[130] The going concern basis in financial statements

Transcription

1 [130] The going concern basis in financial statements (Issued November 1994) Contents Paragraphs Introduction 1 2 The applicability and scope of this SAS 3 16 Definitions Audit evidence Assessing disclosures in the financial statements Reporting on the financial statements Application to groups Preliminary announcements 53 Financial statements not prepared on the going concern basis Compliance with International Standards on Auditing 56 Effective date 57 Withdrawal of material in other guidance 58 Appendix 1 Preparation of the financial statements: note on legal and professional requirements Appendix 2 Illustrative examples of audit procedures and auditors reports Appendix 3 Illustrative examples of the auditors assessment of whether evidence provided to them by the directors, concerning the attention they have paid to the period one year from the date of approval of the financial statements, is sufficient Appendix 4 Going concern and reporting on the financial statements

2 The going concern basis in financial statements Statements of Auditing Standards ( SASs ) are to be read in the light of The scope and authority of APB pronouncements. In particular, they contain basic principles and essential procedures ( Auditing Standards ), indicated by paragraphs in bold type, with which auditors are required to comply in the conduct of any audit. SASs also include explanatory and other material which is designed to assist auditors in interpreting and applying Auditing Standards. The definitions in the Glossary of terms are to be applied in the interpretation of SASs. Introduction The purpose of this SAS is to establish standards and provide guidance for auditors in respect of their consideration of the going concern basis in financial statements prepared by directors. When forming an opinion as to whether financial statements give a true and fair view, the auditors should consider the entity s ability to continue as a going concern, and any relevant disclosures in the financial statements. (SAS 130.1) 1 2 The applicability and scope of this SAS This SAS contains standards and guidance for auditors in relation to the going concern basis that is generally presumed in financial statements which are required to be properly prepared in accordance with the Act, and to give a true and fair view. In the absence of specific legal or other provisions to the contrary, the principles and procedures embodied in the SAS apply also to the audit of the financial statements of other entities, including those within the public sector. This SAS does not establish standards nor provide guidance about going concern in any other context, such as that of an engagement to report on an entity s future viability. In particular, Bulletin 1994/1 Disclosures relating to corporate governance (Revised) gives advice to auditors in connection with any statement regarding going concern made by the directors in compliance with the Code of Best Practice published by the Committee on The Financial Aspects of Corporate Governance ( The Cadbury Report ). Guidance for directors in relation to such a statement is contained in Going Concern and Financial Reporting: Guidance for directors of listed companies. 3 4 Going concern as an accounting concept Appendix 1 to this SAS summarises, in relation to going concern, the legal and professional accounting requirements with which directors comply in preparing financial statements. Under these accounting requirements (and consequently for the purposes of this SAS) the going concern basis is considered as an accounting concept in accordance with which financial statements are generally prepared on a presumption that the entity will continue in operational existence for the foreseeable future. Accordingly, in financial statements: 5

3 (a) assets are recognised and measured on the basis that the entity expects to recover (through use or realisation) the recorded amounts in the normal course of business; and (b) liabilities are recognised and measured on the basis that they will be discharged in the normal course of business. Where the directors are unable to accept the going concern presumption on the basis of their own information and judgments, the entity may not be able to recover (through use or realisation) the amounts recorded in the financial statements in respect of its assets. There may also be changes in the amounts and dates of maturities of liabilities. In these circumstances, the amounts and classification of assets and liabilities in the financial statements would need to be adjusted by the directors if the effects were material. 6 An important consequence of the legal and professional accounting requirements is that, when preparing financial statements, the directors should satisfy themselves as to whether the going concern basis is appropriate. Even if it is appropriate, it may still be necessary for the financial statements to contain additional disclosures, for instance relating to the adoption of that basis, in order to give a true and fair view. 7 Accordingly, the auditors procedures in complying with this SAS are intended to provide them with assurance that: (a) the going concern basis used in the preparation of the financial statements as a whole is appropriate; and (b) there are adequate disclosures regarding that basis in the financial statements in order that they give a true and fair view. 8 The auditors procedures necessarily involve a consideration of the entity s ability to continue in operational existence for the foreseeable future. In turn, that necessitates consideration both of the current and the possible future circumstances of the business and the environment in which it operates. Foreseeable future: guidance and inherent limitations in application 9 In defining the going concern accounting concept, Statement of Standard Accounting Practice Number 2 ( SSAP 2 ) uses the term foreseeable future without further elaboration. Neither the Act nor accounting standards expand on that term in the context of going concern. 10 Any consideration involving the foreseeable future involves making a judgment, at a particular point in time, about future events which are inherently uncertain. The following factors are relevant. (a) In general terms, the degree of uncertainty increases significantly the further into the future the consideration is taken. The manner in which the uncertainty increases with time depends on the circumstances of each particular entity. (b) Any judgment about the future is based on information available at the time at which it is made. Subsequent events can overturn a judgment which was reasonable at the time it was made. 11 Accordingly, the foreseeable future depends on the specific circumstances at a point in time, including the nature of the entity s business, its associated risks and external influences.

4 As a consequence, it is not possible to give any certainty in relation to going concern. Any judgment made, whether by directors or auditors, although reasonable at the time, can be valid only at that time and can be overturned by subsequent events. 12 Consideration of going concern by the directors and auditors In assessing going concern, directors take account of all relevant information of which they are aware at the time. The nature of the exercise entails that the directors look forward, and there will be some future period to which they will pay particular attention in assessing going concern. It is not possible to specify a minimum length for this period: it is recognised in any case that any such period would be artificial and arbitrary since in reality there is no cut off point after which there should be a sudden change in the approach adopted by the directors. The length of the period is likely to depend upon such factors as: the entity s reporting and budgeting systems; and the nature of the entity, including its size or complexity. 13 Where the period considered by the directors has been limited, for example, to a period of less than one year from the date of approval of the financial statements, the directors will have determined whether, in their opinion, the financial statements require any additional disclosure to explain adequately the assumptions that underlie the adoption of the going concern basis. The basis for the auditors procedures is the information upon which the directors have based their assessment and the directors reasoning. The auditors assess whether this constitutes sufficient appropriate audit evidence for their purpose and whether they concur with the directors judgment about the need for additional disclosures. The following factors in particular may affect the information available to auditors, and whether the auditors consider this information constitutes sufficient audit evidence for the purposes of their audit. (a) The nature of the entity (its size and the complexity of its circumstances, for instance). This SAS applies to the audits of the financial statements of all sizes of entity. The larger or more complex the entity the more sophisticated is likely to be the information available and needed to support the assessment of whether it is appropriate to adopt the going concern basis. (b) Whether the information relates to future events, and if so how far into the future those events lie. The information relating to the period falling after one year from the balance sheet date is often prepared in far less detail and subject to a greater degree of estimation than the information relating to periods ending on or before one year from the balance sheet date. Appendix 2 illustrates how the auditors might decide to apply the SAS in certain circumstances. Example 1 within that Appendix is of particular relevance to entities with uncomplicated circumstances, which includes many smaller companies Definitions The following definitions apply for the purposes of interpreting the requirements and the guidance in this SAS. 17

5 18 The going concern basis: financial statements prepared under the presumption that the entity is carrying on business as a going concern are described in this SAS as being prepared on the going concern basis. 19 The Act: for Great Britain, the Act refers to the Companies Act For Northern Ireland, the equivalent legislation is provided by the Companies (Northern Ireland) Order 1986 and for the Republic of Ireland by the Companies Acts 1963 to Directors: the directors of a company or other body, the partners, proprietors, committee of management or trustees of other forms of entity, or equivalent persons responsible for directing the entity s operations and preparing its financial statements. Audit evidence 21 The auditors should assess the adequacy of the means by which the directors have satisfied themselves that: (a) it is appropriate for them to adopt the going concern basis in preparing the financial statements; and (b) the financial statements include such disclosures, if any, relating to going concern as are necessary for them to give a true and fair view. For this purpose: (i) the auditors should make enquiries of the directors and examine appropriate available financial information; and (ii) having regard to the future period to which the directors have paid particular attention in assessing going concern, the auditors should plan and perform procedures specifically designed to identify any material matters which could indicate concern about the entity s ability to continue as a going concern. (SAS 130.2) 22 The examples in Appendix 2 illustrate the importance of planning the audit approach regarding going concern. The auditors approach includes a preliminary assessment (at the stage at which they are developing an overall audit plan) of the risk that the entity may be unable to continue as a going concern. 23 The auditors may need to consider some or all of the following matters: whether the period to which the directors have paid particular attention in assessing going concern is reasonable in the entity s circumstances and in the light of the need for the directors to consider the ability of the entity to continue in operational existence for the foreseeable future; the systems, or other means (formal or informal), for timely identification of warnings of future risks and uncertainties the entity might face; budget and/or forecast information (cash flow information in particular) produced by the entity, and the quality of the systems (or other means, formal or informal) in place for producing this information and keeping it up to date; whether the key assumptions underlying the budgets and/or forecasts appear appropriate in the circumstances; the sensitivity of budgets and/or forecasts to variable factors both within the control of the directors and outside their control;

6 any obligations, undertakings or guarantees arranged with other entities (in particular, lenders, suppliers and group companies) for the giving or receiving of support; the existence, adequacy and terms of borrowing facilities, and supplier credit; and the directors plans for resolving any matters giving rise to the concern (if any) about the appropriateness of the going concern basis. In particular, the auditors may need to consider whether the plans are realistic, whether there is a reasonable expectation that the plans are likely to resolve any problems foreseen and whether the directors are likely to put the plans into practice effectively. In many entities the headroom between the financial resources required in the foreseeable future and the facilities available is large. In others, it will often be marginal. The nature and scope of the auditors procedures depends on the circumstances. The extent of the procedures is influenced primarily by the excess of the financial resources available to the entity over the financial resources that it requires. The entity s procedures (and the auditors procedures) need not always be elaborate in order to provide sufficient appropriate audit evidence. For example, auditors may not always need to examine budgets and forecasts for this purpose. This is particularly likely to be the case in respect of entities with uncomplicated circumstances. Many smaller companies fall into this category. Thus for example: regarding the systems or other means for timely identification of warnings of future risks and uncertainties, the directors might consider that it is appropriate simply to keep abreast of developments within their individual business and their business sector. In the circumstances, the auditors might concur with the directors, or the directors might not, as a matter of course, prepare periodic cash flow and other budgets, forecasts or other management accounts information apart from the accounting records required by law and outline plans for the future. In the directors view, this might be acceptable where the business is stable. In the circumstances the auditors might concur with the directors. Hence the auditors procedures regarding budgets, forecasts and related issues might comprise discussion of the directors outline plans in the light of other information available to the auditors. 24 The auditors examination of borrowing facilities In examining borrowing facilities the auditors could decide, for example, that it is necessary: (a) to obtain confirmations of the existence and terms of bank facilities; and (b) to make their own assessment of the intentions of the bankers relating thereto. 25 The latter assessment could involve the auditors examining written evidence or making notes of meetings which they would hold with the directors and, occasionally, with the directors and the entity s bankers. In making their assessment of the bankers intentions the auditors ascertain, normally through enquiries of the directors, whether the bankers are aware of the matters that are causing the auditors to decide that such an assessment is necessary. It is also important that the relationships between the auditors, the directors and the bankers are clarified and understood.

7 26 The auditors might be more likely to decide that it is necessary to obtain confirmations of the existence and terms of bank facilities, and to make their own assessment of the intentions of the bankers relating thereto, in cases where, for example: there is a low margin of financial resources available to the entity; the entity is dependent on borrowing facilities shortly due for renewal; correspondence between the bankers and the entity reveals that the last renewal of facilities was agreed with difficulty, or that, since the last review of facilities, the bankers have imposed additional conditions as a prerequisite for continued lending; a significant deterioration in cash flow is projected; the value of assets granted as security for the borrowings is declining; or the entity has breached the terms of borrowing covenants, or there are indications of potential breaches. 27 In accordance with SAS 600 Auditors report on financial statements the auditors consider whether any inability to satisfy themselves regarding the existence and terms of borrowing facilities and the intentions of the lender relating thereto, and/or the factors giving rise to this inability, need to be: disclosed in the financial statements in order that they give a true and fair view; and/or referred to (by way of an explanatory paragraph or a qualified opinion) in the auditors report. 28 The British Bankers Association has assisted in drafting the guidance above and in Appendix 2, regarding the auditors examination of the entity s banking facilities. The guidance aims to improve communications between directors, auditors and bankers, whilst stressing the importance of each party s clear understanding of their relationships to each other. The guidance does not alter existing practice regarding confirmation letters from bankers about their intentions concerning facilities. Determining and documenting the auditors concerns 29 The auditors should determine and document the extent of their concern (if any) about the entity s ability to continue as a going concern. In determining the extent of their concern, the auditors should take account of all relevant information of which they have become aware during their audit. (SAS 130.3) 30 In addition to information obtained having regard to the future period to which the directors have paid particular attention, the information of which the auditors are aware includes: (a) any information of which they have become aware relating to the period thereafter; and (b) their other audit evidence (such as their knowledge of the entity, its industry and possible developments therein). 31 The auditors might be more likely to conclude that there is a significant level of concern about the entity s ability to continue as a going concern if, for example, indications such as the following are present:

8 Financial an excess of liabilities over assets; net current liabilities; necessary borrowing facilities have not been agreed; default on terms of loan agreements, and potential breaches of covenant; significant liquidity or cash flow problems; major losses or cash flow problems which have arisen since the balance sheet date and which threaten the entity s continued existence; substantial sales of fixed assets not intended to be replaced; major restructuring of debt; denial of (or reduction in) normal terms of trade credit by suppliers; major debt repayment falling due where refinancing is necessary to the entity s continued existence; inability to pay debts as they fall due; Operational fundamental changes in the market or technology to which the entity is unable to adapt adequately; externally forced reductions in operations (for example, as a result of legislation or regulatory action); loss of key management or staff, labour difficulties or excessive dependence on a few product lines where the market is depressed; loss of key suppliers or customers or technical developments which render a key product obsolete; Other major litigation in which an adverse judgment would imperil the entity s continued existence; and issues which involve a range of possible outcomes so wide that an unfavourable result could affect the appropriateness of the going concern basis. However, in situations such as these the auditors may have obtained sufficient appropriate evidence causing them to conclude that there is not a significant level of concern about the entity s ability to continue as a going concern. Appendix 2, example 1 contains such a situation. The auditors could consider that there is a significant level of concern about the entity s ability to continue as a going concern, or they could disagree with the preparation of the financial statements on the going concern basis. In such cases (whether or not this is because of potential insolvency) the auditors might decide to write to the directors drawing their attention to the need to consider taking suitable advice. In particular, the directors of an entity may need to obtain advice from specialist accountants or lawyers on the appropriateness and implications of continuing to trade while they know, or ought to know, that the entity is insolvent. 32 Written confirmations of representations from the directors The auditors should consider the need to obtain written confirmations of representations from the directors regarding: 33

9 (a) the directors assessment that the company is a going concern; and (b) any relevant disclosures in the financial statements. (SAS 130.4) 34 Such written confirmations are necessary in respect of matters material to the financial statements when those representations are critical to obtaining sufficient appropriate audit evidence. In view of their importance, it is appropriate for such confirmations to be provided by the directors, rather than other levels of the entity s management. 35 If they are unable to obtain such written confirmations of representations as they consider necessary from the directors, the auditors consider whether: in the light of SAS 600 Auditors report on financial statements, there is a limitation on the scope of their work which requires a qualified opinion in except for or disclaimer terms; or the failure of the directors to provide the written confirmations could indicate that there is concern. Assessing disclosures in the financial statements 36 The auditors should consider whether the financial statements are required to include disclosures relating to going concern in order to give a true and fair view. (SAS 130.5) 37 If the going concern basis is inappropriate at the balance sheet date or significantly uncertain in the foreseeable future, this affects the manner in which the other fundamental accounting concepts are applied in the financial statements. It is thus important, where there is concern as to the entity s ability to continue as a going concern, that readers of the financial statements have a proper understanding of the context in which the directors have satisfied themselves that the financial statements prepared on the going concern basis show a true and fair view. Therefore, in such cases, if the financial statements do not include disclosures relating to the entity s ability to continue as a going concern, the auditors consider: whether the financial statements give a true and fair view; and hence whether they need to qualify their audit opinion in respect of disagreement with the disclosure of this matter in the financial statements. 38 In particular, if the future period to which the directors have paid particular attention is, as described in paragraph 13, not very long, the directors will have determined whether, in their opinion, the financial statements require any additional disclosures to explain adequately the assumptions that underlie the adoption of the going concern basis. The auditors assess whether they concur with the directors judgments regarding the need for additional disclosures and their adequacy. Disclosure, however, does not eliminate the need to make appropriate judgments about the suitability of the future period as an adequate basis for assessing the position. 39 To avoid repetition, the text in the financial statements might refer readers to specific disclosures located elsewhere in the annual report (for instance in the Operating and Financial Review). The auditors take account of such specified disclosures in considering the adequacy of disclosures in the financial statements.

10 Reporting on the financial statements In relation to going concern Appendix 4 summarises, in flowchart form, how auditors formulate their opinion as to whether the financial statements give a true and fair view. When auditors of regulated financial entities consider that they might need to either qualify their audit opinion or add an explanatory paragraph to their report, they may have a duty to inform the appropriate regulator at an early stage in the audit. In such cases the regulator might, if it has not already done so, specify corrective action to be taken by the entity. At the time at which they formulate their report, the auditors take account of matters such as: any views expressed by the regulator; any legal advice obtained by the directors; and the actual and planned corrective action. Where the auditors consider that there is a significant level of concern about the entity s ability to continue as a going concern, but do not disagree with the preparation of the financial statements on the going concern basis, they should include an explanatory paragraph when setting out the basis of their opinion. They should not qualify their opinion on these grounds alone, provided the disclosures in the financial statements of the matters giving rise to the concern are adequate for the financial statements to give a true and fair view. (SAS 130.6) This requirement is consistent with SAS 600, Auditors report on financial statements. The explanatory paragraph describes clearly the nature of the matters giving rise to the auditors concern and refers to the relevant disclosures in the financial statements. The auditors use their judgment to decide the extent to which it is necessary for the description in their report to repeat information taken from the notes to the financial statements. The extent of the auditors concern is one factor affecting the nature and extent of the description in the auditors report. The prime consideration is clarity of communication. The description is normally identified within the auditors report through the use of the sub-heading Going concern. The auditors might have concluded that there is a significant level of concern about the entity s ability to continue as a going concern. In these cases the auditors do not normally regard the disclosures as adequate unless (in addition to any disclosures otherwise required, for example by accounting standards) the following matters are included in the financial statements: a statement that the financial statements have been prepared on the going concern basis; a statement of the pertinent facts; the nature of the concern; a statement of the assumptions adopted by the directors, which should be clearly distinguishable from the pertinent facts; (where appropriate and practicable) a statement regarding the directors plans for resolving the matters giving rise to the concern; and details of any relevant actions by the directors Neither the guidance above, nor the illustrative examples in Appendix 2, regarding disclosures in the financial statements constitute accounting standards.

11 45 If the period to which the directors have paid particular attention in assessing going concern is less than one year from the date of approval of the financial statements, and the directors have not disclosed that fact, the auditors should do so within the section of their report setting out the basis of their opinion, unless the fact is clear from any other references in their report. They should not qualify their opinion on the financial statements on these grounds alone. (SAS 130.7) 46 Where, in forming their opinion, the auditors have based their assessment of going concern on a period to which the directors have paid particular attention which is less than one year from the date of approval of the financial statements, it is appropriate for the auditors to disclose that fact within the basis of their opinion, unless it is disclosed in the financial statements or accompanying information (for example, the Operating and Financial Review). In deciding whether to disclose the fact, the auditors assess whether the evidence supplied to them by the directors is sufficient to demonstrate that the directors have, in assessing going concern, paid particular attention to a period of one year from the date of approval of the financial statements. 47 A determination of the sufficiency of the evidence supplied to the auditors by the directors will depend on the particular circumstances. However, to be sufficient the evidence may not require formal cash flow forecasts and budgets to have been prepared for the period ending one year from the date of approval of the financial statements. Although such forecasts and budgets are likely to provide the most persuasive evidence alternative sources of evidence may also be acceptable. Often, the auditors through discussion with the directors of their plans and expectations for that period may be able to satisfy themselves that the directors have in fact paid particular attention to a period of one year from the date of approval of the financial statements. Appendix 3 illustrates circumstances where formal budgets and forecasts have, with justification, not been provided for the entire twelve month period yet the auditors are able to conclude that the directors have paid particular attention to the period ending one year from the date of approval of the financial statements. 48 The auditors qualify their opinion if they consider that the directors have not taken adequate steps to satisfy themselves that it is appropriate for them to adopt the going concern basis. This might arise, for example, when the auditors do not consider that the future period to which the directors have paid particular attention in assessing going concern is reasonable in the entity s circumstances. This is a limitation on the scope of the auditor s work, as they are unable to obtain all the information and explanations which they consider necessary for the purpose of their audit. 49 Where the auditors disagree with the preparation of the financial statements on the going concern basis, they should issue an adverse audit opinion. (SAS 130.8) 50 Where the going concern presumption is inappropriate: even disclosure in the financial statements of the matters giving rise to this conclusion is not sufficient for them to give a true and fair view, and the effect on financial statements prepared on that basis is so material or pervasive that the financial statements are seriously misleading. Accordingly, an adverse opinion is appropriate in such cases.

12 Application to groups The principles and procedures set out in this SAS apply also to the audit of consolidated financial statements. It may be appropriate, on the grounds of materiality, for the group financial statements to be prepared on the going concern basis even though it is inappropriate for the individual financial statements of one or more members of the group to be prepared on the going concern basis Preliminary announcements The London Stock Exchange does not explicitly require a preliminary announcement to refer to the company s ability to continue as a going concern. However, the auditors would be unlikely to agree a preliminary announcement if they have concluded that there is a significant level of concern about that matter which is not appropriately disclosed in the announcement. 53 Financial statements not prepared on the going concern basis In rare circumstances, in order to give a true and fair view, the directors may have prepared financial statements on a basis other than that of a going concern. If the auditors consider this other basis to be appropriate in the specific circumstances, and if the financial statements contain the necessary disclosures, the auditors should not qualify their audit opinion in this respect. (SAS 130.9) Some enterprises are formed for a specific purpose, such as a joint venture to undertake a construction project, and are wound up or dissolved when the purpose is achieved. Under these circumstances the financial statements may be prepared on a basis that reflects the fact that assets may need to be realised other than in the ordinary course of operations. In these circumstances the auditors may wish, without qualifying their opinion, to refer in their report to the basis on which the financial statements are prepared; the auditors may do this in the introductory paragraph of their report Compliance with International Standards on Auditing Compliance with this SAS ensures compliance in all material respects with International Standard on Auditing 570 Going Concern. 56 Effective date Auditors are required to comply with the requirements of this SAS in respect of audits of financial statements for financial periods ending on or after 30 June Adoption of the requirements when reporting on financial statements for financial periods ending before that date is encouraged. 57

13 Withdrawal of material in other guidance 58 This SAS supersedes guidance given to auditors in the Auditing Guideline The auditor s consideration in respect of going concern. Appendix 1 Preparation of the financial statements: note on legal and professional requirements Company law and accounting standards 1 The Act specifies certain accounting principles which should normally be adopted in preparing the financial statements of a company. One of these principles is that: the company shall be presumed to be carrying on business as a going concern (paragraph 10 of Schedule 4 to the Act). However such a presumption is not conclusive and may be disregarded if the facts of the particular situation so require. The term going concern is not defined in the Act but, as discussed below, is defined in SSAP 2. 2 Paragraph 15 of Schedule 4 to the Act states that departures from the Act s accounting principles may be made if it appears to the directors that there are special reasons for doing so. The financial statements must disclose any such departure, the reasons for it and its effect. Special reasons would include circumstances where the directors conclude, on the basis of the facts as they appear to them, that it is appropriate to depart from the going concern presumption. 3 Furthermore, in addition to that particular provision of the Act, section 226 of the Act contains an overriding requirement for directors to prepare financial statements which give a true and fair view of the state of affairs of the company as at the end of the financial year and of its profit or loss for the financial year. 4 If compliance with the provisions of the Act would not be sufficient to give a true and fair view, the Act requires the directors to give the necessary additional information in the financial statements. If, in special circumstances, compliance with the provisions of the Act is inconsistent with the requirement to give a true and fair view, the Act requires the directors to depart from the particular provision to the extent necessary to give a true and fair view. The financial statements must disclose the particulars of any such departure, the reasons for it and its effect. 5 Accordingly, directors cannot assume that preparing the financial statements on the going concern basis and in accordance with the other provisions of the Act will necessarily result in the financial statements giving a true and fair view. Whilst, in general, compliance with accounting standards is also necessary to meet the requirement to prepare financial statements giving a true and fair view, such compliance is not of itself sufficient to ensure that a true and fair view is given in all cases. Accounting standards and the definition of going concern 6 SSAP 2 identifies going concern as one of the fundamental accounting concepts and defines going concern thus:

14 the enterprise will continue in operational existence for the foreseeable future. This means in particular that the profit and loss account and balance sheet assume no intention or necessity to liquidate or curtail significantly the scale of operation. SSAP 2 also provides that if financial statements are prepared on the basis of assumptions which differ materially from those concepts the facts should be explained in the financial statements. This is similar to the statutory requirement to disclose departures from accounting principles. However, there are currently no more detailed accounting standards or guidance dealing specifically with going concern as an accounting principle. 7 Appendix 2 Illustrative examples of audit procedures and auditors reports The appendix is illustrative only and does not form part of the Auditing Standards. The purpose of the appendix is to illustrate the application of the Auditing Standards to assist in clarifying their meaning in a number of commercial situations. The examples focus on particular aspects of the situations illustrated and are not intended to be a comprehensive discussion of all the relevant factors that might influence either the directors or auditors assessments of the appropriateness of the going concern basis. As auditors would need to exercise judgment in the circumstances described it is possible that different auditors may arrive at different conclusions. This does not, however, detract from the examples which demonstrate thought process and the implications for an audit report once certain conclusions have been reached by the auditors. These examples neither modify nor override the Auditing Standards. Example 1 A company with uncomplicated circumstances and a significant bank overdraft Situation 1 Auditors consider that the possibility of the overdraft facility not being renewed is remote. Unqualified auditors report without an added explanatory paragraph. Situation 2 The possibility of the overdraft facility not being renewed is not remote, but auditors do not consider there is a significant level of concern about the ability of the company to continue as a going concern. Relevant disclosures in the financial statements. Unqualified auditors report without an added explanatory paragraph. Situation 3 As above except that the nature of the business is such that there can be considerable variation in the timing of cash inflows, and the auditors consider there is a significant level of concern about the ability of the company to continue as a going concern.

15 Relevant disclosures in the financial statements. Unqualified auditors report with an added explanatory paragraph. Example 2 A large processing company Situation 1 Directors have plans mitigating exposure to price fluctuations. Unqualified auditors report without an added explanatory paragraph. Situation 2 Large contract tender may not be accepted. Unqualified auditors report with an added explanatory paragraph. Example 3 Auditors disagree that disclosures are adequate Example 1 A company with uncomplicated circumstances and a significant bank overdraft Situation 1 1 In this case, in their capacity as accountants and financial advisors, the auditors also act as agents for the directors in that they: prepare the financial statements to be audited; extract the extended trial balance upon which the financial statements are based; prepare other financial information, such as the outline plans referred to below; and assist the directors in financial matters generally, based on information supplied to them by the directors. The directors take responsibility for the financial information and decisions, and the auditors ensure that they remain, and are seen to remain, independent. In these circumstances the auditors consider that the financial information can act as audit evidence. 2 When planning the audit, the auditors become aware of the following matters. The company does not prepare periodic cash flow and other budgets, forecasts or other management accounts information apart from the accounting records required by law. In view of the size, lack of complexity and stability of the business, the auditors might concur with the directors view that such information is not required for the purposes of the directors assessment of going concern in the context of the preparation of the financial statements. From their knowledge of the company s circumstances based on previous experience (including previous audits) and their discussions with the directors about the financial year (including discussions prompted by a review of the year end extended trial balance), the company still appears to operate under relatively stable conditions, for example regarding customers, suppliers and

16 competitors. The trial balance shows a net asset position and that the company continues to be profitable. Based on discussions, the directors outline plans for the future do not appear to be inconsistent with the other information available to the auditors at this stage of the audit. The outline plans consist of considering the company s performance during the financial year, and adjusting for key circumstances, both those under the directors control (such as one-off capital expenditure) and those which the directors estimate will be different (such as planned sales, and price rises for materials). As in prior years the company has a significant bank overdraft. The bankers have in the past always renewed an adequate overdraft facility and the company has to date been able to operate well within it. The date on which the bankers are due to consider renewal of overdraft facilities is after the likely date of approval of the financial statements. It is emphasised that views reached by the auditors at this stage are preliminary only, and may be confirmed or otherwise by subsequent audit work. The auditors initial assessment might be that there is not a significant level of concern about the ability of the company to continue as a going concern. They plan: 3 to perform their other audit work with an awareness that there may be nevertheless situations which cause them to consider that there is a significant level of concern about the ability of the company to continue as a going concern; and to obtain evidence as to whether the company has, to the date of their report, operated well within its overdraft facility. The auditors consider that this will be sufficient in these circumstances to satisfy the SAS s requirements on audit evidence. Having completed their audit, the auditors consider that: 4 the results of their procedures confirm their preliminary assessments, in particular the preliminary decision not to seek a letter from the bankers regarding maintenance and renewal of the overdraft facility; the information in the financial statements, and that received during their preparation and audit, does not suggest that there is a significant level of concern about the ability of the company to continue as a going concern; having reconsidered the directors outline plans for the future, the plans do not appear to be inconsistent with the other information of which the auditors are aware; and there is no reason to disagree with the directors view, based on their discussions with the bankers, that it likely that the bankers will renew an overdraft facility which meets the anticipated needs of the company by a reasonable margin. The directors consider that no special disclosures are required in the financial statements. The auditors agree, and accordingly, the auditors do not consider it necessary to qualify their audit opinion or to add an explanatory paragraph to their audit report. 5

17 Situation 2 1 The circumstances and audit work are as in Situation 1 except as follows. 2 The auditors past experience and preliminary planning procedures reveal that the company has, on several occasions in the past few years, exceeded its agreed bank facility. In the past the bankers have not withdrawn the facility, but the auditors are aware that the company s relationship with the bankers is worsening. In these circumstances the bankers have for some time requested and received each quarter management accounts covering the year to date. (As a result, recent financial information is available. Had the bankers not adopted this practice the auditors would have decided whether it was appropriate to base their work on other available sources of information about financial performance and position after the balance sheet date. For instance, the auditors might have decided to base their work on a recently updated trial balance.) 3 Towards the end of the audit, the auditors examine the most recent management accounts. In particular, they consider whether the management accounts and any assumptions underlying their preparation are inconsistent with other information of which they are aware. The directors have started to implement a cost reduction exercise, and this appears to be reasonable and proceeding according to plan. The management accounts show that the company is so far managing to remain within its current overdraft facility, and the directors outline plans (which take account of the cost reduction exercise) indicate that the company should be able to continue to do so. 4 The auditors scrutinise the company s correspondence and notes of conversations between the directors and the bankers, who examine the draft financial statements and the most recent management accounts. The auditors also examine a letter which they have requested the directors to obtain from the bankers regarding maintenance and renewal of overdraft facilities. The letter (addressed to the directors with a copy sent by the bankers directly to the auditors) contains a number of normal banking caveats. From the comments made in the letter it is evident that: the bankers have not made a decision about the continuance of the facilities; the bankers will continue to monitor the facilities in the light of information which becomes available to them; and (subject to the foregoing) the bankers will consider renewal of the facility on the agreed review date, which falls after the date on which the directors plan to approve the financial statements. 5 On this basis the auditors decide that: in the absence of indications that the facility may be exceeded in the 12 month period to the anniversary of the date of approval of the financial statements which they are auditing; and together with the results of other audit work they consider that there is concern about the ability of the company to continue as a going concern, but not of such significance as to require to be highlighted in the audit report. 6 In this particular case, the possibility that adequate overdraft facilities will not be renewed is not remote. The financial statements thus contain disclosures such as those shown below.

18 Extract from notes to the financial statements Note 12 Creditors: amounts falling due within one year 19X1 19X0 Current instalments due on debenture loans xx xx Bank overdrafts xx xx Obligations under finance leases xx xx The company meets its day to day working capital requirements through an overdraft facility which is repayable on demand. The company expects to operate within the facility currently agreed and within that expected to be agreed on (date), when the company s bankers are due to consider its renewal for a further year. These views are based on the company s plans and on the successful outcome of discussions with the company s bankers. If the note to the financial statements illustrated above omitted the narrative paragraph, the auditors might decide that the disclosures in the financial statements were insufficient to give a true and fair view of the state of the company s affairs. If so, they would qualify their audit opinion, for example as follows. 7 Extract from the auditors report Qualified opinion arising from disagreement as to the adequacy of a disclosure in the financial statements In our opinion, the financial statements should disclose the following matters. The company meets its day to day working capital requirements through an overdraft facility which, in common with all such facilities, is repayable on demand. We understand from the directors that they expect that the company will continue to operate within the facility currently agreed and within that which they expect will be agreed on (date), when the company s bankers are due to consider renewing the facility for a further year. The directors inform us that their views are based on their plans and on discussions with the company s bankers but that, inherently, there can be no certainty in relation to those views. Except for the absence of the disclosure referred to in the paragraph above, in our opinion the financial statements give a true and fair view of the company s state of affairs as at 31 December 19.. and have been properly prepared in accordance with the Companies Act In our opinion the financial statements give a true and fair view of the company s profit for the year ended 31 December Registered auditors Address Date

19 Situation 3 1 The circumstances and audit work are as in Situation 2, except that the nature of the business is such that there can be considerable unpredictable variation in the timing of cash inflows. Because of this the company s bankers have frequently requested and received a rolling cash flow forecast (supported by a sensitivity analysis) covering the year ahead. 2 Since the last balance sheet date, the company has operated within its overdraft facility, and towards the end of the audit, the auditors examine the latest available cash flow forecast. This covers the year ending 9 months from the date on which the directors plan to approve the financial statements. The cash flow sensitivity analysis prepared by the directors takes into account the cost reduction exercise and reveals the following. The best case shows the company can remain within the current overdraft facility. The worst case shows that the company would exceed its current overdraft facility throughout the period covered. The most likely case shows the company would remain within the current overdraft facility, but would be close to it on several occasions during the period covered. 3 The auditors scrutinise correspondence and notes of conversations between the directors and the bankers, who examine the draft financial statements, the cash flow information and forecast and the sensitivity analysis. The auditors also examine a letter from the bankers regarding renewal of overdraft facilities. The letter is similar to that mentioned in Situation 2, and is addressed to the directors with a copy sent by the bankers directly to the auditors. The renewal is scheduled to be considered by the bankers at a date which falls after the date on which the directors plan to approve the financial statements. The auditors consider that the frequent requests by the bankers for cash flow forecasts indicates considerable concern on the part of the bankers. Taking into account all the information available to them, the auditors might decide to request the directors to arrange a tripartite meeting between the auditors, the directors and the bankers. Following any such meeting the auditors would make appropriate notes in their working papers. 4 The auditors update their audit work on the cash flow forecast and sensitivity analysis to cover the period falling after that covered by these documents. They do this principally through discussion with the directors of the outline plans for this period. 5 The financial statements contain disclosures such as those shown below. Extract from notes to the financial statements Note 1 Basis of preparing the financial statements The company meets its day to day working capital requirements through an overdraft facility which is repayable on demand. The nature of the company s business is such that there can be considerable unpredictable variation in the timing of cash inflows. The directors have prepared