Sokha Apparel: covenant breach, overdraft renewal and a December cut-off
Sokha Apparel Manufacturing Co., Ltd is a Phnom Penh garment exporter with revenue of $42.4 million for the year ended 31 December 2025 and profit before tax of $1.9 million. You are engagement partner on the statutory audit. Overall materiality is $380,000 (0.9% of revenue) and performance materiality is $266,000.
Two matters emerged during fieldwork.
Covenant and liquidity. The main bank covenant requires a current ratio of at least 1.20:1 at year end; the draft statement of financial position shows 1.06:1, and no waiver has been issued. Management's going concern assessment covers twelve months from the date of the financial statements, assumes renewal of a $6 million overdraft that falls due in April 2026, and contains no sensitivity analysis. The overdraft has been rolled over annually for nine years.
Cut-off. Your sample identified four shipments with a carrying value of $512,000 recorded as December 2025 revenue, where the bills of lading are dated 3–6 January 2026. Sales invoices are dated 28–31 December 2025. The finance manager states the goods "left the factory" in December and that the company's terms are FOB Phnom Penh.
1. Evaluate management's going concern assessment and describe the further audit procedures you would perform before concluding whether the going concern basis is appropriate.
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Framework - ISA 570 (Revised). The going concern basis is presumed appropriate; my job is to challenge management's assessment, not to make it.
Deficiencies in management's assessment:
- Period covered. The assessment must cover at least twelve months from the date the financial statements are approved, not from the balance sheet date. Management's version is short by the period between year end and sign-off.
- No sensitivity analysis. A single-point forecast for a business whose largest customer represents 38% of revenue, with USD/KHR and minimum-wage exposure, is not a robust assessment.
- Unconfirmed refinancing. The plan depends on renewal of a $6 million overdraft and a covenant waiver that have not been agreed. A nine-year history of roll-over is corroborative but not evidence of the bank's present intention.
- Covenant breach already projected - this is an identified event or condition that casts doubt on the entity's ability to continue.
Additional procedures:
- Obtain the facility agreement and all bank correspondence; confirm directly with the bank whether a waiver or renewal has been granted and on what terms, and whether any cross-default applies.
- Obtain the cash flow forecast, check clerical accuracy and agree opening balances to the audited figures.
- Test the reasonableness of key assumptions against order books, post year-end sales and receipts, aged receivables, supplier credit terms and FX rates.
- Run downside scenarios (e.g. 20% revenue fall, loss of the largest customer, no overdraft renewal) and see whether headroom remains.
- Read board minutes, budgets and management accounts to the date of the audit report; enquire about any post year-end developments.
- Consider the enforceability of any shareholder or parent support letter.
- Obtain written representations on the plans and the completeness of the information provided.
Conclusion. If the bank confirms renewal and downside scenarios still leave adequate headroom, an unmodified opinion is appropriate. If a material uncertainty remains but is adequately disclosed, give an unmodified opinion with a separate "Material Uncertainty Related to Going Concern" section. If the basis is not appropriate, the opinion is adverse; if disclosure is inadequate, qualify on that basis.
2. Determine whether the four shipments are a misstatement, quantify the effect, and explain the consequence for the audit opinion if management refuses to adjust.
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Is it a misstatement? Under IFRS 15, revenue is recognised when control of the goods transfers. The bill of lading date is strong evidence of the shipment date, but control transfer depends on the shipping terms. The finance manager says the terms are FOB Phnom Penh: under FOB, risk and control pass when the goods are loaded on board at the port of shipment, which is consistent with the bill of lading date. On that evidence, control passed in January 2026, so recognising the $512,000 in December 2025 is premature. "Left the factory" is not the test; movement to the port is not delivery. I would inspect the actual sales contracts and Incoterms for these four customers before concluding - if the terms are DDP or CIF, control transfers even later, which reinforces the conclusion.
Quantification. Reverse revenue and receivables by $512,000; the goods remain the company's inventory in transit, so bring back the related cost (say $390,000), reducing cost of sales. Net effect: profit before tax down by about $122,000, and the required tax adjustments follow.
Effect on the current ratio. Receivables fall by $512,000 but inventory rises by the cost, so net current assets fall by roughly $122,000. The ratio therefore deteriorates, which widens the covenant breach and feeds directly into the going concern assessment.
Materiality and opinion. $512,000 exceeds overall materiality of $380,000, so it is material. If management refuses to adjust and the misstatement is not pervasive, issue a qualified ("except for") opinion. If it combines with the covenant matter to undermine the going concern basis, reassess whether the effect becomes pervasive and whether a disclaimer or adverse opinion is needed.
Other actions. Revenue recognition is a presumed fraud risk under ISA 240, so test whether other shipments show the same pattern, evaluate the control deficiency, and communicate the matter to those charged with governance.