The role of audit committees is set to assume greater importance in assessing a company’s financial position and its ability to continue operations as a going concern. A staff publication by the National Financial Reporting Authority (NFRA) has set out a framework of 35 potential questions that audit committees may ask statutory auditors about their evaluation of going concern assessments.
The areas covered include cash flow projections, management assumptions, future funding plans, financial covenant breaches, support from promoters or parent entities and regulatory risks.
The publication is part of the NFRA Auditor-Audit Committee Interaction Series on going concern assessments under SA 570 (Revised). It sets out questions that audit committees may consider in different circumstances while reviewing whether an entity can continue as a going concern.
The document also makes clear that going concern assessment is not solely the responsibility of the statutory auditor. The board and audit committee are expected to discharge their respective responsibilities independently.
According to the NFRA publication, management is responsible for assessing the company’s ability to continue as a going concern. Under the Companies Act, 2013, the board is required to state in the Directors’ Responsibility Statement that the annual accounts have been prepared on a going concern basis. The audit committee is also required to review the annual financial statements and consider the appropriateness of the going concern assumption.
The role of the statutory auditor is not to prepare management’s assessment but to evaluate it. Under SA 570 (Revised), the auditor is required to obtain sufficient appropriate audit evidence and conclude whether the use of the going concern basis is appropriate and whether any material uncertainty exists that may cast significant doubt on the company’s ability to continue its operations.
What Should Audit Committees Ask About Cash Flow?
Where events or conditions may cast significant doubt on a company’s ability to continue as a going concern, the audit committee can question the basis of management’s assessment. This may include asking whether the cash flow projections cover the required period, whether the assumptions used are reasonable and whether there is adequate support for the company’s future plans.
Auditors may also be asked how they assessed the reliability of the data underlying cash flow projections and whether sensitivity analysis was conducted on critical assumptions.
If the company’s ability to remain a going concern depends on the proposed sale of an asset, the committee may examine whether there is an identified buyer or market, whether the valuation is reasonable, what the expected net realisable value is and when the cash is likely to be received.
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How Will Promoter Support Be Examined?
If a company’s ability to continue operations depends on financial support from a parent company, promoter or another party, the audit committee may ask whether written confirmation of the support was obtained directly from the supporting party.
It may also examine whether the arrangement is legally enforceable and whether the supporting party has the financial capacity to provide the promised assistance when required.
Potential or existing breaches of financial covenants are also part of the assessment. Audit committees may ask how management assessed the impact of such breaches and how the auditor evaluated that assessment.
When Can Going Concern Issues Affect the Audit Report?
The publication explains six different situations under SA 570 (Revised) and their potential consequences for the auditor’s report. Where there are no events or conditions that cast significant doubt on the company’s ability to continue as a going concern, normal reporting may follow. Where such conditions exist but the auditor concludes that no material uncertainty exists, an unmodified opinion may still be issued if the financial statements contain adequate disclosures.
Where the going concern basis is appropriate but a material uncertainty exists and the related disclosures are adequate, the audit report may contain a separate section titled “Material Uncertainty Related to Going Concern”. If the disclosures are inadequate, the circumstances may result in a qualified opinion where the effects are material but not pervasive, or an adverse opinion where the effects are material and pervasive.
How Are CARO and SA 570 Assessments Different?
NFRA has also highlighted the distinction between the going concern assessment under CARO 2020 and the requirements under SA 570. Under CARO, auditors consider financial ratios, the ageing and expected dates of realisation of financial assets, the payment schedule for financial liabilities, plans of the board and management, and other relevant information.
The objective is to assess whether the company is capable of meeting liabilities existing at the balance sheet date as and when they fall due within one year.
SA 570, by contrast, involves a broader assessment of the company’s financial position and its ability to continue operations. As a result, the conclusions under the two assessments can differ.
For example, a company may have sufficient current assets or short-term financing arrangements to meet its existing liabilities, while broader circumstances may still raise significant doubt under SA 570.
These could include recurring operating losses, erosion of net worth, loss of a key customer or licence essential to the business, discontinuation of a principal product line or lack of committed funding beyond the immediate schedule of existing liabilities.
What Regulatory Risks Must Be Considered?
For regulated entities, audit committees may also ask whether auditors have assessed compliance with capital, solvency, liquidity and other regulatory requirements. They may examine the potential impact of changes in law, regulations or government policy that could adversely affect the company, as well as whether disclosures relating to breaches or potential breaches of prudential norms are adequate.
NFRA has emphasised that the board’s statement and the audit committee’s review of the going concern basis are their respective responsibilities and are expected to be carried out independently of the statutory auditor’s work.
The420 Takeaway
NFRA’s framework puts greater focus on active scrutiny by boards and audit committees. A company’s ability to continue operations should not be accepted merely because management or an auditor says so. Cash flows, funding commitments, promoter support, covenant breaches and regulatory risks need independent examination backed by evidence.
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