How Can an Auditor Gather Evidence of a Company’s ‘Going Concern’ Status?
For an auditor to accurately determine a company's going concern status, certain evidence must be gathered and analyzed. A company's going concern status refers to its ability to continue as a going concern for the foreseeable future, without liquidation or bankruptcy. To assess this critically important aspect of a company's financial health, auditors employ a variety of methods and sources of evidence. This article will explore some of the most common and effective techniques used in the auditing process to evaluate a company's going concern status.
1. Analyzing Historical Data and Trends
One of the primary methods for gathering evidence is through the analysis of historical data. An auditor will examine historical financial data to identify any patterns or changes that might indicate potential issues. For example, if a company has experienced a significant drop in cash flows from operations, a large increase in debt, or frequent layoffs, these could all be red flags. The auditor may also look at other relevant indicators such as declining sales, mounting warranty costs, or closing factories. These factors can serve as strong indicators of a company's financial health and its ability to continue operating.
2. Inquiring with Management
In addition to historical data analysis, auditors may also inquire directly with management to gain insights into any potential future changes or liquidity issues. Management can provide valuable information about planned changes, ongoing processes, and the company's overall strategy. This can include discussions about any upcoming financial strategies, which may include capital injections or leveraging fixed assets to raise funds. It is essential to obtain candid and comprehensive information from management to ensure a thorough evaluation.
3. Evaluating Market Performance and Industry Trends
Another critical aspect of the evaluation process is assessing how the company and its industry are performing in the broader market. Auditors can review market statistics and trends to gain a holistic view of the company's position. This involves benchmarking various metrics in the business, such as market share, revenue growth, and competitive positioning. If the industry is declining or the company is lagging behind its competitors, this could indicate a higher risk of financial difficulties and a potential loss of going concern status.
4. Performing Due Diligence and Confirmation Procedures
To further substantiate the findings, auditors may perform due diligence and confirmation procedures. These can include:
Checking orders and sales figures to see if there is a decline for any product or service.
Confirming the status of unpaid invoices and loans receivable through direct letters to the creditors.
Opening and verifying assets such as buildings, equipment, and production facilities on-site. This involves overseeing the simultaneous opening of multiple safety deposit boxes with management and auditor/representatives present to ensure the integrity of the assets.
Auditors may also confirm bank balances and other financial records through direct inquiries or physical observations.
It’s important to note that these procedures are performed to verify the company's financial position and assets, not to uncover any misappropriations of funds or wrongdoing.
5. Evaluation of Remedial Actions
Once all the evidence has been gathered and analyzed, the auditor will evaluate whether any remedial actions are being taken to address the identified risks. If the company is taking appropriate and adequate measures, such as securing a new capital injection or using fixed assets as collateral, this can mitigate the risk of a loss of going concern status. However, if no action is being taken or the actions are insufficient, the auditor must consider expressing an opinion that the entity is no longer a going concern.
It’s also worth noting that in some cases, a company might have a strong financial position but may no longer engage in its core business due to factors like obsolescence, illegality, or market changes. Unless an alternative activity is identified, the company will be considered to have ceased its going concern status.
Conclusion
Accurately determining a company's going concern status is a complex but crucial task for auditors. Through a combination of historical data analysis, inquiries with management, market performance evaluations, and robust confirmation procedures, auditors can gather the necessary evidence to make an informed judgment. The thoroughness and accuracy of these procedures are vital to maintaining public trust and ensuring the financial integrity of a company.