Audit and Technical Partner Leavitt Walmsley Associates Ltd
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FRC toughens going concern requirements: Part 1

In light of recent criticism aimed squarely at the auditing profession, the FRC has beefed up its going concern requirements for audits commencing 15 December. In the first of a two-part series, Steve Collings takes a look at some of the changes.

8th Oct 2019
Audit and Technical Partner Leavitt Walmsley Associates Ltd
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In September 2019, the Financial Reporting Council (FRC) issued a revised version of ISA (UK) 570 Going Concern, which becomes effective for audits of financial statements for periods commencing on or after 15 December 2019. Early adoption is permitted.

This revised ISA (UK) has been extensively amended in light of the well-publicised criticisms of the auditing profession. ISA (UK) 570 (Revised September 2019) increases the work which auditors are required to do when auditing the going concern status of an entity.

This article examines some of the notable features of ISA (UK) 570 (Revised September 2019).

Responsibilities of the auditor

The previous version of ISA (UK) 570 stated at paragraph 6 that the auditor’s responsibilities are to ‘obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management’s use of the going concern basis of accounting … and to conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity’s ability to continue as a going concern.’

This responsibility still applies under the revised ISA (UK) 570 but paragraph 6 has been restructured so it is clearer to understand.

Definitions

ISA (UK) 570 (Revised September 2019) contains defined terms in paragraph 9-2 which defines ‘management bias’ and a ‘material uncertainty related to going concern’ as follows:

Management bias – A lack of neutrality by management in the preparation of information.

Material uncertainty related to going concern – An uncertainty related to events or conditions that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern, where the magnitude of its potential impact and likelihood of occurrence is such that appropriate disclosure of the nature and implications of the uncertainty is necessary for:

  1. in the case of a fair presentation financial reporting framework, the fair presentation of the financial statements; or
  2. in the case of a compliance framework, the financial statements not to be misleading.

Extended auditor’s responsibilities

The risk assessment procedures and related activities section of ISA (UK) 570 (Revised September 2019) has been significantly increased. ISA (UK) 570 (Revised September 2019) requires the auditor to obtain an understanding of:

  • the entity and its environment;
  • the applicable financial reporting framework; and
  • the entity’s system of internal control.

In addition, if the auditor identifies events or conditions which may cast significant doubt on the entity’s ability to continue as a going concern which management has not previously identified or disclosed to the auditor, ISA (UK) 570 (Revised September 2019) requires the auditor to:

  1. request management to perform additional procedures to understand the effect of the events or conditions on management’s going concern assessment;
  2. inquire as to why management’s going concern assessment failed to identify or disclose the events or conditions; and
  3. perform additional audit procedures relating to the newly identified events or conditions.

Evaluating management’s assessment of going concern

The auditor is still required to obtain sufficient appropriate audit evidence to identify whether events or conditions exist which may cast significant doubt on the entity’s ability to continue as a going concern and identify whether a material uncertainty exists.

In addition, the auditor is also still required to obtain sufficient appropriate audit evidence concerning the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements.

The auditor’s responsibilities are extended further as ISA (UK) 570 (Revised September 2019) also requires the auditor to:

  • evaluate the method used by management in assessing the entity’s ability to continue as a going concern, including determining if:
    • the method selected is appropriate in the context of both the financial reporting framework and the auditor’s understanding of the entity;
    • changes from the method used in prior periods are appropriate; and
    • whether the calculations are applied in accordance with the method and are mathematically accurate;
  • evaluate the relevance and reliability of the underlying data used to make the assessment;
  • evaluate the assumptions on which management’s assessment is based which requires the auditor to determine whether there is adequate support for the assumptions underlying management’s assessment which includes determining:
    • whether the assumptions are appropriate in the context of the applicable financial reporting framework and, where applicable, changes from the prior period are appropriate; and
    • whether the assumptions are consistent with each other and with related assumptions used in other areas of the entity’s business activities, based on the auditor’s knowledge obtained in the audit;
  • evaluating management’s plans for future actions in respect of going concern, including evaluating whether the outcome of these plans is likely to improve the situation and whether they are feasible;
  • considering whether any additional facts or information have become available since the date on which management made its assessment; and
  • requesting written representations from management and, where appropriate, those charged with governance, concerning their plans for future actions and the feasibility of those plans.

The auditor is also required to make greater use of the entity’s viability statement where one is produced.

Part two of Steve Collings’ examination of the revised standard, is available here.

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By tedbuck
09th Oct 2019 10:32

Absolute Magic. That'll sort out all the problems then. Just what was needed - a few more tick boxes and we are saved.

That'll stop the Carillions, Thomas Cooks et al. won't it? Won't it?

The FRC are really star aren't they? Fantastic performance to solve all the problems just like that.

Could they dream up a few tick boxes for Brexit so we can get that settled as well?

I think we all need a few more regs to comply with so that we really don't have to think about anything seriously.

Hooray for regulation - where would we be without it - might have to use our brains.

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By SAservices31
09th Oct 2019 11:11

When will we grasp the nettle and address the real problem ?

It does not matter how many times FRC tweak their standards, the ‘top’ audit firms simply ignore them with impunity. This is because FRC are dominated by the ‘top firms’ and its a case of the tail wagging the dog.

Until FRC are reformed properly and become independent of audit firms then massive corporate collapses in the UK will continue.

The answer is simple - the top firms audit wings should be broken up and smaller firms - who are properly independent - should be allowed to the audit table.

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By matthewleitch
09th Oct 2019 11:52

There is an underlying problem with the way uncertainty is dealt with in the going concern basis decision. The company is required to decide whether or not the going concern basis is applicable. It's a black and white question, but in reality there are shades of grey. Our probability of not being a going concern fluctuates over time, usually being very, very low but occasionally rising a bit - or a lot.

The effect of the auditor insisting on the alternative basis might be that it precipitates, perhaps unnecessarily, the very outcome everyone wants to avoid. That's a reason why everyone involved with the audit wants things to be rosy.

So, one thing that might help here is to revise the decision and the action. Require companies to state their probability of failure and to show the financial effects of such failure on their financial statements (as they would if not a going concern) regardless of what that probability is.

In addition to taking the pressure off auditors it would provide more information to investors and readers. They could reach their own probability of failure, if they want to, in combination with the company's assessment of the effects on the statements.

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By tedbuck
09th Oct 2019 13:11

Quite right. One can foresee the danger of a self-fulfilling prophecy - a doubt caused by a potential problem may exist but what weight does the auditor give to it? If it is over-emphasised then people would look at it and say to themselves "We had better watch this one and cut back the loans/credit etc." The possibility suddenly becomes a probability and the Company may be unnecessarily imperilled.
Of course it might work the other way too and save a loss to creditors, but what a fine judgement to make and potentially with huge consequences as I suppose the auditor could be sued for destroying the Company unnecessarily. Catch 22.
Perhaps the answer is as with Sports Direct for the auditors to walk away. Quo vadis Auditor?

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By matthewleitch
09th Oct 2019 13:35

Walking away might be as damaging as an unnecessary switch to non-going concern basis. Quo Vadis Auditor indeed.

Another issue is with costs. The usual situation with audit judgements of any kind that have an all-or-nothing character (which most do) is that the level of work necessary to confidently reach the decision increases the closer reality is to the dividing line. In other words, the finer the judgement needed the more the work needed. If your client turns out to be nearer to the line than you thought the difference can be large and of course budgets and fees are set in advance.

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By matthewleitch
09th Oct 2019 13:40

I just noticed a good example of what I am talking about. AccountingWEB tells the story of Pizza Express, currently struggling with massive debt. https://www.accountingweb.co.uk/business/finance-strategy/pizza-express-...

It seems PwC signed off the accounts on going concern basis despite it being technically insolvent, because it was still pulling in plenty of cash. (That's what AccountingWEB says anyway - PwC had no comment on the story.)

This is a good example of a business that should have had a higher than usual probability of failure, even if PwC could not conclude that the business would probably fail.

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By AnnAccountant
09th Oct 2019 16:07

I don't think the issue lies with audit alone. It starts with the trend of loading companies with debt, stripping all value out of them, then letting them crash when, inevitably, there is a slight blip in profits at some point down the line.

Some people make a lot of money, but it is trashing otherwise viable companies and putting people out of work.

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