Going concern: ISA 570

Every set of financial statements rests on a quiet assumption: the business will still be trading a year from now. If that is wrong, assets are worth less, liabilities may be higher and the figures mean something different. The directors must judge whether the assumption holds. The auditor must decide whether the directors’ judgement is sound and whether the statements say enough about any doubt.

Going concern is a favourite scenario topic. The examiner gives you losses, a net current liability position and a letter of comfort, and asks for the warning signs and the procedures. This topic gives you the method, the checklists and the report consequences, so you can answer with the case facts in front of you.

What the going concern basis means

The going concern assumption means the statement of financial position and the statement of comprehensive income are prepared on the assumption that the entity will continue in operational existence for the foreseeable future. It is a fundamental principle of financial reporting.

If the entity is not a going concern, the effect on the statements is large:

• the difference between current and non-current assets and liabilities ceases to have meaning, so everything becomes current;
• assets must be carried at net realisable value instead of cost or depreciated cost; and
• there may be additional liabilities, such as redundancy payments and penalties for breaking contracts.

This different way of preparing the statements is called the break-up basis. The auditor has to be satisfied that the going concern basis is appropriate, so the investigation of the entity’s financial and operating position cannot be left to the last minute.

Who is responsible: directors and auditor

The directors

In preparing the statements, the directors must satisfy themselves, under International Accounting Standard (IAS) 1, that the going concern basis is appropriate. In some countries large or listed companies must say in the annual report that, in the directors’ opinion, the company is a going concern. The assessment is management’s responsibility. The auditor’s job is to evaluate it, not to make it.

The auditor

ISA 570 sets three objectives for the auditor:

1. to obtain sufficient appropriate evidence about whether management’s use of the going concern assumption is appropriate;
2. to conclude whether a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern; and
3. to decide what this means for the audit report.

The auditor must perform risk assessment procedures to consider whether events or conditions exist that may cast significant doubt. If management has already made an assessment, the auditor must:

• discuss it with management;
• decide whether it identified relevant events or conditions; and, if it did,
• find out management’s plans to deal with them.

If management has not yet made an assessment, the auditor discusses with management the basis for intending to use the going concern assumption and asks whether events or conditions exist that may cast significant doubt.

The period of the assessment

The auditor looks at the same period as management. The syllabus says that if management looked less than 12 months ahead, the auditor asks management to reassess for at least 12 months. The auditor also asks whether management knows of relevant events or conditions beyond that period.

Background: The revised ISA 570 measures the 12 months from the date of approval of the financial statements, not from the reporting date. If management is unwilling to extend or make its assessment, the auditor considers the effect on the report, because it may be a limitation on the scope of the audit.

Events and conditions that raise doubt

The auditor stays alert throughout the audit for signs of trouble. ISA 570 gives examples, grouped in three headings.

One sign alone rarely decides the issue. A net current liability position matters less for a retailer that sells for cash and pays suppliers on credit than for a manufacturer with a loan falling due. The auditor looks at the combination and at management’s plans.

Audit procedures when doubt exists

When events or conditions have been found that may cast significant doubt, the auditor must obtain sufficient appropriate evidence to decide whether a material uncertainty exists. The procedures in the syllabus are:

1. Discuss with management. Ask why management thinks the assumption is valid and what its plans are. If a loss is expected next year, discuss what that means.
2. Obtain a cash flow forecast. Discuss it with management, check the assumptions and challenge them. If the forecast shows a shortage, ask how management will raise the finance.
3. Review the sales order book. A falling order book needs discussion.
4. Review the ageing of receivables. Slow payment weakens operating cash flow.
5. Consider planned capital expenditure. It may be too low to sustain the business.
6. Consider the loss of key staff. It might lead to the loss of key customers.
7. Consider litigation. A large claim could not be met if lost.
8. Ask the bank. If the entity relies on an overdraft or loan facility, ask the bank to confirm that it will remain available.
9. Obtain a letter of representation. Management confirms in writing that the entity is a going concern.

The syllabus also lists planning-stage and detailed procedures: review loan agreements and the entity’s relationships with finance providers, analyse interim or management accounts, review board minutes, review current and future order levels and customer relationships, and review operating plans and the availability of future resources. Forecasts should normally cover at least a year from the reporting date.

Letters of support

Background: Where management relies on a parent company, a shareholder or a director to keep the entity afloat, the auditor tests the value of the support. A letter of comfort or support is only as good as its answers to these questions:

• Is it legally binding, or is it only a statement of intent?
• Who signed it, and did that person have authority to commit the provider?
• Can the provider actually pay? The auditor looks at the provider’s own financial position, as a parent that is itself in difficulty gives weak comfort.
• How long does it last? It should cover at least 12 months from the date the statements are approved.
• Does it cover the full amount of the shortfall in the cash flow forecast?

In a group audit, the group auditor normally asks for a support letter from the parent’s directors when a subsidiary makes continuing losses but the group has decided to support it.

Communication and delays

Unless all of those charged with governance also manage the entity, the auditor must tell them about events or conditions that may cast significant doubt. The communication covers whether the events or conditions amount to a material uncertainty, whether the use of the going concern assumption is appropriate and whether the disclosures are adequate.

If the approval of the statements is significantly delayed and the auditor believes the delay is linked to going concern, the auditor must repeat the procedures and consider the effect of the delay on the conclusions.

What happens to the audit report

The full form of the report is covered in the later topic on the audit report. For this topic, learn the decision table.

If the auditor considers the going concern assumption invalid and management considers it valid, the auditor discusses the matter with management after carrying out more procedures and tries to persuade management to prepare the statements on a different basis, the break-up basis. If the statements are still prepared on the going concern basis, the auditor expresses an adverse opinion, because the effect is pervasive.

This is also the ISA 570 and ISA 705 position. A qualified report may be considered if management will not change its view. In the exam, give adverse for a clear case of inappropriate use, and mention the qualified option if the question asks what the auditor may consider.

If the statements are prepared on an acceptable alternative basis and it is adequately disclosed, the opinion can be unmodified, with an emphasis of matter paragraph to highlight the basis.

Management is usually reluctant to disclose a material uncertainty. Admitting doubt may alarm banks, suppliers, customers and staff, and it can look like a failure of management. Sometimes management sincerely believes that no uncertainty exists, and the disagreement is real. Either way, a refusal to give an adequate disclosure leaves the statements misstated, and the opinion is modified.

The syllabus also reproduces an International Auditing and Assurance Standards Board (IAASB) alert from the credit crisis. Its key points are that the assumption is fundamental, that management assesses it, that the auditor must consider it on every audit, and that a lack of credit in the economy can affect forecasts that management uses.

The rules in more depth

Material uncertainty and key audit matters

A material uncertainty related to going concern is by nature a key audit matter, but it is not described in the key audit matters section. It has its own section in the report. Matters that cause a modified opinion are also kept out of that section.

Why the basis can be appropriate when there is doubt

Doubt is not the same as failure. If management has credible plans, such as a binding refinancing agreement or asset sales at known prices, the basis may still be appropriate. The note then explains the events and the plans. The uncertainty is material if the plans may not succeed and the outcome would affect users’ decisions.

Subsequent events and going concern

A deterioration after the year end, such as a lender calling in a loan, can be a subsequent event that changes the going concern conclusion. IAS 10 says the statements must not be prepared on the going concern basis if management decides after the reporting date to liquidate or cease trading.

Worked example: a loan falling due

Scenario. Sable Packaging Ltd has a 31 December 2025 year end. Current assets are ₦620 million and current liabilities are ₦940 million. A ₦400 million term loan is repayable in May 2026. The company has a ₦250 million bank facility that expires in June 2026 and has not been renewed. Management’s forecast for 2026 shows opening cash of ₦20 million, operating cash inflow of ₦180 million and capital expenditure of ₦90 million.

Step 1: the ratios. Net current liabilities are ₦940 million − ₦620 million = ₦320 million. The current ratio is ₦620 million ÷ ₦940 million = 0.66. Both are warning signs.

Step 2: test the forecast. Cash available before the loan is ₦20 million + ₦180 million − ₦90 million = ₦110 million. After the ₦400 million loan repayment, the position is ₦110 million − ₦400 million = −₦290 million. If the facility is renewed in full, the position is −₦290 million + ₦250 million = −₦40 million. There is still a shortfall of ₦40 million.

Step 3: sensitivity. If operating cash inflow is 10% lower, it falls by ₦18 million to ₦162 million, and the shortfall widens to ₦40 million + ₦18 million = ₦58 million. The forecast leaves no headroom.

Step 4: decide the procedures. The auditor asks the bank to confirm the facility terms and the timing of renewal, obtains evidence of any binding refinancing or parent support, checks the loan agreement for covenants, reviews the order book and receivables ageing, and obtains a representation letter.

If management has a binding ₦100 million support letter from a financially sound parent covering 12 months from approval, the shortfall is covered and the basis is likely to be appropriate. But a note on the uncertainty may still be needed. If no support exists and the facility is not renewed, a material uncertainty exists and, if the note is adequate, the report carries the separate going concern section.

How to score full marks

• Quote the case. Use the numbers and facts in the scenario for every sign of doubt. Write “net current liabilities of ₦320 million”, not “liquidity problems”.
• Group the signs. Financial, operating and other headings help you cover the field.
• Name the procedure and what it tests. “Obtain the cash flow forecast and challenge the assumptions” earns the mark. “Check liquidity” does not.
• Test the support. Whenever a letter of comfort appears, assess whether it is binding, who signed it, whether the provider can pay and how long it lasts.
• End with the report. State the effect on the opinion for each outcome.

Common mistakes in the exam

• Listing general audit procedures instead of going concern procedures.
• Missing the signs in the scenario that the examiner placed there on purpose.
• Accepting a letter of comfort at face value.
• Saying the auditor makes the going concern assessment. Management makes it.
• Putting a going concern uncertainty in the key audit matters section.
• Giving an unmodified opinion with the separate section when the disclosure is inadequate.

Quick revision

• Going concern: the entity will continue for the foreseeable future. If not, use the break-up basis.
• Management assesses, the auditor evaluates, over at least 12 months in the syllabus.
• Signs: financial, operating and other.
• Procedures: management, forecast, order book, receivables, capital expenditure, key staff, litigation, bank, representation letter, communication with governance.
• Letters of support: binding, signed by an authorised person, provider able to pay, long enough, big enough.
• Report: unmodified with separate section, qualified or adverse for inadequate disclosure, adverse if the basis is inappropriate, with the qualified option noted.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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