Going Concern Judgement With a Maturing Loan
During the audit of Harborline Trading for the year ended December 31, Year 3, the auditor learns that a ₱25,000,000 term loan matures in March Year 4. Cash flow projections show operating cash of ₱6,000,000 over the next twelve months against ₱22,000,000 of scheduled debt service. Harborline has had recurring losses for three years, a current ratio of 0.7, and a customer representing 40% of receivables that is 120 days past due. Management has begun negotiations with the bank for refinancing but has no signed commitment. The bank has verbally indicated willingness to extend. Management prepared projections assuming a 30% revenue increase and no bad debt on the overdue customer.
1. Evaluate management's going concern assessment and identify the deficiencies in its projections. State whether a material uncertainty exists and what the auditor should do.
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Management's assessment is not adequately supported. The projections assume a 30% revenue increase without evidence and assume full collection from a customer already 120 days overdue, which contradicts observable collection history. The cash flow forecast shows operating cash of ₱6,000,000 against ₱22,000,000 of debt service, a shortfall of ₱16,000,000, and there is no signed refinancing commitment. Recurring losses and a 0.7 current ratio reinforce doubt.
A material uncertainty related to going concern exists because the ability to continue depends on refinancing that is not yet agreed. The auditor should challenge the assumptions, obtain the bank's written indication or term sheet, test the realizability of the overdue receivable, and consider downside scenarios. If the uncertainty remains, the auditor must evaluate the adequacy of management's disclosure and, where disclosure is adequate, include a material uncertainty paragraph in the auditor's report. If disclosure is inadequate, a qualified or adverse opinion is required. The auditor should also obtain written representations on the plans and their feasibility.
2. Management argues that because the bank gave verbal assurance, no disclosure is needed. Assess this position and describe the reporting consequence if management refuses to disclose.
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Verbal assurance is not sufficient evidence to eliminate the uncertainty. It is not a binding commitment, can be withdrawn, and does not address the ₱16,000,000 shortfall even if the loan is extended. The going concern uncertainty therefore remains and must be disclosed.
Management's refusal to disclose is a misstatement of the financial statements because users would not be informed of a matter that could affect their decisions. If the auditor concludes the uncertainty is material and disclosure is inadequate, the auditor should express a qualified or adverse opinion, depending on how pervasive the effect is, and clearly describe the matter in the basis for opinion. The auditor should communicate with those charged with governance, document the bank communications, and consider whether the refusal indicates a broader risk of management bias affecting other estimates such as receivables.