What does ISA 570 (Ireland) Going Concern (Revised) mean for directors and statutory auditors? Noreen O’Halloran explains.
Trust matters. The importance of accurate and reliable corporate information, especially information subject to external audit, is fundamental to the confidence of shareholders, investors, and the wider public. Recent corporate failures, particularly in the UK, severely affected that confidence and unsurprisingly led to public concern over whether more could have been done to prevent these failures from occurring. The collapse of several high-profile companies prompted the UK government and regulators to conclude that radical action was necessary to restore public trust and confidence in audit quality and the effectiveness of the audit in the UK.
To identify the required changes, the UK government commissioned several very significant reports on the regulation and operation of statutory audits in the UK. These reports included Sir John Kingman’s Independent Review of the Financial Reporting Council (FRC), which stated that it was time for the FRC “to build a new house”. The report proposed that the FRC be replaced with a new independent statutory regulator with a clear focus on shareholders, investors and the wider public, and the power and support to regulate appropriately. Separately, the Competition and Markets Authority (CMA) conducted a study of the statutory audit market and provided its recommendations thereon. Sir Donald Brydon also carried out an independent review of the quality and effectiveness of the audit.
The FRC has witnessed examples of audit weakness through its inspection and enforcement work and believes that a revision of the International Standards on Auditing (ISAs) UK will assist in restoring public trust. One of the most noteworthy of these revised standards is ISA (UK) 570 Going Concern (Revised). The standard sets out significant changes from the previous standard, with the aim of strengthening investor confidence. The Irish Auditing and Accounting Supervisory Authority’s (IAASA) stated policy concerning standard-setting in the Republic of Ireland is to follow the FRC standards, amending where there is a conflict with Irish or EU law. IAASA has therefore released ISA 570 (Ireland) Going Concern (Revised), which is largely based on the FRC’s version. This standard is effective for statutory audits of Irish entities, like the FRC version, for periods commencing on or after 15 December 2019.
The standard addresses the auditor’s responsibility in the audit of the financial statements relating to going concern and requires the auditor to include an independent assessment of the entity’s ability to continue as a going concern. Nevertheless, attention must first be given to what the directors will be expected to provide to the auditor. The responsibility for making the going concern assessment of an entity has, and always will, rest with the directors. But going forward, directors must be prepared for increased scrutiny and challenge from the entity’s auditor in respect of their assessment of going concern, which may result in more work for the directors of an entity when making and supporting their going concern assessment.
Directors’ assessment
Where directors have not performed a going concern assessment, the auditor must request that one be completed and shared with the auditor. If the directors cannot, or will not, make an assessment, the auditor must consider whether there is a significant deficiency in the entity’s internal control system. The inability or unwillingness to prepare a going concern assessment will result in a limitation of scope in terms of the evidence available to the auditor. This limitation is likely to result in a qualified opinion in the auditor’s report.
The assessment made by the directors should take into consideration both the environment in which the entity operates and its internal systems and controls. The auditor will expect the directors to be able to show how developments in the industry or economic environment, along with internal operations, current and future business risks, and any future or prospective plans, have been taken into consideration to assess going concern. The directors’ assessment should explain how alternative methods, assumptions and data were considered. The directors of smaller companies or companies that may not have previously performed, or provided the auditor with, such a detailed assessment on going concern must identify the necessary additional steps.
A transparent process of internal review and challenge will also be important, as the auditor will need to understand the nature and extent of the entity’s oversight and governance regarding its going concern assessment. The oversight and governance within the entity will influence the auditor’s understanding of the effectiveness of the directors’ assessment of going concern. When the assessment has been delegated to management, the auditor should expect that the directors possess the skills and knowledge to understand the methods used by management, the ability to evaluate the assumptions used, and the authority to challenge management. Entities will need to consider whether changes to their systems of internal control are required. These changes will inevitably lead to increased costs for entities when making their going concern assessment, perhaps disproportionately so for smaller entities. Nevertheless, the UK market has demanded more reliable corporate information and IAASA believes that the public interest in Ireland is best served by adopting the FRC’s standard with minimal change.
The standard will also require increased work effort from the auditor:
- As part of the auditor’s risk assessment procedures, the auditor must design procedures that actively look for matters or conditions that may cast significant doubt on the entity’s ability to continue as a going concern;
- The auditor is required to obtain adequate support from the directors for the going concern assessment including methods, assumptions and sources of data used in the analysis;
- The auditor will need to evaluate how the directors have determined the relevance and accuracy of the methods and data used and understand whether alternative methods, assumptions and data have been considered;
- The auditor must maintain professional scepticism and probe the directors when audit evidence obtained suggests that there may be bias or contradictory evidence included in the assessment; and
- The auditor may perform a retrospective review of previous outcomes and forecasts to assist in measuring the effectiveness of the directors’ process for assessing going concern.
Events or conditions not identified by the directors
If the auditor identifies events or conditions that may cast doubt on the going concern assessment, and which the directors have not identified, the auditor must understand why the relevant events or conditions were not identified. They must also determine whether there is a significant deficiency in internal controls and perform additional audit procedures regarding the newly identified events and conditions.
Audit report implications
Shareholders and investors can expect to see a change in the auditor’s report with respect to reporting on going concern. The auditor previously reported by exception as to whether the directors’ use of the going concern basis of accounting was appropriate and whether appropriate disclosures were made. Going forward, the auditor must carry out a process of independent testing and examination on the entity’s assessment of its prospects and conclude based on sufficient and appropriate audit evidence. When the going concern basis is appropriate, the auditor’s report will include a conclusion that the auditor has not identified, either individually or collectively, any events or conditions that result in a material uncertainty that may cast doubt over the entity’s ability to continue as a going concern and that the directors’ use of the going concern basis of accounting is appropriate.
Also, for public interest entities and certain other entities, the auditor must make additional disclosures in the auditor’s report over and above those previously required. This includes an explanation as to how the auditor evaluated the directors’ assessment of the entity’s ability to continue as a going concern and, where relevant, key observations arising concerning that evaluation.
Conclusion
Re-establishing shareholder confidence and trust in the audit is critical. Society wants and expects more from auditors concerning the future prospects of entities. Sir Donald Brydon stated in his Independent Review into the Quality and Effectiveness of Audit that “audit is not broken, but it has lost its way and all the actors in the audit process bear some measure of responsibility”. The regulators are of the view that this new standard will go some way to re-establishing trust in the audit.
The intention of the standard is not to create a checklist for directors and auditors. Instead, it is to ensure that the directors and the auditors focus on the prospects of the entity and consider all available information. It will put the directors’ assessment of the entity’s ability to continue as a going concern under increased scrutiny and challenge by auditors. It will also, in some cases, lead to significant additional cost and effort for the directors and their auditors. However, if it can provide the earlier warning signs concerning corporate distress that are envisioned, this can only be of benefit to society.
Noreen O’Halloran ACA is a Director in the Department of Professional Practice
at KPMG.