Introduction

“This assignment is aimed at understanding how the auditor approaches to the director’s assertions of going concern and how and why it has changed over time what are the current criticisms which has been proposed since the credit crunch crisis in relation to the going concern”. Since this assignment has more than one factor to it, to make findings from my research more effective, applicable and comprehensive I have decided to deliver the information under short subheadings.

Going concern is emerging as one of the hot topics most frequently talked about in all accounting bodies. One of the fundament of the financial accounting is going concern. As per the IAS 570, an entity’s ability to operate its operation for a foreseeable future relates to going concern. Operating period is not exactly defined but most of the audit firms have assumed the period to be 12 months or more. It should not be applied to financial statements when the company intends or has got no other way than to cease trading or to file for bankruptcy

Assessing the risk of the going concern issues is a requirement as per AUS 708 and ISA 570 at the planning stage and repeating the same task in the final review. Above mentioned task should be taken in the relevant period. Furthermore as per the ISA 570 and AUS 708 the auditor needs to take an active role in such a case that s/he becomes aware of any circumstances that may raise doubts on the going concern of a business after the relevant period.

An entity is tagged as a going concern when it is in a position to realize its assests at the same time repaying its debts. It is possible that a company might prepare its financial statements in conformity with a particular framework and in this situation the going concern may not be relevant and auditors may go through it case by case. If the auditor has difficulties to confirm a company as a going concern, he can carry on additional audit procedures in the final review stage of the audit. It is crucial for auditors to use the Going concern concept to be able to scrutinize the activities of an entity to comprehend the clear picture of a company’s future existence.

Auditor’s approach to the directors going concern assertion- from the Auditors perspective:

When approaching to the director’s going concern assertion auditor’s objective should be to find applicable, sufficient audit evidence which will satisfy oneself that management has followed the relevant accounting standards in reaching their conclusion whether or not a company is a going concern. Example of audit evidence could be a written statement from the directors confirming their view. However written evidence tells only half of the story, especially if the company has a history of loss making operations. Auditors need to assess for themselves whether the director’s opinion is indeed true. Auditors may asses the financial statements to see if there are indications of a significant material effect on company’s going concern relating to any kind of uncertain events. There are a lot of signs, some of them could be solvency problems, and major losses recorded post balance sheet date, significant fall in share price and the unfortunate changes in the economy such as the recent credit crunch. Furthermore the auditor can analyze future risks and uncertainties the company is likely to face due to events such as the credit crunch, the effectiveness of any plans made by the entity to solve problems likely to arise, the feasibility and the capability of directors to accomplish such plans.

If the auditor incertitude’s the entity can be a going concern i.e. the entity can no longer survive as a going concern due to existence of a material uncertainty the auditor is expected to write to the directors suggesting they take appropriate action. In the director’s report if the directors fail to disclose such information it is required by CA 2006 that the auditor state in the audit report if the financial statement and the directors report agree. If the disclosures are made in the statements to a level the auditor is satisfied auditor is expected to express an unmodified opinion and in the audit report to include and Emphasis of matter paragraph (ISA 570.19). On the other hand if the auditor is not satisfied with the disclosures made in the financial statements s/he is bound to express either a qualified opinion or an adverse opinion whichever suits best to that situation

How and why audit regulation on going concern has changed overtime?

Traditionally auditors rely on the directors going concern assertion since the directors are answerable to the Shareholders. Although directors of a company are tied by fiduciary duties to act in the best interest of the shareholders the directors may not always work in the best interest of the Shareholder, and they can’t be trusted. Usually the case could be that the directors and shareholders may not share the same interest, this is referred to as the agency problem. Along with this problem other issues such as those raised by tournament theory and managerial concepts, it’s hard to judge director’s opinion on going concern alone as sufficient audit evidence. In addition the developments in IFRS and introductions of new acts such as the Sabarnes Oxley act and the changes in economic market together  has changed regulations on going concern.

The main reason why audit regulations on going concern has changed overtime is due to problems created by events such as the frequency of sudden financial system failures, banks going bankrupt, while some countries went nearly bankrupt to everyone’s surprise one country actually going bankrupt due to Credit crunch. One could say that the change in auditing procedures in terms of going concern were repercussion of accounting scandals.

Recent corporate scandals were the aftermath of credit crunch crisis. “Credit crunch relates when the debts increase due to the growing of interest rates. Due to the rise of interest rates a situation arise where the people can no longer pay back the loans or mortgages and had to default.

Significantly credit crunch has increased the audit risk, and this was mainly to the banks. Auditors were forced to look deep in the bank’s lending procedures and impacts to determine if there is any possibility of recovering its money which has been lent. It is important because the auditors must give an audit opinion on the going concern of an entity.  From the history if we take, the audit opinion of Bear Stearns proved to be wrong, and the auditors were accountable for no picking up the mass risk the company had.

With significant borrowings, the credit crunches increased the risk to a whole new level. This has forced the auditors to put more effort when dealing with the debt of their clients, and should emphasis the nature of the substantial risks, and lastly they need to highlight this in their audit report.

The well known audit firm Arthur Anderson applied false standards when they were auditing Enron’s, and this was due to the conflict of interest over the fees that the audit firm generated. Enron’s external auditor Arthur Andersen supported Enron on their fraudulent financial statements confirming that the Enron’s going concern, and this led a mass loss for the investors who had made their economic decision of investing in Enron, based on the auditor’s opinion on going concern, eventually Enron filed for bankruptcy and the company was ceased. Cases like WorldCom, Iceland going bankrupt have forced to change the audit regulation on going concern.

Current Criticism and proposal have been initiated since the credit crunch:

Auditors have been blamed for the losses suffered by investors as a result of companies filing for bankruptcy protection. Investors believe that auditors have a responsibility to show the red signals of going concern problems to them beforehand. According to past studies over half of the companies that have gone bankrupt have been given going concern qualifications. Jospeh Carcello. Good communication among auditors and their clients are growing rapidly due to the credit crunch crisis; this is because auditors need to get enough evidence and forecast the risk due to the credit crunch. (Ernst & Young’s Fletchallm 2009) “Directors and audit committees started to adopt a image that the going concern is truly stating and the auditors are truly implying that the business is going bankrupt.

Auditors disagree with the claim that the directors and audit committees make on Going concern, that is directors and audit committees believes that the going concern adjustment is a sign of that they are failing and the business may not be able to operate in the next 12 months and they believe that its just a forecast and may not be true. The auditors view on this is different and they totally disagree with how they were applying it as the standards necessitate taking several factors in to consideration when the audit is taking place, and those factors may result that the entity cannot carry its operation and cast the doubt the entity is no longer a going concern.

Previously auditors does not requires to be satisfied with the management plans nor to forecast whether the plans of Directors are going to be work and the company can carry its business with those plans, but now the auditors have to be satisfied with the management plans and need to go deep in to the areas where they have doubt, and should demand for a plan to overcome with the issues from the management and it should be feasible, but still the auditors can cast a doubt in this stage.

Recently in Singapore, “Auditors of Advanced Systems Automation (ASA) have found indications that the company many not be able to continue business, since the company incurred a net loss of $6.8 million and auditors believed that its survival is dependent on its restructuring plans and financial support from its shareholders. The reason for the auditors doubt the going concern of the ASA was the fact that ASA won’t be able to discharge its liabilities and realize its assets, as current liabilities of  ASA were in excess of its current assets by $25.7 million.(Today Paper 2010)

Though directors testify the entity will be able to continue business for the next 12 months, the auditor needs to analyze various signs that indicate otherwise. Auditors need to test if the business will indeed hold the ground for the next 12 months, procedures on how the  auditor test this has changed over time, now the auditor need to take a lot of factors in to consideration. There are several factors that can indicate that the business may not be a going concern, some of them are, adverse current ratio or trend, excess stocks, excessive debtors, overdrafts in excess of facilities granted, restriction on trading terms, long term loans becoming due with no arrangements for refinance, credit terms taken in excess of agreed terms.