Foundry at the edge: going concern, a suspicious year-end sale and a pending insolvency petition

What ISA 570 (Revised) requires. The auditor evaluates management's assessment, covers the same period management used (at least 12 months from the reporting date), considers whether that period is adequate, and challenges the assumptions and the supporting evidence. The auditor does not make the assessment; the auditor tests it.

Evidence to obtain.

• Cash-flow forecasts at monthly granularity for at least 12 months from the date of the report, with the assumptions written down and each one traced to supporting evidence.
• For the CZK 150m investor: a signed term sheet or subscription agreement, evidence of funds, regulatory approvals, and the conditions precedent. An expression of interest is not evidence.
• For the bank: a signed forbearance or standstill agreement. Note that the waiver runs to 31 March 20X5 only, so at 31 December 20X4 the entity had no unconditional right to defer settlement for 12 months; the loan is current, and the same question about reclassification applies to the covenant breach (IAS 1.74–75).
• For the tender: the tender documents, the stage reached, the competitor field and any post-year-end announcement. An undecided tender is not evidence of future cash.
• Sensitivity analysis: what happens if all three conditions fail, if two fail, and if the investor arrives in September instead of June.
• Written representations from management and, where relevant, from the parent or the owners.

Conclusion. On these facts the going concern basis is questionable, and the three conditions are cumulative and outside management's control. There is clearly a material uncertainty. Whether the going concern basis remains appropriate is the harder judgement: if liquidation is imminent or inevitable – a pending petition, no committed funding, an overdrawn position – the financial statements should be prepared on a liquidation basis and a going concern presentation is inappropriate.

Reporting.

• Material uncertainty, adequately disclosed, going concern basis still appropriate: unmodified opinion plus a separate Material Uncertainty Related to Going Concern section that refers to the disclosure, placed after the basis for opinion.
• Basis inappropriate: adverse opinion under ISA 570.
• Disclosure inadequate: qualified or adverse under ISA 705, depending on pervasiveness.

Do not sign before the court rules without considering the effect of that decision, and record how you dealt with the timing.

Accounting. Goods left in January 20X5, so the risks and rewards and control had not passed at 31 December 20X4: this is a cut-off error and the invoice does not create revenue. The effect is a CZK 36m receivable that should not exist, CZK 36m of revenue overstated and a CZK 24m loss on disposal that belongs in 20X5 if the transaction is genuine at all. Against materiality of CZK 15m, this is material individually.

Substance and related parties (ISA 550). A buyer incorporated at the address of the managing director's law firm, paying 40% below cost, is a signal to test whether it is an undisclosed related party. Search ARES, the insolvency register, VIES and any group structure chart; ask for beneficial ownership; obtain the sale contract, the shipping documents, the customs declaration and the bank receipt. If the buyer is a related party, the disclosure requirements apply and the business rationale must be documented.

Fraud (ISA 240). Fictitious or circular sales to conceal losses are a classic fraud pattern in a distressed company, and this one also transfers assets out of the company shortly before insolvency, which exposes the management to creditor-protection and possibly criminal-law consequences. Treat it as a fraud risk: extend the procedures to the whole sales ledger for November–December, look for similar invoices, and review credit notes issued after the year-end.

Professional and legal steps.

1. Raise it with the managing director and those charged with governance in writing, and require correction.
2. If management refuses to correct a material fraud-related misstatement, the opinion is qualified or adverse under ISA 705; resigning without reporting solves nothing.
3. The auditor is an obliged entity under Act No. 253/2008 Coll. (AML); a suspicious transaction must be reported to the Financial Analytical Office without tipping off the client.
4. The auditor is not entitled to breach confidentiality generally, but must assess whether any statutory duty to report applies (including under the Criminal Code) and should take legal advice before deciding.
5. Document everything: the evidence, the discussion, the advice, the decision and the communication. The file may later be required by an insolvency administrator or a court.

Czech insolvency framework. Under Act No. 182/2006 Coll. (Insolvency Act) a debtor is insolvent where it has multiple creditors and monetary obligations more than 30 days past due that it is unable to pay (§ 3). Here there are 22m of payables 68 days overdue, so the statutory test is met on its face. The debtor itself must file a petition without undue delay after learning of its insolvency (§ 98), and failure by the statutory body has consequences for its members personally. Once insolvency is declared, the debtor's ability to dispose of assets is restricted and a liquidation basis becomes the relevant accounting question.

Procedures before signing.

1. Search the insolvency register (insolvenční rejstřík) on or very close to the signing date, and print the search into the file.
2. Obtain management's written representation on the petition, on any communication with the bank and the investor, and on the completeness of disclosed subsequent events.
3. Inspect correspondence with the court, the supplier and the bank; confirm with the entity's lawyers whether any petition has been filed or is threatened.
4. Evaluate the event under ISA 560: the deteriorating liquidity existed at the reporting date, so the petition confirms a condition that existed at 31 December 20X4 and is adjusting for the going concern assessment, however the court decides.
5. Ask management to update the going concern disclosure to reflect the petition; without it the disclosure is incomplete.

If the court declares insolvency before 28 April. The going concern basis is no longer appropriate; the financial statements should be re-prepared on a liquidation basis, or the report must be modified with an adverse opinion on the going concern presentation. The auditor must not sign an unmodified report on a going concern basis once liquidation is the realistic outcome. Discuss the position with those charged with governance, consider whether the audit report should refer to the insolvency proceedings in an emphasis of matter section (only if the disclosure is adequate) and confirm that the entity has informed the bank and the court.

If the court has not ruled. That is not a reason to relax: the material uncertainty section is required, the disclosure must describe the petition, and the auditor documents why signing before the decision was appropriate and how the report addresses the outcome.