Existing and New Guidance
As the going concern assumption is integral to any general purpose financial reporting framework such as ASPE, ASNPO, and IFRS the consideration of the application of the going concern assumption must be included in a review engagement. However, the guidance on what the responsibilities of the accountant regarding going concern for a review engagement have not been very clear in the past. This is because the principal existing review engagement standards (Sections 8100 and 8200) were silent on this subject. In fact, the only guidance that existed what one question included in AuG-20 Performance of a Review of Financial Statements in Accordance with Sections 8100 and 8200 which included the following:
During the review, did you become aware of conditions that cast doubt on the ability of the entity to continue as a going concern?
Now that the new review engagement standard, CSRE 2400, has been released there is better guidance for the consideration of the going concern assumption in a review engagement.
CSRE 2400 includes specific inquiries that must be made of management and others within the entity, as appropriate. These required inquiries include the following related to the application of the going concern assumption:
- The basis for management's assessment of the entity's ability to continue as a going concern; and
- Whether there are events or conditions that appear to cast doubt on the entity's ability to continue as a going concern.
Often in smaller entities, management may not have prepared an assessment of the entity's ability to continue as a going concern, but instead may rely on knowledge of the business and anticipated future prospects. In these circumstances, it may be appropriate to discuss the medium- and long-term prospects and financing of the entity with management, including consideration of whether management's contentions are not inconsistent with the practitioner's understanding of the entity.
Events of Conditions that May Cast Significant Doubt on the Entity’s Ability to Continue as a Going Concern
CSRE 2400 explains that a review of financial statements includes consideration of the entity's ability to continue as a going concern. In considering management's assessment of the entity's ability to continue as a going concern, the practitioner shall cover the same period as that used by management to make its assessment as required by the applicable financial reporting framework, or by law or regulation where a longer period is specified. CSRE 2400.53 provides guidance when the practitioner becomes aware of events or conditions that may cast significant doubt on the entity's ability to continue as a going concern.
If, during the performance of the review, the practitioner becomes aware of events or conditions that may cast significant doubt on the entity's ability to continue as a going concern, the practitioner's procedures to determine whether a material uncertainty exists shall include:
- Inquiries of management about:
- Whether management has identified any material uncertainty;
- Plans for future actions affecting the entity's ability to continue as a going concern;
- The feasibility of those plans; and
- Whether management believes the outcome of those plans will improve the situation regarding the entity's ability to continue as a going concern;
- Consideration of management's responses in light of all relevant information of which the practitioner is aware as a result of the review; and
- Evaluation of whether management's responses provide an appropriate basis to:
- Support the preparation of the financial statements on a going concern basis; and
- Conclude whether the financial statements are materially misstated, or are otherwise misleading, as a result of inadequate disclosure with respect to a material uncertainty related to events or conditions that may cast significant doubt on the entity's ability to continue as a going concern.
Additionally, CSRE 2400.A105 provides a list of examples of events or conditions that, individually or collectively, may cast significant doubt about the going concern assumption. The guidance points our that the list is not all-inclusive, and the existence of one or more of the items does not always signify that material uncertainty exists about whether the entity can continue as a going concern. The list provided by CSRE 2400.A105 is:
- Net liability or net current liability position.
- Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive reliance on short-term borrowings to finance long-term assets.
- Indications of withdrawal of financial support by creditors.
- Negative operating cash flows indicated by historical or prospective financial statements.
- Adverse key financial ratios.
- Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.
- Arrears or discontinuance of dividends.
- Inability to pay creditors on due dates.
- Inability to comply with the terms of loan agreements.
- Change from credit to cash-on-delivery transactions with suppliers.
- Inability to obtain financing for essential new product development or other essential investments.
- Management intentions to liquidate the entity or to cease operations.
- Loss of key management without replacement.
- Loss of a major market, key customer(s), franchise, license, or principal supplier(s).
- Labour difficulties.
- Shortages of important supplies.
- Emergence of a highly successful competitor.
- Non-compliance with capital or other statutory requirements.
- Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy.
- Changes in law or regulation or government policy expected to adversely affect the entity.
- Uninsured or underinsured catastrophes when they occur.
The significance of such events or conditions often can be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counter-balanced by management's plans to maintain adequate cash flows by alternative means, such as by disposing of assets, rescheduling loan repayments, or obtaining additional capital. Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply.
Alerting Readers that a Material Uncertainty Exists Relating to Going Concern
Similar to the CASs, CSRE 2400 provides guidance on the use of emphasis of matter paragraphs. CSRE 2400.99 provides guidance for alerting readers that a material uncertainty exists relating to going concern:
If adequate disclosure is made in the financial statements about the entity's ability to continue as a going concern, the practitioner shall express an unmodified conclusion and include an Emphasis of Matter paragraph in the practitioner's report to:
- Highlight the existence of a material uncertainty relating to the event or condition that may cast significant doubt on the entity's ability to continue as a going concern; and
- Draw attention to the note in the financial statements that discloses the matter.
The following is an illustration of an emphasis of matter paragraph when the practitioner is satisfied as to the adequacy of the note disclosure in the financial statements about the entity's ability to continue as a going concern:
Without qualifying our conclusion, we draw attention to Note X in the financial statements, which indicates that the Company incurred a net loss of ZZZ during the year ended December 31, 20X1 and, as of that date, the Company's current liabilities exceeded its total assets by YYY. These conditions, along with other matters as set forth in Note X, indicate the existence of a material uncertainty that may cast significant doubt about the Company's ability to continue as a going concern.