Going Concern and Subsequent Events in a Small Entity Audit
You are completing the audit of Raduga LLC, a small Belarusian manufacturer, for the year ended 31 December. The company has a bank loan of 500,000 BYN due for repayment on 31 March of the following year. At the date of the auditor's report (15 March), the company has 40,000 BYN cash, negative working capital of 300,000 BYN, and a net loss for the year of 150,000 BYN. Management has provided a cash-flow forecast showing it expects to refinance the loan and has begun negotiations with the bank, but no written commitment exists. On 10 March, a major customer cancelled a 200,000 BYN order. Management's forecast does not reflect this cancellation. The financial statements are prepared on a going-concern basis.
1. Evaluate the appropriateness of the going-concern basis and the effect of the subsequent event on management's assessment.
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The indicators are adverse: loan due within one month of the report date, negative working capital, losses, and minimal cash. Management's forecast relies on an uncommitted refinancing, which is not sufficient evidence on its own. The cancellation of the 200,000 BYN order on 10 March is an adjusting/non-adjusting subsequent event that occurred before the report date and directly affects the reliability of the forecast; management's forecast must be revised to reflect it.
Given the revised forecast, there is material uncertainty about the entity's ability to continue as a going concern. The going-concern basis may still be appropriate if management has realistic plans (e.g., a signed refinancing), but at present there is no written commitment. The auditor should:
- Obtain updated cash-flow forecasts incorporating the cancellation.
- Seek written confirmation from the bank on the refinancing status.
- Assess whether the financial statements adequately disclose the material uncertainty.
If the uncertainty is adequately disclosed, an unmodified opinion with a Material Uncertainty Related to Going Concern paragraph is appropriate. If disclosure is inadequate, modify the opinion (qualified or adverse). If the going-concern basis is not appropriate, an adverse opinion is required.
2. Describe the audit procedures and reporting consequences arising from the subsequent event and the loan covenant.
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Procedures:
- Review minutes, correspondence, and bank communications after year-end for evidence of the refinancing and the cancellation.
- Obtain and test the revised cash-flow forecast, including sensitivity analysis.
- Confirm the loan balance, terms, and any covenant breaches with the bank.
- Review the financial statements for disclosure of the material uncertainty and the subsequent event.
- Obtain written representations from management on the going-concern assessment and the subsequent event.
Reporting:
- If the material uncertainty is adequately disclosed, issue an unmodified opinion with a separate Material Uncertainty Related to Going Concern section (ISA 570).
- If disclosure is inadequate, issue a qualified or adverse opinion.
- If the going-concern basis is inappropriate, issue an adverse opinion.
- Consider whether the subsequent event requires adjustment or disclosure under IAS 10; the cancellation is a non-adjusting event that may require disclosure if material, but it affects the going-concern assessment.
- Communicate with those charged with governance before finalizing the report.