FRC toughens going concern requirements: Part 2
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 second of a two-part series, Steve Collings takes a look at some of the changes.
This article examines more notable features of the revised ISA (UK) 570 standard. For an introduction to the new standard, see part one of this article series.
ISA (UK) 570 (Revised September 2019) uses the words ‘appropriate’ and ‘appropriateness’ in terms of the disclosures made in the financial statements relating to going concern rather than ‘adequate’ and ‘adequacy’.
Use of the going concern basis is inappropriate
As is currently the case, if the financial statements have been prepared on a going concern basis, but, in the auditor’s judgement, this basis is inappropriate, the auditor expresses an adverse opinion.
It is worth noting that where the entity does conclude that the going concern basis is inappropriate and is preparing its financial statements under FRS 102, it would not be appropriate to use the ‘break up’ basis to prepare the financial statements as this basis is inconsistent with FRS 102.
A basis other than the going concern basis would be required and the basis on which the financial statements have been prepared will be disclosed in the financial statements.
Use of the going concern basis is appropriate
Where the auditor concludes that the going concern basis is appropriate, the auditor must include a section in the auditor’s report headed up ‘Conclusions related to going concern’ or other appropriate heading and include:
- where there is no material uncertainty related to going concern (see below), a statement that the auditor has not identified a material uncertainty related to events or conditions which, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern for a period of at least 12 months from the date on which the financial statements are authorised for issue (not 12 months from the balance sheet date);
- a conclusion that management’s use of the going concern basis is appropriate;
- where the entity is required to, or voluntarily chooses to, report under the UK Corporate Governance Code, or to explain why they have not, the auditor is required to state that they have nothing material to add or draw attention to in respect of the directors’ statement in the financial statements about whether the directors considered it appropriate to adopt the going concern basis of accounting in preparing the financial statements; and
- for public interest entities, other listed entities, entities that are required, and those that voluntarily choose to report on how they have applied the UK Corporate Governance Code, and other entities which are subject to the governance requirements of The Companies (Miscellaneous Reporting) Regulations 2018 (SI 2018/800), an explanation as to how the auditor evaluated management’s assessment of the entity’s ability to continue as a going concern and, where relevant, key observations arising with respect to that evaluation.
Use of the going concern basis is appropriate but a material uncertainty exists
Where management has made appropriate disclosures in the financial statements, the auditor expresses an unmodified (unqualified) opinion. The auditor’s report must include a section headed up ‘Material Uncertainty Related to Going Concern’ (which is currently the case under ISA (UK) 570 (Revised June 2016)) which:
- draws attention to the relevant note in the financial statements that discloses the material uncertainties;
- states that these events or conditions indicate a material uncertainty exists and that it may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s report is not modified in respect of this matter; and
- for entities which are required, or voluntarily choose to, report on how they have applied the UK Corporate Governance Code, or to explain why they have a not, a statement that the auditor has nothing material to add or draw attention to in respect of the directors’ identification in the financial statements of any material uncertainties to the entity’s ability to continue to do so over a period of at least 12 months from the date of approval of the financial statements.
Auditors must keep in mind that it is not correct to use an emphasis of matter paragraph where material uncertainties related to going concern have been appropriately/adequately disclosed in the financial statements.
Such issues must be included under a material uncertainty related to going concern paragraph, which acts in a similar way to an emphasis of matter paragraph but is not an emphasis of matter paragraph. The paragraph must cross-reference to the relevant disclosure note in the financial statements and must confirm that the auditor’s opinion is not modified (qualified) in respect of this matter.
It should also be noted that the use of a material uncertainty related to going concern paragraph is only used when adequate or appropriate disclosure has been made in the financial statements. If inadequate/inappropriate disclosure has been made, the auditor’s report will be modified (qualified) accordingly.
Appropriate disclosure has not been made in the financial statements
Where the entity has not made appropriate disclosures in the financial statements about a material uncertainty related to going concern, the auditor expresses a qualified opinion or adverse opinion in accordance with ISA (UK) 705 (Revised June 2016) Modifications to the Opinion in the Independent Auditor’s Report as appropriate.
This article has considered some of the more notable aspects of ISA (UK) 570 (Revised September 2019) – it has not gone into every aspect. The standard itself applies mandatorily for audits of financial statements for periods commencing on or after 15 December 2019 and so future articles will examine some of the more technical detail.