Practical issues in applying ISA 570 Revised: Going concern

Nov 30, 2020
Leigh Harrison outlines the practical issues, for both the auditor and management, that may arise when applying the revised going concern standard.

As auditors rapidly approach the start of ‘busy season’ and management near the end of the financial year, one of the biggest challenges that will impact on both the auditor and management are the changes to the going concern auditing standard.

The revised standard, applicable for periods beginning on or after 15 December 2019, increases the auditor’s work effort, which includes expanded risk assessment procedures over going concern, increased scrutiny over management’s going concern assessment and enhanced reporting requirements in the auditor’s report.

The directors’ responsibility for going concern is seated in company law, with the duty to prepare financial statements that give a true and fair view, in accordance with the applicable financial reporting framework. The accounting standards require the preparation of a going concern assessment, taking into account all available information about the future, for a period of at least 12 months. The financial statements are prepared on a going concern basis unless management determines that they intend to liquidate the entity, cease trading, or have no realistic alternative but to do so.

Complexities in the current year

The world is now a very different place than it was at the start of 2020. In a matter of months, COVID-19 swept across the globe. The pandemic subsequently led to travel restrictions, business closures, cancelled events, and lockdowns. Governments responded with a range of financial supports in an attempt to support jobs and businesses.

During this time, management will have had to revisit their business plans, forecasts and cash flows in response to the ever-changing economic environment. Meanwhile, calls for better climate change reporting and the end to the Brexit transition period compound the complexity.

Practical issues for management

Although the directors are ultimately responsible for the assessment of going concern, in many cases, they may delegate the preparation of the assessment to management. The directors will need to possess the skills and knowledge to understand and challenge the assessment prepared by management and have a robust governance, oversight and approval process to challenge and validate management’s assessment.

For management in smaller businesses, where an assessment of going concern may not have been formally prepared and documented in previous years, the requirement in the current year is likely to be a step-change. In some ways, the continually changing economic environment in which businesses currently operate will have prepared management for the preparation of their going concern assessment as they continuously re-assess the impact of change on their business.

Ahead of year-end, management should engage with their auditor to agree on the expected audit deliverables and ensure that they have the processes in place and resources required to perform the assessment.

Remote working may add further complications as inputs required for the assessment are likely to be prepared across the finance function, and team members may be on furlough. Management will need to factor in additional time for scenarios where, for example, additional funding is required or waivers of covenants must be negotiated and agreed, as credit approval may be delayed due to the impact of bank staff working remotely.

Management will need to have specific processes in place, including a risk assessment process to identify, assess and address risks facing the business relating to going concern. Management will also need to explain to the auditor how they measure and review financial performance, use their information systems to identify and capture events or conditions that may impact the going concern assessment, and how management identified the relevant method, data and assumptions used within their going concern assessment.

The assessment must be prepared and documented by management in all cases and should be tailored and right-sized for the business. For some non-complex businesses with high levels of cash reserves, management’s assessment may not require detailed cash flow forecasts. A memorandum detailing management’s analysis and considerations may suffice. In contrast, more complex entities will require a thorough assessment of current and future risks, forecasted cash flows, consideration of current funding available, and the identification and assessment of plans to address identified risks.

The area management must consider when preparing their assessment is wide-ranging and includes risks facing the business (both internal and external, current and future), the business environment, developments in the industry, and future prospective plans. The purpose of the assessment is to determine whether certain events or conditions may cast significant doubt on going concern and whether those events result in a material uncertainty to exist. In preparing and documenting their assessment of going concern, the auditor might expect to see the following:
  1. Analysis of the core operations of the business as they relate to going concern, including the business model, types of investments or disposals planned, how the business is financed and so on.
  2. Analysis of the current financial position compared to the prior year, considering key metrics such as net current assets/liabilities, operating cash inflow/outflow for the year-to-date, funding arrangements in place and related covenants, and so on.
  3. Analysis of the results post-year-end compared to the prior year, including revenue, profits, and status of funding.
  4. Details of events or conditions identified by management that may cast significant doubt on going concern and may affect the future performance of the business. For example, changes in demand for products or liquidity challenges.
  5. Where events or conditions are identified by management, management should document their plans to address those events.
  6. When management consider that a detailed assessment is required, they should document the model, assumptions and source of data used in their assessment. Management may find it useful to prepare a sensitivity analysis, where there are several potential assumptions or actions. The assumptions and data used in the assessment of going concern must be consistent with those used elsewhere in the business – when considering the valuation of goodwill, for example.

Practical issues for the auditor

In the planning phase, the auditor will need to ensure that the team has the resources and experience necessary to perform the required procedures.

Where the new requirements present a step-change for clients, it will be particularly important for the auditor to engage early. Doing so will help clients better understand the extent of audit evidence expected, and the level of input that will be required from management throughout the audit process to assist the auditor in their enquiries and procedures.

There is no prescribed methodology for management to use when preparing their assessment of going concern. In scenarios where management has determined that detailed forecasts and cash flows are not required, the auditor will need to use their professional judgement to determine whether they consider the assessment to be appropriately detailed. This may lead to difficult conversations.

At the other end of the scale, management’s assessment may include, for example, detailed forecasted cash flows that are built on complex models with multiple assumptions and sources of data. In these situations, the auditor will need to obtain a detailed understanding of the model, and careful consideration will be required to determine which assumptions and sources of data are critical to the assessment.
Professional judgement will be needed when designing the required audit procedures, which may include evaluating the design, implementation, and testing management’s controls over the process for preparing the assessment.

For 2020 year-ends, more entities will likely face liquidity issues given the continuing impact of COVID-19 on business. As such, management’s plans may include seeking reliance on group support. Auditors of components within groups will need to get a ‘big picture’ view of the group’s ability to provide the support required.

More than ever, there is a greater need for the auditor to maintain their professional scepticism, challenge management throughout the audit process, and evidence that on the audit file.

Conclusion

For some businesses, the implementation of the revised going concern standard will be a step-change that will result in changes to processes, controls, oversight arrangements and increased management input to prepare management’s assessment of going concern.

For the auditor, greater audit effort will be required, resulting in additional time input throughout the audit process. The auditor will need to exercise their professional judgement when evaluating management’s assessment, identifying the critical assumptions and data, considering whether sufficient appropriate audit evidence has been obtained, and concluding on going concern in the audit report. 
Leigh Harrison is Director at KPMG’s Department of Professional Practice.