Going concern: covenant breach, a short waiver and a stale forecast
Brantwood Care Homes Ltd operates 22 care homes and has a 31 March 2025 year end; the audit report is due 25 June 2025. At year end, net current liabilities were $8.2m and EBITDA was $3.6m against a $4.0m covenant on a $15m term loan, so the covenant was breached. The bank granted a waiver of the 31 March test on 5 May 2025, valid until 30 September 2025; the next test is 30 June 2025. Management's cash flow forecast to June 2026 assumes an 8% fee increase from July 2025, 95% occupancy, capital maintenance deferral of $2.1m, and refinancing of the term loan by December 2025, although no term sheet exists. Management's sensitivity shows a 5% occupancy shortfall causes a liquidity gap in February 2026; management nevertheless concludes there is no material uncertainty and discloses the waiver and the refinancing intention in a note. On 10 June 2025 Brantwood's largest local authority customer (22% of revenue) announced a fee review that could cut rates by 10% from October 2025. Management has not updated the forecast.
1. Evaluate whether a material uncertainty exists and whether the going concern disclosure is adequate.
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A material uncertainty exists if events or conditions cast significant doubt on the entity's ability to continue as a going concern. Several factors point that way here.
The covenant was breached at 31 March; the waiver runs only to 30 September 2025, and the 30 June test is the next cliff edge. The forecast's key assumptions are not adequately supported: an 8% fee increase with no contractual or regulatory basis, occupancy at 95%, a refinancing with no term sheet, and a $2.1m deferral of capital maintenance that may create regulatory and operational risk. Management's own sensitivity shows that a 5% occupancy shortfall produces a liquidity gap in February 2026, leaving very little headroom. The 10 June rate review announcement from a customer representing 22% of revenue increases the risk and makes the forecast out of date.
Management's conclusion that there is no material uncertainty is not supportable on these facts. The auditor should require an updated forecast, test the assumptions against external evidence such as fee schedules, local authority budgets, occupancy data and bank correspondence, and consider whether the waiver actually gives a right to defer settlement at the reporting date, which affects the current or non-current classification of the $15m loan.
Disclosure must state clearly that a material uncertainty exists, describe its nature and extent, and explain management's plans and the possible effects. A note that merely mentions the waiver and the refinancing intention is not adequate.
2. Analyse the effect on the auditor's report if management refuses to update the forecast or enhance the disclosure, and whether the going concern basis of preparation is still appropriate.
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If management refuses to update the forecast or strengthen the note, the auditor should first escalate to those charged with governance and explain the consequences. There are two separate questions.
First, is the going concern basis still appropriate? If the auditor concludes that the entity will continue for at least twelve months, the basis remains appropriate but the disclosure is inadequate, which is a misstatement. If the auditor concludes the entity is not a going concern, the financial statements should be prepared on a liquidation basis; refusing to do so would lead to an adverse opinion.
Second, what is the effect on the opinion? Inadequate disclosure when the basis is appropriate gives a qualified opinion where the effect is material but not pervasive, or an adverse opinion where it is pervasive. If the auditor cannot obtain the evidence needed because management will not cooperate, for example by refusing to provide an updated forecast or bank correspondence, that is a scope limitation, which leads to a qualified opinion or a disclaimer.
If the disclosure is adequate, the auditor issues an unmodified opinion with a separate Material Uncertainty Related to Going Concern section and includes the matter as a key audit matter. A disclaimer is not appropriate merely because there is a material uncertainty; it is reserved for pervasive scope limitations.
3. Explain how the post-year-end events, the waiver obtained on 5 May and the rate review announced on 10 June, affect the evaluation and the reporting.
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The waiver dated 5 May 2025 is a subsequent event, but its accounting effect is not simple. Under IAS 1, a loan is classified as current unless the entity has a right at the reporting date to defer settlement for at least twelve months. A waiver obtained after 31 March does not create that right at the reporting date unless the original agreement already gave the bank discretion, or the waiver confirms a right that existed. The auditor should inspect the loan agreement and the waiver wording; if the breach was not waived until May, the $15m loan is likely current at 31 March, which feeds directly into the net current liabilities and the going concern assessment.
The 10 June rate review announcement is a non-adjusting subsequent event, but it is relevant to going concern and to disclosure, and it undermines the forecast's fee assumptions. If the review was already under discussion before year end, it may provide evidence of conditions at the reporting date.
The auditor should consider whether the subsequent events indicate a material uncertainty, whether they require adjustment or disclosure, and whether management's assessment and the auditor's report adequately reflect them. Also consider the next covenant test at 30 June: it falls after the reporting date but before the report date, its outcome is unknown, and that uncertainty belongs in the going concern evaluation and in the auditor's consideration of subsequent events.