7522 Risk assessment procedures and related activities

Sep-2022

OAG Guidance

Many of our audit entities may not perform a going concern analysis. We consider the nature of the audit entity and use our judgment in determining whether a formal analysis is required. If management has not performed a going concern assessment, we may consider including it in our planning interviews inquiry of whether events or conditions exist that, individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern. Other procedures may include the review of plans and priorities documents, ministerial directives and/or other documents that could identify risk indicators.

OAG Guidance

CAS 570, Going Concern, explains that, because the going concern basis of accounting is a fundamental principle in the preparation of financial statements, the preparation of the financial statements requires management to assess the entity’s ability to continue as a going concern even if the financial reporting framework does not include an explicit requirement to do so. In other words, the standard is explicit that it is management’s responsibility to assess the ability of the entity to continue as a going concern. The form and content of management’s assessment will vary depending on factors such as the size and complexity of the entity and the degree of uncertainty associated with the outcome of future events and conditions.

As the auditor, our responsibility is to obtain sufficient appropriate audit evidence regarding the appropriateness of management’s conclusion about use of the going concern basis of accounting and to independently conclude whether a material uncertainty about the entity’s ability to continue as a going concern exists. An important part of fulfilling our responsibility under the auditing standards is our risk assessment procedures, where we are required to consider whether there are events or conditions impacting the entity that may cast significant doubt on the entity’s ability to continue as a going concern. During this process, we may identify the same events and conditions already identified by management, but we may also identify additional events or conditions. We document our risk assessment, including our evaluation of the management’s assessment and any identified events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern in relevant planning procedures.

When performing our risk assessment, we bring an independent perspective and knowledge and experience of conditions which have historically been present in circumstances where financial viability of an entity was at risk.

The following are some further examples of conditions that, individually or collectively, could provide an indication that an entity may be showing signs of financial distress that may ultimately cast significant doubt on an entity’s ability to continue as a going concern and are therefore worth considering (together with the considerations provided in CAS 570.A3) when independently assessing going concern risks. This list is not all‑inclusive nor does the existence of one or more of these conditions always signify that a material uncertainty exists.

Liquidity conditions

• Trend of declining cash and negative cash flows
• Creditors not being paid on due dates on a consistent basis and entity relies on this payment delay as a source of needed liquidity
• Customers taking longer to pay and/or extending payment terms
• Frequent use of short-term debt (e.g., revolving lines or bank account overdrafts)
• Credit facilities fully drawn and entity operates with limited additional liquidity headroom
• Inability to comply with the terms of loan agreements or covenant terms close to being breached
• Unusual financing products (e.g., current period sale of future revenues of new product under development, supply chain financing/“reverse factoring”)
• Off balance sheet debt
• Reliance on parent company support for liquidity
• Indications of withdrawal of financial support by creditors (e.g., credit insurers pulling coverage or a change from credit to cash-on-delivery terms with suppliers)

Adverse changes in environment, market position or operating conditions

• Profit warnings and declining margins or other adverse key financial ratios
• Operating in a market known to be in long-term decline
• Changes in government regulation which bans or significantly increases regulation related to the entity’s primary product or trade
• Aggressive pricing on new contracts
• Credit rating downgrades
• Significant decrease in share price
• Significant short seller positions held in entity’s stock
• Entity’s debt instrument is trading below par value (especially if below 80% of par value)
• Entity engagement of bankers/consultants specializing in negotiating restructuring of troubled debt obligations (i.e., “workout”/”turnaround” consultants or bankers)
• Entity’s debt is purchased by distressed debt funds

Strategic conditions

• Lack of a clear strategic plan
• Management too busy managing day‑to‑day to think/act strategically
• Many changes in management over a short period of time
• Departments working in ‘silos’
• Failing to adapt to technological change
• Failed merger or acquisition
• Reliance on small numbers of customers and/or suppliers
• Reliance on support of another group entity

Financial reporting conditions

• Limited financial information readily available or inability to produce basic information within a relatively short period of time
• Inability to provide a short-term cash forecast
• Financial information that doesn’t make sense (e.g., not consistent with historical information or industry)
• Poorly designed or ineffective internal controls

In addition to considering the risks above, it is important to remain alert to events and conditions such as changes in government regulation, changes in market conditions or a delay in bringing a new product to market. One way of identifying such events is to monitor media coverage, analyst reports and other available information related to the entity and its industry.

When assessing conditions that could threaten the financial viability of the entity, it is important to recognize that events and conditions outside the entity’s control can have significant impact. It is important to have appropriate engagement team discussions during the planning phase of the audit but also to remain alert to changing conditions and to continue to assess and discuss the impacts on the entity as the engagement progresses.

Engagement leaders and other senior engagement team members need to be involved in engagement team meetings where going concern risks are identified, discussed and assessed. In addition to the sharing of knowledge and experience, engagement leaders and other senior engagement team members can set the right tone through their involvement, including empowering engagement team members to be professionally skeptical, apply a questioning mindset and encouraging them to be alert to potential indicators of going concern issues. Engagement leaders and other senior engagement team members also need to be involved in conversations with management as they are best placed to challenge management when some of the assumptions underlying their assessment may not be reasonable.

Also consider whether the results of audit procedures performed in planning, gathering evidence, and completing the audit, identify events and conditions that, individually or collectively, may cast significant doubt about the going concern assumption. Examples are:

• Acceptance & Continuance assessment (see OAG Audit 3010)
• Risk assessment procedures through understanding of the entity and its environment, and the applicable framework (see OAG Audit 5020)
• Risk assessment procedures related to climate change (see OAG Audit 5026)
• Risk assessment procedures related to cybersecurity (see OAG Audit 5035.2)
• Risk assessment analytical procedures(see OAG Audit 5012)
• Review of subsequent events (such as discontinued operations, sales of significant facilities, or termination of proposed transactions) (see OAG Audit 9040)
• Review of compliance with the terms of debt and loan agreements
• Reading of minutes of meetings of shareholders, Board of Directors, and important committees of the Board (see OAG Audit 7560)
• Inquiry of an entity’s legal counsel about litigation, claims, and assessments (see OAG Audit 7540)
• Confirmation with related and third parties of the details of arrangements to provide or maintain financial support
• Reading of cash flow, profit and other relevant forecasts and discussion with management
• Consideration of the entity’s position regarding unfilled customer orders
• Review of correspondence with banks to establish whether commitments for credit lines are confirmed