Going concern is one of the most important concepts in financial reporting, and one of the most misunderstood. When an auditor issues a going concern audit opinion, or flags a going concern risk, it sends a signal to shareholders, lenders, and creditors. The concept of going concern underpins the preparation of financial statements – getting it wrong can cause real damage to the entity and its environment.
This guide explains what going concern means in the context of an audit, how it affects the opinion, and what directors should do when going concern becomes an issue.
What is the going concern assumption in auditing?
The going concern basis of accounting assumes that the entity will continue in operational existence for the foreseeable future. In practice, that means at least 12 months from the date the financial statements are approved.
Under ISA 570, the auditor has a responsibility to evaluate whether management’s use of the going concern basis of accounting in the preparation of the financial statements is appropriate, and whether a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern.
ISA 570 outlines specific audit procedures the auditor should perform when assessing going concern. This isn’t a box-ticking exercise. The auditor must actively assess the audit evidence, challenge management’s assumptions with professional scepticism, and form their own view. If the auditor concludes that a material uncertainty related to going concern exists and management has made adequate disclosure, the auditor’s report includes a “Material Uncertainty Related to Going Concern” section. If management refuses to make the disclosure, the auditor may need to issue either a qualified or adverse opinion.
Types of audit opinion relating to going concern
Going concern can affect the audit opinion on the financial statements in several ways:
- Unmodified opinion with no going concern paragraph – the auditor is satisfied that the going concern basis of accounting is appropriate and no material uncertainty exists. This is the standard clean audit report.
- Unmodified opinion with going concern paragraph – the auditor agrees that significant doubt exists but is satisfied that disclosure is adequate. The auditor’s opinion is not modified in respect of this matter, but the paragraph draws attention to the relevant note in the financial statement.
- Qualified opinion – if management hasn’t made adequate disclosure about going concern risks, the auditor may issue a qualified (“except for”) opinion on the financial statements.
- Adverse opinion on the financial statements – if the financial statements have been prepared using the going concern basis but the auditor concludes the going concern basis is inappropriate (the company is not a going concern), the auditor will express an adverse opinion.
- Disclaimer of opinion – in rare cases where the auditor cannot obtain sufficient appropriate audit evidence about whether significant doubt exists, a disclaimer may be issued.
Going concern and the reporting aspects
The respective responsibilities of auditors and management regarding going concern are set out in ISA 570 and the UK Corporate Governance Code. Management is responsible for preparing the financial statements on the going concern basis of accounting and for making disclosures about any material uncertainties. The auditor is responsible for reviewing the appropriateness of management’s use of the going concern assumption and reporting on it.
The going concern and the reporting aspects relating to going concern require the auditor to:
- Review management’s own going concern assessment, including cashflow forecasts and financing arrangements
- Evaluate whether audit evidence obtained supports management’s assessment – are revenue projections realistic? What happens in a worst-case scenario?
- Consider whether events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern exist
- Assess the adequacy of going concern disclosures in the financial statements
- Determine the impact on the audit opinion
The auditor will consider indicators such as net current liabilities, recurring losses, breach of loan covenants, loss of a major customer, pending litigation, and difficulty meeting obligations as they fall due. These could highlight where an entity may not be a going concern.
Material uncertainty: what it means for the audit report
Significant doubt arises when events or conditions may cause concern about the entity’s ability to continue as a going concern, and the outcome depends on future events that are inherently uncertain. The audit evidence about whether the entity can continue must be weighed carefully.
When the auditor identifies this risk and management has disclosed it properly, the auditor’s report includes a specific section. This section describes the concern, references the relevant disclosure, and states that the opinion is not modified in respect of this matter.
A going concern paragraph doesn’t mean the company is about to cease trading. It means there’s a genuine risk that users of the financial statements should know about. Many companies trade through these periods and emerge stronger. But if the going concern basis is inappropriate, and the company has no realistic alternative to cessation, the auditor must express an adverse opinion on the financial statements.
What should directors do?
Directors have a legal obligation to assess going concern before approving the financial statements. This assessment should be documented and supported by evidence. The audit process requires directors to demonstrate their assessment stands up to scrutiny.
Practical steps include:
- Prepare detailed cashflow forecasts covering at least 12 months from the expected approval date
- Stress-test the forecasts – what happens if revenue drops 20%, a major debtor doesn’t pay, or refinancing falls through?
- Document key assumptions and the ability to meet its obligations as they fall due
- If significant doubt exists, disclose it clearly rather than trying to avoid it
- Engage with your auditor early – don’t leave going concern discussions until the audit is nearly complete
Your auditor will challenge your assessment. That’s their job. But if you’ve done the work properly, the review of the going concern position will be constructive rather than confrontational.
We help directors work through going concern assessments and prepare the evidence their auditor needs. Call us on 0161 832 4451 or request a callback.
