Going concern is not simply a question of whether a company made a profit this year. In an audit, it is a forward-looking assessment of whether the entity can continue operating and meet its obligations in the foreseeable future. ICAI's SA 570 (Revised), Going Concern explains both management's assessment responsibility and the auditor's work when events or conditions may cast significant doubt on the entity's ability to continue as a going concern.
What the going concern basis means
Under SA 570, general purpose financial statements are normally prepared on the going concern basis unless management intends to liquidate the entity or cease operations, or has no realistic alternative but to do so. When the basis is appropriate, assets and liabilities are recorded on the assumption that the entity will realise assets and discharge liabilities in the normal course of business.
This distinction matters because going concern basis and material uncertainty related to going concern are not the same conclusion. The basis may remain appropriate even when a serious uncertainty exists. The audit question then becomes whether that uncertainty is material, whether the financial statements disclose it adequately, and what the auditor must say in the report.
Management assesses; the auditor evaluates
Management is responsible for assessing the entity's ability to continue as a going concern. The auditor does not replace management's assessment. Instead, SA 570 requires the auditor to obtain sufficient appropriate audit evidence about the appropriateness of management's use of the going concern basis and to conclude whether a material uncertainty exists.
The auditor must consider going-concern indicators during risk assessment and remain alert throughout the audit. When evaluating management's assessment, the auditor covers the same period used by management under the applicable financial reporting framework or law. If management's assessment covers less than twelve months from the date of the financial statements, SA 570 requires the auditor to ask management to extend it to at least twelve months from that date.
Red flags that deserve attention
SA 570 gives examples of events and conditions that may cast significant doubt, while making clear that the list is not exhaustive and that one indicator does not automatically prove a material uncertainty.
- Liquidity pressure: a net current liability position, inability to pay creditors when due, or negative operating cash flows.
- Financing pressure: borrowings nearing maturity without realistic refinancing or repayment prospects, withdrawal of creditor support, or breach of loan terms.
- Operating deterioration: substantial operating losses, loss of a major market, key customer, licence, supplier or key management without replacement.
- Legal or regulatory exposure: proceedings that could result in claims the entity may be unable to satisfy, or non-compliance with important statutory or regulatory requirements.
- External shocks: adverse changes in law, regulation or government policy, or uninsured or underinsured catastrophes.
These indicators must be assessed in context. A debt maturity can be severe if refinancing is doubtful, but less threatening if binding replacement finance is already available. A lost customer may be critical for a concentrated business but manageable for a diversified one.
What the auditor should test when warning signs exist
Once relevant events or conditions are identified, SA 570 requires additional audit procedures and consideration of mitigating factors. A practical file should move beyond merely recording management's statement that the business will survive.
- Obtain or update management's assessment. If management has not prepared one, request it.
- Challenge management's plans. Evaluate whether actions such as refinancing, capital infusion, asset sales, cost reduction or restructuring are feasible rather than aspirational.
- Test cash-flow forecasts. Where forecasts are significant to the assessment, evaluate the reliability of the underlying data and whether key assumptions have adequate support.
- Check later information. Consider facts that became available after management prepared its assessment.
- Obtain written representations. SA 570 requires representations regarding management's plans for future actions and their feasibility where going-concern events or conditions have been identified.
Worked illustration
Assume a manufacturing company has a large term loan maturing six months after year-end, weak operating cash flow and a covenant breach. Management says the bank will renew the facility. The audit file should not treat that statement as sufficient evidence. The auditor would examine lender correspondence and financing terms, test the cash-flow forecast, compare forecast assumptions with historical performance and current orders, evaluate covenant consequences, consider alternative funding plans and inspect subsequent developments. If renewal remains uncertain, the auditor then evaluates whether the uncertainty is material and whether the disclosures explain the principal conditions and management's response clearly.
Four reporting outcomes to distinguish
1. Going concern basis is appropriate and no material uncertainty exists
The auditor still evaluates relevant disclosures when events or conditions were identified. The existence of warning signs does not automatically require a modified opinion.
2. Going concern basis is appropriate, material uncertainty exists, and disclosure is adequate
SA 570 requires an unmodified opinion together with a separate section headed Material Uncertainty Related to Going Concern. That section draws attention to the relevant financial statement note and states that the events or conditions indicate a material uncertainty that may cast significant doubt on the entity's ability to continue as a going concern. The opinion itself is not modified in respect of that matter.
3. Material uncertainty exists but disclosure is inadequate
The auditor expresses a qualified or adverse opinion, as appropriate, under SA 705 (Revised), and explains that the material uncertainty has not been adequately disclosed.
4. Use of the going concern basis itself is inappropriate
If management prepared the financial statements on a going concern basis but the auditor concludes that use of that basis is inappropriate, SA 570 requires an adverse opinion. This is fundamentally different from a viable going concern basis accompanied by adequately disclosed uncertainty.
Common mistakes in going-concern audit files
- Treating current-year profit as proof that no going-concern risk exists.
- Accepting a cash-flow forecast without testing the data and assumptions behind it.
- Relying on an unsigned or vague promise of promoter or lender support without assessing its credibility and feasibility.
- Confusing an emphasis paragraph with the specific Material Uncertainty Related to Going Concern reporting required by SA 570 when a material uncertainty is adequately disclosed.
- Assuming an unmodified opinion guarantees the entity's survival. SA 570 expressly states that absence of a material-uncertainty reference in the auditor's report is not a guarantee that the entity will continue.
Practical audit checklist
- Identify financial, operating and regulatory warning signs during risk assessment and update the assessment throughout the audit.
- Document management's assessment period and ensure it covers at least the period required by SA 570.
- Reconcile forecast opening balances to audited or reliable financial information.
- Challenge revenue, margin, collection, funding and cost assumptions against evidence.
- Inspect financing agreements, covenant calculations, lender correspondence and subsequent receipts or payments where relevant.
- Evaluate the feasibility of management's mitigating plans, not just their stated intention.
- Assess whether financial statement disclosures clearly describe the principal events or conditions and management's plans.
- Link the final going-concern conclusion to the correct reporting outcome.
Practical takeaway
A strong going-concern audit is a structured chain: identify indicators, evaluate management's assessment, test forecasts and mitigating plans, decide whether a material uncertainty exists, assess disclosure, and map that conclusion to the auditor's report. The most useful primary references are ICAI's current Engagement and Quality Control Standards page and the official Implementation Guide to SA 570 (Revised).
