Going concern: Whose responsibility is it anyway?

The going concern principle is foundational to financial reporting. It assumes a business will continue operating for the foreseeable future. Determining whether this assumption is reasonable is a judgement call with real consequences. But who is responsible for making that call?

The Australian Securities and Investments Commission's (ASIC) 2024 financial reporting and audit surveillance program identified going concern as a key focus area. This highlights the need for thorough evaluations and clear disclosures.

What is a going concern?

The term 'going concern' is a core concept in financial reporting. It is the assumption that the entity reporting its finances will continue to operate for at least 12 months. 

Why is going concern important for financial reporting?

The going concern principle forms the basis for preparing financial statements. Going concern changes the valuation and presentation of an entity's assets and liabilities. It provides a context for financial data that changes how we interpret it.

The going concern basis of preparation will not always be appropriate. A financial statement must reflect a true and fair view of the entity's financial health. If a business is not a going concern, its financial statements may not accurately reflect its financial position.

This could mislead investors, creditors and other stakeholders who rely on these reports for decision-making. Therefore, assessing and disclosing any uncertainties related to going concern is essential to provide clear and reliable financial information.

Do auditors decide if going concern is appropriate?

No. Under Australian Accounting Standards, management and the board bear full responsibility. They decide whether a going concern basis of preparation is appropriate.

Auditors provide an independent assessment of management’s conclusions.

Is going concern the same as solvency?

Although the two are related, going concern is not the same as solvency. Solvency refers to the business’s ability to pay its existing debts as and when they fall due. Going concern refers to the business’s ability to continue its operations for at least 12 months. The Corporations Act requires directors to sign off on the Company’s solvency in their Directors Declaration.

If a business has no realistic alternative but to cease trading, or has already decided to do so, then the going concern assumption is deemed invalid. If this occurs, the entity will need to prepare its financial statements on a different basis. This will alter their presentation and interpretation.

RSM has prepared a guide to preparing financial statements on a non-going concern basis.

What does material uncertainty around going concern mean?

Under Australian Accounting Standards, "material uncertainty around going concern" refers to situations where there is significant doubt about an entity's ability to continue operating for the foreseeable future, typically at least the next twelve months. This uncertainty arises from conditions or events that cast substantial doubt on the entity's capacity to meet its financial obligations as they become due. When such material uncertainty exists, it must be disclosed in the financial statements, along with management's plans to address these uncertainties. This ensures transparency and provides stakeholders with a clear understanding of the risks involved.

Key indicators of going concern issues

Companies must identify and disclose any potential going concern issues in their financial statements.

As auditors, our role is to evaluate the going concern assessment made by CFOs and boards. We recommend ensuring these assessments are well-documented, justified, and supported by relevant analysis, especially where any indicators of uncertainty exist. Bear in mind, both financial and non-financial indicators can signal going concern issues.

Financial indicators may include:

• Operating losses, operating cash outflows, difficulties in servicing debt obligations.
• Large debts maturing soon without viable refinancing options.
• A net current liability position, or inability to meet financial obligations as they become due.
• Limited ability to raise equity.

Non-financial indicators might encompass:

• Loss of key customers or suppliers.
• Legal issues or regulatory challenges.
• Natural disasters, pandemics, or other unforeseen events.

When these indicators are present, management and directors must investigate further. Perform additional procedures to assess the severity of the situation and its potential impact on the going concern assumption.

Management assessment of going concern

Management bears the primary responsibility for evaluating the entity's ability to continue as a going concern. This evaluation occurs at the end of each reporting period and must be conducted with due diligence and impartiality. Take into account all pertinent information and any indicators that may signal going concern issues.

The assessment typically includes preparing budgets and cash-flow forecasts for at least the next 12 months. It involves making judgements about inherently uncertain future outcomes of events or conditions. Several factors influence this judgement:

• The size and complexity of the entity.
• The nature and condition of its business.
• The extent to which it is influenced by external factors.

The uncertainty around an event or condition increases as the forecast period lengthens. Accordingly, most financial reporting frameworks limit the length of this forecast period. Australia requires at least 12 months from the financial report's date of signature. Management must consider all available information within the forecast period.

Judgements about the future are based on information available at the time the judgement is made. Subsequent events may lead to outcomes that differ from those initially anticipated, even if the original judgements were reasonable at the time.

Directors should also be aware that subsequent events (post balance date) may require updated assessments or additional disclosures.

Additionally, the Corporations Act 2001 requires those charged with governance to provide a formal solvency statement. This statement must be included in the financial report.

Responsibilities of those charged with governance (TCWG)

Governance and oversight

Those charged with governance (TCWG) are responsible for ensuring the integrity and transparency of financial reporting. TCWG typically comprise the board of directors or audit committee members and oversee the audit process. 

Their role involves:

• Reviewing and challenging key management judgments.
• Ensuring the financial statements present a balanced and accurate view of the company’s financial position.
• Addressing any qualified opinions or significant errors in the financial report.

Oversight of management’s assessment

Strong governance in the going concern assessment process enhances transparency and accountability. It protects the interests of stakeholders who rely on the company’s financial reports for decision-making.

TCWG must define clear roles and responsibilities for the going concern assessment. This includes the roles of management, internal audit, and external auditors.

The audit committee should have specialised knowledge in financial reporting and risk management. Their role is to scrutinise management’s going concern assessment. They should challenge and question management's assumptions. This process ensures management considers all significant risks and uncertainties.

Ensure the board receives timely, comprehensive reports. They need oversight of cash flow forecasts, funding arrangements and contingency plans.

Disclosure and communication

TCWG are responsible for the integrity of financial statements. This includes disclosing any material concerns about a company's ability to continue as a going concern. 

Detail any key events or conditions that raise substantial doubt about the company’s viability. Also include management's evaluation of their significance and plans to address them. 

These disclosures should enable users of the financial statements to understand the risks and uncertainties the company may face.

Supplementary disclosures, investor presentations or ASX announcements can provide further clarity to stakeholders. 

TCGW may face legal repercussions if they fail to adequately disclose these uncertainties. Or for a misleading disclosure that leads readers to misunderstand the severity of the situation. 

Clear disclosures are crucial for building investor trust and fulfilling the directors' legal responsibilities under the Corporations Act. Be transparent about going concern issues to maintain that trust and meet your legal and ethical obligations.

What are an auditor's duties in evaluating a going concern?

External auditors play a key role in evaluating a company's ability to continue operating. Once management decide an entity is a going concern, an auditor will step in to check their work. They must gather enough appropriate evidence to determine whether management have made the right call. However, it’s important to recognise that the auditor’s role is not to decide whether the entity is a going concern. Rather, they are there to evaluate and question the assessment made by management. 

The auditor will review management's assessment, learning about the company and its industry. They will focus on whether management has:

• Considered all relevant facts and circumstances.
• Applied reasonable assumptions.
• Disclosed any material uncertainties transparently.

Directors and CFOs can reduce the risk of a modified audit opinion by ensuring the assessment process is:

• Well-documented.
• Realistic.
• Stress-tested against downside scenarios.

What sources of information do auditors use?

Auditors use a variety of information sources to assess going concern. Management and boards should already review and monitor many of these as part of their regular risk oversight. Information sources include:

Operating results

Your auditor will compare post-year-end management accounts with budgets or forecasts. This will help them assess whether actual performance supports assumptions.

Operational information

When examining operational information, your auditor will:

• Evaluate key customer or contract wins and losses.
• Assess the status of new contracts.
• Analyse the impact of acquisitions or sales of business units on performance.

Financial information

The assessment covers the status of finance facilities, including breaches, expiries, and renewals. It also evaluates changes in capital structure and liquidity headroom. Additionally, the assessment considers contingent liabilities, such as legal exposures and warranty claims.

Expect your auditor to request robust supporting documentation and sensitivity analyses. They need this information to evidence the going concern position.

Critically evaluate management’s assumptions

Auditors must critically evaluate management's assumptions, methodologies, and information used in their going concern assessment. This includes examining management's cash flow forecasts, funding strategies, and risk mitigation plans to identify any overly optimistic or unreasonable assumptions.  The review typically spans a period of at least 12 months from the date of signing the financial report. Boards should ensure this forward-looking horizon is factored into their governance processes.

Consideration of external risks

Auditors must also consider how external risks might affect the company's ability to continue as a going concern. This includes factors such as:

• Economic downturns
• Regulatory changes
• Increased competition
• Supply chain disruptions. 

They gather sufficient and appropriate audit evidence regarding these risks and their potential impact on the entity’s financial position, performance, and cash flows.  This includes cross-referencing management’s forecasts against independent industry data and market conditions.

What is an audit opinion?

When your auditor concludes their evaluation, they must communicate their findings to TCWG. They will deliver this information in what is known as an audit opinion. This is a formal expression of whether they view the financial statement as true and fair. 

There are several 'types' of audit opinion. What type they issue will depend on their assessment of your financial statement. This includes their going concern evaluation. 

Here is a brief overview of different audit opinions:

Unmodified opinion

Also known as a clean opinion. This indicates the financial statements are presented fairly, in all material respects.

Unmodified opinion with a material uncertainty in respect of going concern

Provided when a material uncertainty exists and is adequately disclosed. It means the financial statements are presented fairly in all material respects. However, the auditor believes there is a material uncertainty over whether the Company will continue as a going concern. Because the material uncertainty was disclosed, the auditor’s opinion is not 'qualified'.

The auditor will include a ‘material uncertainty related to going concern’ paragraph in their opinion.

Qualified opinion

Given when the auditor agrees with the financial statements except for a specific part or parts. This could be because a material misstatement is present. Or they couldn't find sufficient audit evidence for a particular amount or disclosure.

A qualified opinion indicates that the financial statements are mostly correct, except for specific areas impacted by the going concern uncertainties.  This might be the case if the financial statements do not adequately disclose the source of a material uncertainty. 

Adverse opinion

The auditor believes the financial statements as a whole are materially misstated and do not present a true and fair view.

An adverse opinion is issued when the doubts are so significant that they pervasively affect the overall financial statements. This might occur where the financial statements have been prepared on the going concern basis, and the auditor believes they should not have been.

Disclaimer of opinion

The auditor cannot form an opinion on the financial statements as a whole. This is due to a lack of sufficient appropriate audit evidence.  In severe cases, where the auditor cannot obtain sufficient appropriate audit evidence about the company's ability to continue as a going concern, they may issue a disclaimer of opinion

Modified opinion

Provided when material uncertainties exist but aren't adequately disclosed in the financial statements. This is not the same as a 'qualified' opinion. 

When there are uncertainties about a company's ability to continue as a going concern, the auditor will closely examine the severity of these doubts and their potential impact on the financial statements. If the auditor concludes that a material misstatement is likely due to these concerns, they will modify their audit opinion accordingly.

Key takeaways

As you can see, the going concern principle is key for robust financial reporting and sound governance. And while auditors do play a critical role in assessing going concern, responsibility lies with management and the board.

Moving forward, we recommend proactively managing your going concern issues. Engage early with your auditor and be transparent about any challenges. This will help you avoid surprises late in the audit process.

Embed going concern assessments into your regular risk management and financial planning. This will help strengthen your organisation's resilience and long-term sustainability.

Directors and CFOs must:

• Ensure forecasting processes are credible and well-documented
• Consider scenario planning and downside risks
• Ensure management’s mitigation strategies are realistic and implementable
• Ensure disclosures are transparent and aligned with audit evidence 

If you have any questions about going concern assessments or would like support implementing these measures, reach out to your local RSM auditor.