Going concern under pressure: covenant breach and subsequent events
You are the engagement partner on the statutory audit of Alatau Machinery JSC (Kazakhstan), a manufacturer with a 31 December 2025 year end. Draft financial statements show profit before tax of KZT 410 million and total assets of KZT 9.2 billion. During the audit you learn that: (a) the company breached a covenant on a KZT 3.4 billion bank loan (current liabilities now include the full balance); (b) management obtained a written waiver from the bank dated 12 February 2026, but the waiver covers only the 31 December 2025 covenant test and the next test falls on 30 June 2026; (c) forecast cash flows show a shortfall of KZT 280 million in Q3 2026 unless a planned KZT 1.1 billion refinancing succeeds; (d) the audit report is expected to be signed on 20 March 2026. Management's going-concern assessment concludes no material uncertainty exists, citing the waiver and 'strong customer relationships'.
1. Evaluate whether management's going-concern conclusion is supportable and identify the specific audit procedures you would perform before concluding.
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Management's conclusion is not supportable on the evidence described.
Reasoning:
- The waiver is limited - it cures only the 31 December 2025 test. The 30 June 2026 test falls within the going-concern assessment period (at least 12 months from the date of the financial statements, i.e. to 31 March 2027), so the covenant risk is not eliminated.
- The Q3 2026 cash shortfall of KZT 280 million is a known liquidity gap that depends on an unconfirmed KZT 1.1 billion refinancing. An unexecuted refinancing is not, by itself, adequate evidence to remove material uncertainty.
- 'Strong customer relationships' is not audit evidence; forecasts must be corroborated.
Procedures:
- Obtain and inspect the loan agreement and the waiver; confirm directly with the bank that no further breach exists and the terms of the next covenant test.
- Obtain management's cash-flow forecast, test the arithmetic, and challenge the key assumptions (sales volumes, margins, collection periods) against historical data and post-year-end actuals.
- Obtain evidence of the status of the refinancing (term sheet, board approvals, lender correspondence); assess probability of completion.
- Perform a sensitivity analysis: what happens if the refinancing fails or is delayed?
- Review subsequent events to the report date (bank statements, new contracts, covenant compliance certificates).
- Obtain written representations from management and, where relevant, inquire of the bank and the company's legal counsel.
Conclusion: A material uncertainty related to going concern exists and must be disclosed; the auditor should include an Emphasis of Matter / Material Uncertainty paragraph (ISA 570) and consider whether the going-concern basis remains appropriate.
2. Draft the key elements of the auditor's report you would issue, and explain how the covenant breach affects the classification of the loan in the financial statements.
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Classification: At 31 December 2025 the loan was in breach; absent an unconditional waiver as at the reporting date, the liability must be classified as current (IAS 1). A waiver obtained on 12 February 2026 is a non-adjusting subsequent event for classification purposes unless it provides evidence of a condition existing at the reporting date - here it does not cure the breach that existed at 31 December 2025. The full KZT 3.4 billion should therefore be presented as current.
Auditor's report (ISA 700/701/570):
- Basis for opinion - state compliance with ISAs and IFRS.
- Material uncertainty related to going concern - a separate section under ISA 570, cross-referenced to the note in the financial statements describing the covenant breach, the limited waiver, the Q3 2026 cash shortfall and the pending refinancing. State that the events cast significant doubt on the entity's ability to continue as a going concern but that the financial statements adequately disclose the matter.
- Key Audit Matters - going concern and the loan covenant classification would be KAMs (if applicable).
- Opinion - unmodified, provided the disclosures are adequate; if disclosures are inadequate, a qualified or adverse opinion follows.
- Other information / responsibilities - standard sections.
Key point: The auditor does not remove the material uncertainty because a waiver exists; the waiver only addresses part of the risk and the refinancing remains unconfirmed.