Auditing and assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

(a) Describe external auditor‘s responsibilities and the work that the auditor should perform in relation to the going concern status of companies. (5 marks)
(b) Describe the possible audit reports that can be issued where the going concern status of a company is called into question; your answer should describe the circumstances in which they can be issued. (5 marks)

Celtel is a large telecommunications company that is listed on the Nairobi Stock Exchange. It is highly geared because, like many such companies, it borrowed a large sum to pay for a license to operate a mobile phone network with technology that has not proved popular.
The company‘s share price has dropped 50% during the last three years and there have been several changes of senior management during that period. There has been considerable speculation in the press over the last six months about whether the company can survive

without being taken over a rival. There have been three approaches made to the company other companies regarding a possible takeover but all have failed, mainly because the bidders pulled out of the deal as a result of the drop in share prices generally.
The company has net assets, but has found it necessary to severely curtail its capital investment program. Some commentators consider this to be fundamental to the future growth of the business, others consider that the existing business is fundamentally sound. It has also been necessary for the company to restructure its finances. Detailed disclosures of all of these matters have always been made in the financial statements. No reference has been made to the going concern status of the company in previous auditor‘s reports on financial statements and the deterioration in circumstances in the current year is no worse than it has been in previous years.

a) On the basis of the information provided above, describe the audit report that you consider is likely to be issued in the case of Celtel, giving reasons. (4 marks)
b) Explain the difficulties that would be faced Celtel and its auditors if Celtel‘s audit report made reference to going concern issues. (6 marks) (Total: 20 marks)

External auditor responsibilities – going concern ISA 570 Going Concern deals with this issue.

(i) Auditors are required to consider the going concern status of companies and any disclosures regarding going concern in forming their audit opinion. Companies that are listed on stock exchanges may be required to make additional disclosures in relation to going concern issues.

(ii) Auditors are required to assess the adequacy of the means (the processes) which directors have satisfied themselves that the going concern basis is appropriate and that adequate disclosures have been made. Auditors conduct an initial analysis at the planning stage of the audit as well as assessments at later stages.

(iii) Auditors should make enquiries of the directors and examine appropriate documentation supporting the company‘s going concern status such as budgets and cash flow forecasts.

(iv) Auditors consider whether the period to which directors have paid particular attention is adequate. This should normally be at least 12 months from the balance sheet date. Auditors also enquire of management as to their knowledge of events or conditions beyond this period that may cast significant doubt on the entity‘s ability to continue as a going concern.

(v) Auditors need to consider the appropriateness of assumptions which directors have made, the sensitivity of assumptions to external and internal changes, any obligations, guarantees or undertakings arranged with other entities, the existence and adequacy of borrowing facilities and the directors‘ plans to deal with any going concern problems.

(vi) Auditors are required to document the extent of any concerns, taking account of matters that have come to their attention during the course of the audit and in particular, financial, operational, or other indicators of going concern problems that are present.

(vii) Indicators of going concern issues would include trading losses, impairment of assets, net liabilities, defaults on loans, liquidity problems, an inability to refinance loans where necessary, fundamental changes in the markets or technology having an adverse effect on the company, loss of management, staff, customers or suppliers, or major litigation, for example.

(viii) Auditors should consider the need to obtain written management representations.

(ix) Auditors should consider the adequacy of any disclosures in the financial statements.

(b) Possible audit reports and circumstances

(i) Where the auditors consider that there is a significant level of concern about the entity‘s ability to continue as a going concern (but do not disagree with the going concern basis), and where adequate disclosures of the situation are made, they modify (but do not qualify) their opinion including an ‗emphasis of matter‘ paragraph highlighting the existence of a material uncertainty as to the going concern status of the entity and drawing attention to the relevant note in the financial statements. Where adequate disclosures are not made, a qualified or adverse opinion will be issued.

(ii) Where the period to which directors have paid particular attention is less than 12 months from the balance sheet date, the auditors should consider the need to modify the audit report as a result of a limitation in the scope of the audit.

(iii) Where the auditors disagree with the preparation of the financial statements on the going concern basis, they should issue an adverse opinion. This is very rare because auditors rarely have sufficient evidence to be sure.

(iv) If the auditors are unable to form an opinion on the going concern status of a company because of a limitation in the scope of the audit, they will issue an ‗except for‘ opinion, or ‗disclaimer of‘ opinion – but this is unusual.

 Report issued to Celtel

(i) In the case of Celtel, there are some indicators of going concern problems. However, the company may still be a going concern and the fact that the company has been approached take-over bidders does not necessarily mean that there is a going concern problem (possibly quite the opposite).

(ii) The audit opinion issued on Celtel in the current year is not likely to make reference to the going concern status of the company, as in previous years. The situation has not deteriorated significantly in the current year and it will be difficult for auditors to justify any change in their opinion from previous years.

Difficulties associated with reporting on going concern

(i) If the auditors of Celtel were to report on a going concern problem, the mere act of reporting might of itself create a going concern problem (a ‗self-fulfilling prophecy‘). This is particularly the case with large ‗blue-chip‘ companies where the issue of an audit report that is modified in any way is unusual and might well cause the company‘s share price to drop, thus precipitating a going concern problem.

(ii) This means that it is very difficult for companies such as Celtel and their auditors to send out any clear signal to the markets without running the risk of creating a panic.

(iii) However, recent events show that the consequences of companies and auditors failing to report where severe financial difficulties are encountered can be disastrous for both the company (its employees and shareholders) and auditors alike.

(iv) Auditors are failing in their professional duties if they do not report on going concern problems of which they are aware; however, situations involving large companies are rarely clear cut and auditors who propose to make any changes at all to the audit report are likely to encounter fierce resistance from management who may genuinely believe that to make such a report would be wrong.

(v) In the company‘s annual financial statements, it is not the place of the auditor of Celtel to substitute his judgement for that of directors. However, where large companies involved in complex financing arrangements are concerned, auditors may have to fight hard against vested and powerful interests if they disagree with the directors‘ judgements and decide to make reference to the matter in the auditor‘s report. An auditor making reference to going concern issues in an audit report in such circumstances may lose the audit (and any other work) and may run a significant risk of litigation.

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