern basis remains appropriate, explain the reporting consequences and the effect if the disclosure is inadequate.
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Where the going concern basis is appropriate but a material uncertainty exists, the auditor issues an unmodified opinion and includes a Material Uncertainty Related to Going Concern section under ISA 570, placed immediately after the basis for opinion paragraph. The section must draw attention to the relevant note, state that the events or conditions indicate a material uncertainty that may cast significant doubt on the entity's ability to continue as a going concern, and state that the auditor's opinion is not modified in respect of the matter. The section must be specific - referring to the £5m repayment due June 2025, the facilities expiring 31 March 2025 and the covenant sensitivity - rather than generic. If the disclosures are inadequate, the auditor issues a qualified opinion (or an adverse opinion if the misstatement is material and pervasive) and explains the going concern basis is inappropriate or the disclosure is insufficient. If the auditor concludes the going concern basis is not appropriate, an adverse opinion is required. The auditor must also consider whether the directors' use of the going concern basis, given the verbal rebate and unconfirmed bank support, indicates a risk of fraud or of misleading users, and should communicate with those charged with governance before the report is finalised.