Going concern and component auditor reliance at a listed hotel group
Serendib Leisure PLC is a Colombo-listed hotel group with a 60%-owned resort in the Maldives. At 31 March 2026 the group had net current liabilities of LKR 1.9 billion and a term loan of LKR 2.4 billion that is contractually repayable in June 2026. The group breached an interest-cover covenant at 31 March 2026. Management has a draft term sheet from the bank for a three-year refinancing, but the bank has not issued a binding commitment. Management also signed a conditional agreement on 15 May 2026 to sell a Colombo land parcel for LKR 1.8 billion, completion expected 31 August 2026. The cash-flow forecast shows positive headroom only if both the refinancing and the land sale complete. The audit report is due 30 June 2026. The Maldives resort, audited by a local firm, represents 15% of group assets and 22% of group revenue; the group team plans to rely on that firm's work without a site visit.
1. Evaluate whether it is appropriate for the group to prepare the financial statements on a going concern basis, and identify the additional audit evidence required before the auditor can conclude.
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The going concern basis is not automatically inappropriate merely because there are net current liabilities and a covenant breach. The test is whether the group can continue in operation for at least twelve months from the date of approval of the financial statements, or until the audit report is signed if later. Management's plans depend on two events that are not yet certain: a refinancing that is only a draft term sheet, and a conditional land sale due to complete after the audit report date. That creates a material uncertainty, but the basis may still be appropriate if the underlying forecasts are credible and adequate disclosure is made.
The auditor needs evidence that the bank has approved the refinancing or granted a waiver of the covenant breach for at least twelve months, not just a draft term sheet. The auditor should inspect the loan agreement, covenant calculations, board minutes, correspondence with the bank and any credit committee approval. For the land sale, the auditor should review the sale agreement, conditions precedent, buyer's funding evidence, legal opinion on title and completion risk, and any deposit received. The cash-flow forecast should be tested for arithmetical accuracy, challenged for key assumptions such as occupancy, room rates and costs, and subjected to downside sensitivities.
The auditor should also obtain written management representations, consider post-year-end events up to the report date, assess whether the group has other committed facilities or asset-sale options, and evaluate the adequacy of the going concern disclosure. If the refinancing or sale is still not sufficiently certain, the auditor cannot conclude that the going concern basis is appropriate without a material uncertainty disclosure. If the plans are not feasible, the basis may be inappropriate and the opinion would need to be modified.
2. Assume the auditor concludes that a material uncertainty exists and management discloses it adequately. Describe the effect on the auditor's report and on key audit matters. What changes if disclosure is inadequate?
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If the going concern basis is appropriate but a material uncertainty exists, the auditor expresses an unmodified opinion. The auditor's report must include a separate section headed 'Material Uncertainty Related to Going Concern', placed after the basis for opinion and before key audit matters. The section states that the auditor draws attention to the relevant note, that the events or conditions indicate a material uncertainty that may cast significant doubt on the entity's ability to continue as a going concern, and that the opinion is not modified. The section must refer specifically to the note and explain that the auditor's opinion does not express a separate opinion on the matter.
Under SLAuS 701, the going concern material uncertainty is normally communicated through the required going concern section rather than as a key audit matter. The auditor may still identify other significant risks, such as the valuation of the Maldives resort or the covenant breach, as key audit matters if they required significant auditor attention. The auditor should not describe the material uncertainty as a qualification, and should not use ambiguous language suggesting that the opinion is modified.
If management's disclosure is inadequate, the auditor should qualify the opinion on the grounds of material misstatement, or issue an adverse opinion if the matter is pervasive. If the going concern basis is inappropriate, the opinion should be adverse because the financial statements are prepared on an inappropriate basis. The auditor should also consider whether the situation requires communication with those charged with governance and, where required, the regulator.
3. Explain the group engagement team's responsibilities for the Maldives component auditor and whether a site visit is mandatory.
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The group engagement team remains responsible for the group audit opinion. SLAuS 600 requires it to obtain an understanding of the component auditor, evaluate the component auditor's professional competence and independence, communicate the group team's requirements to the component auditor, and determine the work to be performed on the component. The group team must also evaluate whether the component auditor's work is adequate for group purposes and review the component auditor's audit documentation, including the significant findings and the going concern assessment.
A site visit is not mandatory in every case. The need for a visit is risk-based. Factors include the significance of the component, the risks of material misstatement, the nature of the work required, the group team's prior experience with the component auditor, whether the component auditor is subject to independent inspection, and whether the component auditor has the resources and expertise for the resort's going concern and valuation issues. Given that the Maldives resort is 15% of group assets and 22% of revenue, and given the group's covenant breach, the group team should be more involved than a purely desk-based review. It should at least hold detailed discussions with the component auditor, review the component's audit plan and working papers, and consider a visit if the component auditor's work cannot be shown to be sufficient. The group team cannot simply rely on the local firm's report without evaluating the work.