Wednesday, January 14, 2009

Auditors Advised on Going Concern Issues Spawned by Financial Crisis

In light of the impact of the current crisis on financial statements, the European Federation of Accountants has advised auditors on issues ranging from fairly valuing securities to going concern considerations. The advice given by the group is so specific that it rises to the level of best practices for auditors in these difficult financial times. The going concern advice is particularly detailed and relevant.

Auditors will need to ensure that they fully consider the going concern assessments and only refer to going concern in their audit reports when appropriate. For their part, companies’ directors and management need to ensure that they prepare thoroughly for their assessment of going concern and make appropriate disclosure.

In the federation’s view, the current economic situation does not necessarily mean that a material uncertainty exists about a company’s ability to continue as a going concern or justify auditors modifying their reports to draw attention to going concern. Similarly, extensive disclosures, of themselves, are not indicative of the existence of a significant doubt on the company’s ability to continue as a going concern.

The current pressure on corporate cash flows means that liquidity risk is likely to be a material risk for many more companies, said the group, resulting in an increased need for companies to present relevant disclosures concerning liquidity risk. Auditors will need to examine the directors’ processes underlying the preparation of these disclosures which provides useful evidence for auditors with respect to the validity of the going concern assumption.

Auditors’ consideration of the directors’ assessment of going concern will encompass evaluating the means by which the directors have satisfied themselves it is appropriate to prepare the financial statements on a going concern basis, focusing on the future availability of finance, the reliability of the company’s information systems, the adequacy of underlying assumptions, and written representations. Auditors must also conclude whether or not they concur with the directors’ view. They must also assess whether the financial statements contain adequate and readily understandable disclosures relating to going concern.

Following this analysis, the auditors will determine the implications for their reports on the financial statements. If auditors conclude that the disclosures regarding going concern are not adequate, a qualified or adverse opinion will need to be issued by referring to the existing material uncertainty. If a material uncertainty exists that leads to significant doubt about the ability of the company to continue as a going concern and these uncertainties have been adequately disclosed in the company’s financial statements, auditors are required to modify their reports by including an emphasis of matter paragraph.

In this respect, it should be noted that what constitutes a material uncertainty that may cast significant doubt on the company’s ability to continue as a going concern is a judgment involving not only the nature and materiality of the events or conditions giving rise to uncertainty; but also the ability of the company to mitigate the uncertainty by adopting alternative strategies that are reasonably expected to resolve the foreseen problems.

According to the federation, determining what constitutes a material uncertainty involves assessing both the likelihood of an event or condition occurring and the impact it will have if it occurs. For example, the lack of a positive confirmation from a bank does not of
itself provide evidence of a material uncertainty that casts significant doubt on the entity’s ability to continue as a going concern, reasoned the federation, since it could also be increased caution on the part of the bankers. Investors and lenders must read all of the relevant information in annual reports and other financial statements before making decisions. Users should also realize that proper and solvent entities may become rapidly affected when liquidity starts to fall short.

Under such conditions, the going concern assumption that is normally underlying any audit opinion may need to be considered in a different perspective. It would be advisable when the financial statements of entities that are within the boundaries of such expectations disclose these elements at such place that it will attract the attention of the user immediately.