CHAPTER 12
Final Work : General Principles , analytical review of financial statements,
fixed aasets,and debtors
Pre-final work Discussions are held with management near the year-end to
ensure that preparation of financial statements runs smoothly and
timetables are met.Auditors maintain regular contact with management to
detect problems earlyon in the process.
Potentially problematic areas include:
(a) known problems;
(b) stocktaking instructions;
(c) timetable for preparation of year-end financial statements;
(d) circularizations;
(e) requirements of accounting and reporting standards;
(f) new legislation;
(g) requirements of auditing standards
Balance sheet date work.
Typical audit work includes:
(a) bank confirmations;
(b) stock count observation;
(c) stages of completion of long-term contracts/assets in course of
construction;
(d) letters to other professionals.
Some time elapses between interim and final examinations and auditors
should ascertain whether conclusions formed earlier are still valid and
whether systems operated as expected during the whole year This is know
as bridging work
Analytical procedures.
ASB has adopted a balance sheet approach when defining assets and
liabilities and less attention is paid to matching and accruals and to the
profit and loss account. It may mean that it becomes more difficult to
interpret profit and loss account and income/expense headings
The search for audit evidence is conducted on a global and detailed basis
and within a clearly understood risk context. Analytical review is useful
when reviewing the financial statements taken as a whole at the conclusion
of the audit Specifically, auditors determine whether:
(a)financial statements have been prepared using consistent and
appropriate accounting principles;
(b)information published with the financial statements is compatible with
them;
(c)presentation and disclosure are as required by law and by regulatory
bodies and achieve truth and fairness;
(d)conclusions drawn from tests and overall review of the financial
statements enable an opinion to be formed.
Ratio Analysis Auditors use ratio analysis and other interpretativetools.
Significant changes in figures revealed by analytical reviewmay result from:
(a) errors;
(b) changes in accounting practice
(c) changes in management policy;
(d) changes in general commercial factors;
(e) changes in commercial factors affecting the client only;
(f) fraud
In the examination room the best approach is:
(a) look at the figures broadly, before calculating ratios;
(b) calculate selected ratios to confirm initial impression;
(c) remember many ratios are interrelated;
(d) analysis of financial statements directs audit effort.
Ratio analysis can be useful, but must be handled with care as ratios are
meaningless unless compared with other ratios. Auditors should ensure
industry statistics have been prepared in the same way as ratios used for
the company and be aware of special measures of success or performance
indicators used in a particular industry
Other analytical tools include:
(a) graphs;
(b) regression analysis and multiple regression analysis; (c) Z-scores.
True and Fair view of Financial statements
Accounting standards are designed to aid the preparation of financial
statements that give a true and fair view. Members of accounting bodies
acting as auditors or reporting accountants should justify significant
departures to the extent that their concurrence with the departures is
stated or implied.
Financial statement assertions in respect of assets, claims against assets,
and related revenues and costs are grouped under the headings:
1. genuine
2. accurate
3. complete
prompting questions about existence, condition, ownership, valuation and
disclosure/presentation.
Tangible fixed assets
These vary in nature within companies andbetween industries. Inherent risk
factors include:
(a) technological changes;
(b) closure of part of business;
(c) difficulties in making estimates of useful lives;
(d) revaluation of fixed assets;
(e) existence of significant idle fixed assets;
(f) significant fixed assets in course of construction;
(g) own construction of fixed assets;
(h) moveable, high value assets.
Specific control to minimise control risk
A part from a satisfactory control environment,specific controls are
necessary to minimise control risk over:
1. acquisitions, revaluation, impairment;
2. safeguarding;
3. disposals;
4. maintenance, insurance;
5. authorization of depreciation charges and accumulations.
Main control documents for acquisitions are fixed assets budgets long,
medium and short term.The main accounting record for fixed assets is the
fixed assets register. To be a good control document it should be held by
persons independent of those using and having custody of the fixed assets,
and be compared periodically with physical assets and vice versa
Using recorded details, fixed assets should be reconciled by the company at
least annually to cost/valuation, accumulated depreciation and
depreciation charge figures in the financial statements. If a fixed assets
register is not kept or the register is found to be subject to error, control risk
will be increased and auditors may have to extend substantive tests of detail
Proceeds of sale of fixed assets may be misappropriated if controls are not
in place. Disposals should be authorized in writing by individuals with
appropriate authority after careful assessment of continuing value, with
directors to issue guidelines for making assessments
Analytical procedures on fixed assets might be directed to:
1. significant additions and disposals;
2. profits/losses on disposal;
3. revaluations;
4. significant repairs;
5. maintenance charges.
Financial Statement assertions
On revaluation of fixed assets, financial statement assertions include:
1. Genuine: revaluation has taken into account real conditions; selected
basis is appropriate;
2. Accurate: calculation of current values appropriately reflects underlying
value in accordance with relevant accounting principles;
3. Complete: all fixed assets in a particular class have been revalued
Substantive procedures include that the valuer isproperly qualified and that
the valuers scope ofwork is appropriate, including:
(a) objectives and scope;
(b) clear statement of the matters to examine;
(c) why work is being carried out;
(d) information provided to the valuer, and its reliability (from local planning
and similar authorities; and from client officials and solicitors);
(e) assumptions and methods used;
(f) timing of valuation. A second valuation may be appropriate if significant
For disposals of fixed assets, determine thereasons if significant and
whether an impairmentreview of the remaining assets is
necessary.Substantive procedures include:
(1) check number sequence of disposal approvals and to the fixed assets
register;
(2) select random sample of approvals and check authorization signature
and trace to sales despatch notes.
Depreciation Audit work on depreciation is closelyallied to work on the
fixed assets. Specific matters of interest are:
1. useful economic lives and appropriateness of depreciation method;
2. residual values;
3. depreciation on revalued fixed assets.
Trade debtors Trade debtors are normally classified as current assets. It is
important to determine the point at which the property in goods is
transferred or service performed. Sales of goods and services cause trade
debtors to come into existence or increase cash balances, so audit work on
sales cannot be divorced from work on the assets accounts
The auditor would expect to see a satisfactorycontrol environment and
control over:
(1) creation and clearance of trade debtors balances;
(2) safeguarding of trade debtors.
Important elements when safeguarding tradedebtors are as follows:
(a) the rapid billing of customers;
(b) regular preparation of statements and reminder letters;
(c) offer of cash discounts;
(d) approval of entries reducing the stated amount of debtors balances,
(e) ageing statement;
(f) credit limits
CHAPTER 13
Final Work : Specific Problems, Related to stocks, Long-term contracts and
Trade creditors
Determining Cost of stocks
Stocks are normally a significant asset of manufacturing companies with
direct effect on profit. They vary in character and pose a variety of problems
for auditors.The examples used here are taken from the mineral oil industry
and the manufacture of television sets
The costing system is important in determining cost of stocks and long-term
contracts and auditors pay particular attention to ensuring costs are
genuine, accurate and complete. Some costs are easily allocated to
products, but overheads may be allocated on some arbitrary but reasonable
basis, and on the basis of production levels, which are normal, taking one
year with another.
Some products may be main products, whereas others may be by-
products, with income on disposal being treated as reduction in cost of main
products. Net realizable value may not be easy to determinebecause stocks
may not be used or sold orcompleted until after audit field work is
complete.
Inherent risks affecting stocks include:
(a)changes in demand for the companys products;
(b)changes in production levels;
(c)defects in product lines;
(d) stocks can be attractive and easily transportable;
(e) complex production process;
(f) joint products;
(g) significant variances from standard costs;
(h) competitors providing more risky environment;
(i) complex calculation of overheads
Acquisitions: it is important to determine the point at which title
passes, particularly in e-commerce relationships.
Safeguarding stocks: this includes physical safeguards and
restriction of access via documentation.
Disposals of stocks: normal sales are more likely to be controlled
than abnormal disposals.
Determining existence, condition and ownership at period-ends:
physical stock counts, timely reconciliation to stock records and
investigation of significant differences.
Valuation of stocks: the basic principle is the lower of cost and
net realizable value, with controls to ensure costing and other records are
reliable and prepared consistently
Substantive testing of stocks Substantive testing of stocks and related
production costs address:
1. existence;
2. condition;
3. ownership;
4. cut-off;
5. production costs (genuine accurate and complete);
6. production costs (properly allocated to stocks on hand, and amount
attributed to stocks is genuine, accurate and complete)
Normal audit practice to attend stock counts to ensure the stock taking
system is operating satisfactorily and to perform compliance and
substantive tests. Cut-off procedures are performed at external and internal
cut-off points
Procedures to ensure stock is properly countedand recorded are as follows:
(a) issue of stocktaking instructions;
(b) person with overall responsibility, independent of stores personnel;
(c) balanced stock count teams;
(d) stores neat and tidy;
(e) arrangements for cut-off;
(f) issue of pre-numbered stock sheets and completeness check;
(g) stock names and reference numbers on the stock sheets;
(h) members of count teams count stock independently until agreement
reached;
(i)count sheets signed by two members of the count team;
(j) count teams comment on items in poor physical condition;
(k) responsible officials to investigate significant discrepancies between
stock records and count;
(l) count teams responsible for manageable quantities of products;
(m) logical system for recording stock names and reference numbers;
(n) test counts by responsible officials;
(o) marking stock counted;
(p) identification of goods held for or by third parties;
(q) auditors available for advice;
(r) briefing sessions with count teams to ensure instructions properly
understood
Stock count observation, purposes and procedures. Auditors attend the
count to check if instructions are properly followed, and to make test counts
to ensure procedures and internal controls are satisfactory.Auditors select
items from count records and physical count and compare to gain assurance
as to completeness and accuracy of count records, giving particular
consideration to high value stocks
Level of substantive tests of details depends on theauditors view of the
quality of stocktaking instructionsand how they are applied. Stock counts
may becarried out during the year and stock quantities takenfrom records
only if:
(a)controls over stock records are adequate;
(b)stock records are accurate and complete;
(c)significant differences between stock records and quantities counted are
investigated and corrected.
Audit procedures include:
(a) stock count observations during the year;
(b) test the accuracy of stock records;
(c) test for cut-off at count date and balance sheet date;
(d) if necessary, conduct a restricted test count at the balance sheet date.
There are particular problems affecting work inprogress, stocks held at third
parties and at branches.
The basis of stock valuation is the lower of cost and net realizable value.
Basic rules for calculating cost include:
(a) for different categories of stock, not for the stocks as a whole;
(b) comprises cost of purchase and costs of conversion;
(c) cost of purchase comprises direct costs, less cost reductions;
(d) cost of conversion comprises:
o direct costs;
o production overheads based on normal level of activity, taking one year
with another;
o other overheads incurred in bringing a product or service to its present
location and condition;
(e) costs may be allocated to production using an arbitrary method, such as
FIFO and AVCO.
Net realizable value Net realizable value is actual or estimated selling price
less all further costs of production and costs yet to be incurred in marketing,
selling and distributing
Long-term contract long-term contract may be defined as: A contract
entered into for the design, manufacture or construction of an asset or
provision of a service or a combinationsuch that the contract activity usually
falls into different accounting periods.
The major problem is that the construction period overlaps accounting
periods, so a decision must be made as to whether profits and losses should
be taken up before completion. This is subjective and auditors assess the
validity of management judgements.
There are nine judgemental points, each assertion involving an audit
evidence search and testing
(1) costs incurred to date are genuine, accurate and complete;
(2) stages of completion and related costs are properly determined;
(3) invoices issued to customers are calculated in accordance with contract
and certified by the surveyor;
(4) cash received from debtors is genuine, accurate and complete and
properly allocated to contracts
(5) estimated total costs are genuine, accurate and complete;
(6) contract prices are genuine, accurate and complete
(7) when attributable profits on contracts are taken up, it is sufficiently
complete to give adequate assurance that the outcome of the contract is
certain; losses should be provided for when recognized
(8) the profitability of different stages of the contact has been properly
determined;
(9) the method employed in taking up profits is comparable with prior years,
unless appropriate and the effect of change is disclosed.
Trade creditors Trade creditors are normally classified as amounts payable
in the short term. They come into existence as the result of purchase of
goods or the performance of services by third parties, so audit work on
purchases and related assets cannot be divorced from each other
Inherent risks affecting trade creditors include:
(a) new or material transactions or events;
(b) material variances from standard costs;
(c) suppliers experiencing difficulties;
(d) significant changes in terms of trade;
(e) a material increase in the age of trade creditors;
(f) major changes in the nature of purchases;
(g) above-average returns of goods purchased
Apart from a satisfactory control environment,auditors expect to see
controls over:
1. the creation of trade creditors;
2. recorded trade creditors at year-end;
3. payment of trade creditors.
For creation of trade creditors, expected controls include:
(a) preparation of integrated purchases budget and investigation of
variances
(b) record the point at which title in goods acquired passes and services
rendered are complete
(c) for goods accepted on sale or return, a clear statement of company
obligations to suppliers
(d) where title remains with the supplier there may be special disclosure
requirements;
(e) purchases not in the normal purchases system to be kept to a minimum,
and specially authorized;
(g) investigation of reasons for significant returns;
(h) cut-off procedures
For recorded trade creditors at the year-end,expected controls include:
(a) appropriate division of duties;
(b) regular review of suppliers statements;
(c) system for adhering to and renegotiating supplier credit limits;
(d) a system for detecting unrecorded liabilities;
(e) a system for enquiry into unusual features
For payment of trade creditors balances, expected controls include:
(a) independent matching operation;
(b) calculations on purchase invoices checked for accuracy
(c) evidence of controls performed
(d) cheque signatories to see supporting documentation
(e) blank cheques never to be signed.
Substantive approaches cover:
(a)creation of trade creditors balances, including re-performing matching
operation
(b) recorded trade creditors at year-end
(c) search for unrecorded liabilities
CHAPTER 14
Final Work : Specific Problems, Related to stocks, Long-term contracts and
Trade creditors
Stage 18 of the audit process is when auditors pull together evidence
gathered and conclusions arrived at earlier to form a view on the financial
statements as a whole
They also perform the following tasks:
(a)post-balance sheet date work;
(b)audit work on provisions and contingencies;
(c) final working sheet review;
(d) reviews of validity of the going-concern concept;
(e) review work of other auditors.
Finally, they obtain the management letter ofrepresentation.
Post-balance sheet events
This is when auditors routinely assess:
1. debtors collectability;
2. NRV of stocks;
3. useful lives of fixed assets;
4. potential unrecorded liabilities.
Auditors review the post-balance sheet period toascertain whether any
matters should be reflectedin the accounts or disclosed in the audit report.
The period after the balance sheet date may be subdivided into periods as
follows. Each period has its own characteristics and problems for auditors
(1) between balance sheet date and completion of draft accounts.
(2) from completion of draft accounts to completion of audit fieldwork.
(3) from completion of audit fieldwork to date of issuing financial
statements.
(4) after the financial statements have been issued but before the AGM;
(5) after the AGM
Events occurring in periods (1) and (2) are known by both directors and
auditors as they occur before the signing of the accounts and completion of
audit fieldwork. Regarding (3), auditors, becoming aware of a material
event, establish if financial statements need amendment, discuss with
directors and consider the implications for their report.
Regarding (4), auditors have no obligation to perform procedures or make
enquiries, but if they become aware of an event that might have caused
them to issue a different report, they consider whether the financial
statements need amendment, discuss with directors and consider the
implications for their report.
Regarding (5), auditors will not be expected to be aware of an event in the
period after the AGM, but, if they do obtain knowledge of it, the matter
should be discussed with the directors and action, if any, they intend to
take, determined
Provisions, contingent liabilities and contingent assets
Some events, occurring either before or after the balance sheet date, have
uncertain outcomes provisions and contingencies as defined by FRS
Is there a legal or constructive obligation, the latter evidenced by policies or
other authoritative statements from management in the past, and whether
the company is taking any action in respect of the event;
The auditor should determine if a reliable estimate be made of the amount
of the obligation. Potential losses from claims may be particularly difficult
to ascertain.
Provisions must be properly disclosed in accordance with FRS 12, sufficient
to enable the reader to understand the nature of the obligation, the
expected timing of transfers of economic benefits, and the uncertainties
about amount or timing
If the event does not give rise to a present obligation, or there is no probable
outflow of economic benefits or it is not possible to evaluate the timing and
amount of the obligation, it may be treated as a contingency. FRS 12 and
IAS 37 distinguish between contingent liabilities and contingent assets
Contingent liability
(a)A possible obligation that arises from past events and whose existence
will be confirmed only by the occurrence of one or more uncertain future
events not wholly within the entitys control.
(b)A present obligation that arises from past events but is not recognized.
In Part (b) the obligation may not be recognizedfor the following reasons:
(i)it is not probable that a transfer of economic benefits will be required to
settle an obligation;
(ii) the amount of the obligation cannot be measured with sufficient
reliability
Contingent asset
A possible asset that derives from past events and whose existence will be
confirmed only by the occurrence of one or more uncertain future events
not wholly within the entitys control....
Contingencies, like provisions, are problematicbecause of the varying
degrees of certainty fromremote to probable. Note that:
(a) directors consider estimates of outcome and the financial effect of
contingencies;
(b) directors review events occurring after the balance sheet date up to the
date of signing the financial statements;
(c) accounting treatment of a contingency depends on its expected outcome
and nature....
Going concern During the final review period the auditor considers the
validity of assuming that the company is a going concern.
Audit work to detect post-balance sheet events and contingencies
(a) determine company procedures to detect material post-balance sheet
events/ contingencies;
(b) examine minutes of meetings: shareholders, directors and
audit/executive committee;
(c) examine management accounts/accounting records
(d) examine profit and cash flow forecasts;
(e) Enquire of legal department and external legal representatives
(f) review known risk areas;
(g) review correspondence/memoranda;
(h) confirmation from third parties;
(i) review information in the public domain;
(j) management interviews
CHAPTER 17
Fraud and Going Concern
Auditors responsibility for detecting fraud
Auditors responsibility for detecting fraud has generated considerable
controversy and it is popularly believed that auditors are responsible for
detecting fraud. Detection of fraud and error was at one time an important
function of audit, but today auditors concentrate on assessing the integrity
and competence of management, and the effectiveness of internal control,
using analytical procedures, and largely restricting detailed audit work to
high risk areas.
The auditing standard on fraud states that it is not the auditors function to
prevent fraud and error, but that auditors plan, perform and evaluate their
audit work in order to have a reasonable expectation of detecting material
misstatements arising from error or fraud. Management has prime
responsibility to prevent and detect the occurrence of fraud through
appropriate systems of internal control and other means.
Auditors do plan and conduct audit tests to limit the possibility that material
fraud and irregularities go undetected. This process starts at the planning
phase when auditors consider the company and its environment and the
risks facing it.
Auditors limitation
Auditors argue they cannot guarantee detection ofall frauds and errors
because of:
(1) inherent limitations in audit techniques and tests;
(2) deceit, collusion and other means to conceal fraud make detection
difficult;
(3) audit evidence is that required to form an opinion and not specifically to
find fraud.
Motives and Indicators of Fraud
Identification of motives and indicators of potential significant fraud are
important. Pressure to misrepresent financial performancemay be high.In
such circumstances auditors might change theiraudit approach to reflect
higher risk.
Reasons behind misrepresentation might be:
(a) the company has performed badly or is under pressure from markets;
(b) directors wish to show continuing growth;
(c) where the company expands by acquisition, directors may wish to inflate
profits to show success, and to sustain the share price;
(d) there are liquidity problems.
Characteristics of personnel, the management team and its structure may
provide helpful indicators as to when and where a fraud is likely:
1. particular directors are autocratic and authoritarian;
2. staff are poorly qualified or lack motivation;
3. individuals are paid by results;
4. individuals are allowed too much authority or power;
5. turnover of staff is high
Relevant individual characteristics include:
(i)integrity and sense of ethics;
(ii)extent to which motivated by greed
(iii) degree of loyalty exhibited by individuals.
Weaknesses in systems may:
1. reduce the reliability of accounting information;
2. allow employees to commit fraud;
3. allow management to avoid or override controls.
Obtaining audit evidence
Problems in obtaining audit evidence arise where:
(a)external or auditor-generated evidence is not available
(b) the lack of evidence relates to material or unusual or complex
transactions;
(c) the lack of evidence results from managerial action.
Once auditors have ascertained that fraud mightbe taking place they decide
on appropriate action:
(a)confirm understanding of facts, nature of fraud and likely magnitude to
aid determination of additional audit tests;
(b) discuss the fraud or error with senior management, directors or audit
committee.
If fraud has been discovered, auditors should:
(i)ask directors to consider changing financial statements;
(ii) ask management to determine the extent of fraud or error;
(iii) assess the impact on other audit work.
If auditors suspect non-directors may be implicated, they should discuss the
matter with the directors. If directors may be involved, they should consider
reporting to the audit committee. They might also seek legal advice and, in
some circumstances, report their suspicions to third parties.
If directors do not take appropriate action, it may be difficult to determine
the full extent of the fraud or error, may have implications for the audit
report, and may cause the auditors to re-evaluate the integrity of
management and the control environment.
Audit Process documentation
Auditors should document the process until it issatisfactorily resolved,
including:
(a) initial grounds for suspicion;
(b) additional audit work;
(c) details of what, when and to whom they reported;
(d) managements response and any action;
(e) implications for audit work.
Board of Directrs and Internal Controls Board of directors responsibilities
include maintaining sound internal controls to safeguard shareholders
investment and company assets, including prevention and detection of
fraud and error.
Means to achieve these include:
1. developing an appropriate control environment;
2. establishing a strong and effective system of internal control;
3. encouraging a strong ethical environment and developing a code of
conduct;
4. establishment of an audit committee;
5. reporting on the effectiveness of the companys internal control system.
Auditors may report to third parties that they have found a fraud, or suspect
it is taking place, if it is in the public interest to do so. They would normally
discuss the issue with the board of directors and the audit committee first,
unless they believe the directors may be implicated or are aware of it.
Only after discussion, and if the directors do not inform an appropriate
authority, will auditors report the fraud. Auditors must use professional
judgement to determine if the matter is in the public interest, perhaps
seeking legal advice, especially as the duty of confidentiality may be
breached.
The Audit Agenda
The Audit Agenda: Next Steps did not proposechanges in auditors
responsibilities for detectingfraud, but recommended that:
(1) auditors should report to the board and audit committees of listed
companies on the appropriateness and adequacy of control systems;
(2) training and education to improve understanding of fraud and its
detection;
(3) directors to commission forensic audits.
The Audit Agenda highlighted the difficulty of detecting fraud where it is
well planned, ingenious or involving collusion or top management, but
noted that auditors can contribute to the prevention of fraud by informing
management of weaknesses in the control systems.It also referred to the
limited nature of penalties imposed on directors if they mislead auditors.
ICAEW Audit Faculty has recommended that auditors be prepared to take a
more active role in detecting fraud, and has made suggestions as to the
knowledge auditors should have. It was suggested that a Fraud Advisory
Panel be established. APB has admitted it is difficult to detect management
fraud, but has made proposals regarding potential ways in which audit could
be made more effective.
Audit standard and Fraud management
Some auditing standards might be amended but APB says that a significant
increase in the likelihoodof detecting management fraud requires radical
change, including:
(a) increased emphasis on professional scepticism;
(b) tighter rules on acceptable audit evidence;
(c) reporting material matters in the financial statements that are supported
only by managements representations.
APB considers that expanding the auditors rolecould be helpful in
preventing and detecting fraud,perhaps by:
(a) reporting to boards and audit committees on controls to prevent and
detect fraud;
(b) forensic fraud review;
(c) more reporting of suspected frauds
Obligations for Auditors Obligations here for auditors include:
(a) understanding relevant laws and regulations and how the entity ensures
compliance;
(b) inspecting correspondence with relevant authorities;
(c) determining if management are aware of non-compliance;
(d) obtaining from directors written confirmation they have disclosed non-
compliance and the actual or potential consequences.
When auditors become aware of possible non-compliance they determine
its nature and conclude on the potential effect on the financial statements.
The outcome of discussions with management and legal representatives
may influence auditors judgement of managements integrity. Auditors
may consider including the matter in their audit report
Financial statements are usually prepared on the going-concern basis
because measures based on break-up values tend not to be relevant to
users.Users assume that, if there is no comment to the contrary, the
company will survive beyond the short-term.
Directors responsibilities include determining whether a company is a
going concern. Auditors must satisfy themselves that the going-concern
basis is appropriate and disclosures in the financial statements are
sufficient. They should determine how directors concluded the company is
a going concern, and assess the logic, rationale and strength of information
used.
To do so auditors should:
(i) make enquiries of directors and examine appropriate
available financial information;
(ii) having regard to the future period to which the directors
have paid particular attention, plan and perform
procedures specifically designed to identify any material
matters that could indicate concern about the entitys
ability to continue as a going concern.
When planning, auditors should:
(1)assess business/inherentand control risk;
(2)perform analytical procedures.
Assessment of Inherent and control risk
Assessment of business/inherent riskrequiresauditors to be knowledgeable
about the company,its products, main suppliers, competitors and
itsenvironment. Assessment of control risk is important because it gives
guidance on reliability of historical and budgeted financial information.
Means to predict the future include:
(1)cash flow budgets or forecasts;
(2) forecast profit and loss accounts and balance sheets;
(3) information on forecast sales, costs and products. Indicators that might
suggest going-concernproblems are: negative cash flows;
1. significant losses;
2. substantial debts difficult to service;
3. substantial overdraft and overdraft limit exceeded;
4. net current liabilities;
5. loan repayments or overdraft facilities renegotiated;
6. reduction in dividends;
7. longer creditor payment period;
8. company has made employees redundant and/or has had to
reorganize/rationalize its operations;
9. declining market and/or out-of-fashion products;
10. forced sale of fixed assets.
Auditors obtain written confirmation of directorsrepresentations about
going concern.
Where financial statements are prepared on a going-concern basis, the
entity is assumed to continue in existence for the foreseeable future, the
extent of which varies from entity to entity influenced by the nature of the
entitys business, its business risk and external influences.
Directors judge what is an appropriate period for them to look into the
future. If this period is less than one year, additional disclosures in the
financial statements may be required, and the auditors refer to this in the
audit report even where there is little doubt about going-concern status.
If there is no doubt, neither directors nor auditors need refer specifically to
going concern in the financial statements or audit report. However, the
Combined Code states that
the directors should report that the businessis a going concern, with
supportingassumptions or qualifications as necessary
Where there are doubts, auditors will consider if the directors have included
sufficient appropriate disclosures such that the financial statements give a
true and fair view. If so, they need not issue a qualified audit opinion, even
where there is fundamental uncertainty, but include an explanatory
paragraph on the going-concern problems, referring to the note disclosure
in the audit report.