Going concern, an uncommitted bank letter and inadequate disclosure
Riverbend Care Group Ltd operates 14 aged-care facilities and is listed on the ASX. At 30 June 20X5 the group reports revenue of $310 million, a net loss of $22 million and net current liabilities of $38 million. A $120 million syndicated facility expires 31 March 20X6, and the interest cover covenant (EBITDA/interest at least 2.0x) was breached at 30 June: actual 1.6x. The bank wrote on 18 August 20X5 that it 'intends to waive the breach and negotiate a refinance in the ordinary course', but has not executed a waiver or standstill. Management's cash flow forecast to 30 September 20X6 shows $6 million headroom, but assumes a 4% government funding increase from 1 January 20X6 that has not been announced, and no further covenant testing. The audit report is due 12 September 20X5. Management's going concern note states only that the group 'has adequate resources to continue in operation'.
1. Assess whether a material uncertainty exists and whether management's going concern disclosure is adequate.
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Material uncertainty exists on these facts.
- The covenant breach at 30 June means the $120m facility is repayable on demand unless validly waived. A letter saying the bank 'intends' to waive is not a waiver: it is not enforceable and may be withdrawn. Under ISA 570 the auditor assesses the reliability of support, including whether it is committed and covers at least 12 months.
- The facility expires 31 March 20X6, within 12 months of the report date, so refinancing risk is live.
- The forecast's 4% funding increase is unannounced and unsupported; a sensitivity removing it should be prepared. The assumption of no further covenant testing contradicts the loan agreement, which tests quarterly. These assumptions are not reliably supported.
Disclosure. Saying the group 'has adequate resources' does not describe the uncertainty, the breach, the bank position or the refinancing risk. It is inadequate under IAS 1. The note should identify the uncertainty and management's plans.
2. What is the effect on the auditor's report if disclosure is adequate, and what is the effect if it is inadequate? Include the position if the bank withdraws support on 5 September 20X5.
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If disclosure were adequate: an unmodified opinion with a separate 'Material Uncertainty Related to Going Concern' section under ISA 570, after the Basis for Opinion, referring to the note. Do not use Emphasis of Matter - ISA 570 requires its own section, and the Key Audit Matters section must not duplicate it.
On the actual facts, disclosure is inadequate: the financial statements are materially misstated under ISA 705 because they omit required disclosure. The effect is material and, given the $120m facility and $38m net current liabilities, pervasive to the financial statements as a whole. An adverse opinion is likely rather than a qualified opinion, because the uncertainty affects the entity's ability to continue and therefore the basis of preparation.
If the bank withdraws support on 5 September, before signing: this is a subsequent event under ISA 560. It provides evidence of conditions at year end (the waiver was never committed). Reassess going concern. If the going concern basis is no longer appropriate, the financial statements should be prepared on a liquidation basis; if management refuses, modify the opinion. Consider reporting to ASIC and the audit committee.