-: The collapse of Carillion, a multi-national company
listed at the London stock exchange caused shock waves
around the world and multiple parliamentary inquiries
in the UK.
Prior to it's liquidation the company had over 40,000
employees and revenues of over five billion pounds.
It's collapse was considered the largest ever trading
liquidation in the UK.
What is more disturbing is that it had received
a clean audit opinion from KPMG.
But are stakeholders right to expect a company to continue
operating in the future
if it has received a clean audit opinion?
Accounting standards require financial statements
to be prepared on a going concern assumption.
This means that there is an assumption that the company
will continue it's operations for the foreseeable future.
If management however have intentions to liquidate
the company or seize operations,
then the going concern assumption can not be used.
Instead, another basis such as the liquidation basis
can be used.
So what is the difference between applying the going concern
assumption and the liquidation basis?
Let's look at an example.
Jenga Enterprises owns investment properties.
The fair value of these assets best unexpected future
cash flows is $450 million dollars.
The properties could however only be disposed of
in the current market for $300 million dollars
after deducting costs to sell.
If management used the going concern assumption,
the investment properties can be accounted for
at $450 million dollars.
If the liquidation basis is however used,
management can only recognise
an amount of $300 million dollars.
There is therefore a significant difference between
applying the going concern assumption
and the liquidation basis.
It is therefore very important for the auditor
and management to assess whether the going concern
assumption is appropriate.
ISA 570 requires the auditor to obtain sufficient
appropriate audit evidence regarding the appropriateness
of management's use of the going concern assumption
and to assess whether a material uncertainty exists
about the entity's ability
to continue operations in the foreseeable future.
So how does the auditor assess whether the use of the
going concern assumption is appropriate?
The auditor will start by first looking at whether
management have done a formal assessment on whether
the company can continue operating in the future.
It should be noted that the international accounting
standards require management to make a formal assessment
of the entities ability to continue operating
over the foreseeable future.
Management generally do this assessment by preparing
and reviewing budgets, cash flow focus, directors minutes
and reports from their solicitors.
Management's assessment must cover at least 12 months
from the date of the audit report.
The auditor will then review these reports and also assess
any assumptions to ensure that they are reasonable.
The auditor will then hold discussions with management
to determine if they're aware of any events or conditions
that could threaten the going concern of the company.
If conditions or events exist the auditor will assess
whether they are material uncertainties
and will also assess management's plan to mitigate
or address these uncertainties.
The type of audit report and opinion issued will depend
upon whether the material uncertainties exist and
whether they have been adequately disclosed.
To recap, the auditor must obtain sufficient appropriate
evidence to support management's use
of the going concern assumption.
The auditor will generally do this by reviewing the
formal assessment that management have made
and will also make inquiries
on whether material uncertainties exist.
The type of audit report and opinion issued will depend
upon whether material uncertainties exist
and if so, whether they have been adequately disclosed.