Introduction
One of the auditor’s critical responsibilities is to evaluate whether an entity can continue as a going concern. The going concern assumption underpins the preparation of financial statements. If an organization is unlikely to remain operational for the foreseeable future, financial reporting and audit procedures must reflect this reality.
In this blog, we explore the importance of going concern assessments in auditing, key financial and operational indicators, auditor responsibilities, and reporting requirements. Understanding this process is essential for accurate financial disclosures and safeguarding stakeholder interests.
What is the Going Concern Assumption?
The going concern principle assumes that a company will continue its operations for at least the next 12 months without the intention or necessity of liquidation. This assumption allows businesses to defer the recognition of certain expenses and liabilities.
When doubts arise about an entity’s ability to continue, auditors must assess the severity of those risks and determine whether financial statements should reflect such uncertainty.
Auditor’s Responsibilities Under Going Concern
Auditors are required by ISA 570 (Revised) and U.S. GAAS (AU-C 570) to:
- Evaluate management’s use of the going concern basis of accounting
- Review supporting forecasts and plans
- Identify and assess material uncertainties
- Conclude whether disclosures are adequate
- Modify the auditor’s report if necessary
Auditors do not predict the future, but they must gather sufficient appropriate evidence to support conclusions about going concern viability.
Key Indicators of Going Concern Risk
Auditors assess various financial, operational, and external indicators, including:
| Indicator Type | Examples |
|---|---|
| Financial | Negative operating cash flows, recurring losses |
| Loan defaults, net current liabilities | |
| Operational | Loss of key personnel, supply chain disruption |
| Product obsolescence | |
| External | Economic downturn, legal proceedings |
| Declining industry or market conditions |
Audit Procedures for Going Concern Assessment
- Review Management’s Assessment
- Examine forecasts, budgets, and cash flow projections (typically 12 months post-reporting date)
- Challenge assumptions (e.g., revenue growth, financing availability)
- Analyze Subsequent Events
- Identify events after year-end that support or contradict the going concern assumption
- Evaluate Plans to Mitigate Risks
- Assess the feasibility of plans such as refinancing, cost-cutting, or asset sales
- Assess the Need for Disclosures
- Ensure management appropriately discloses material uncertainties, if applicable
- Communicate with Those Charged with Governance
- Discuss risk factors, audit findings, and implications for financial reporting
Reporting on Going Concern
Depending on the outcome, auditors may issue
- Unmodified Opinion with No Material Uncertainty: When no significant risk exists
- Unmodified Opinion with Material Uncertainty Paragraph: When uncertainties exist, but disclosures are adequate
- Qualified or Adverse Opinion: When disclosures are inadequate or the going concern basis is inappropriate
Under PCAOB standards and ISA 570, auditors must highlight going concern doubts in the Key Audit Matters (KAM) or Critical Audit Matters (CAM) section if applicable.
Example Scenario: Retail Chain with Liquidity Issues
Background: A regional retail chain has suffered declining sales for two consecutive years, missed vendor payments, and has an upcoming loan maturity.
Management’s Plan: Launch online sales, close unprofitable stores, seek short-term financing.
Audit Steps:
- Evaluate the credibility of the e-commerce strategy
- Assess lender communication and financing likelihood
- Review updated cash flow forecasts
Conclusion: An Auditor includes a material uncertainty paragraph while issuing an unmodified opinion.
Common Challenges in Going Concern Evaluations
- Management optimism bias
- Limited forecast reliability in volatile industries
- Judging the adequacy of mitigating plans
- Balancing professional skepticism with objective evidence
Best Practices for Auditors
- Begin assessment early during risk planning
- Involve senior team members and specialists
- Seek written representations from management
- Ensure documentation supports conclusions
Conclusion
Going concern assessments in auditing are critical in protecting the integrity of financial statements and fostering stakeholder confidence. Auditors must exercise professional judgment, challenge management assumptions, and ensure transparent disclosure.
In an environment marked by economic uncertainty and rapid change, robust going concern evaluations are more important than ever. Firms should prioritize training, use analytical tools, and engage experts to enhance the reliability of these assessments.
References
- International Standard on Auditing (ISA) 570 (Revised) – Going Concern
- AU-C Section 570 – The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern
- Messier, Glover & Prawitt (2022). Auditing & Assurance Services
- PCAOB Staff Audit Practice Alerts