7524 Additional audit procedures when events or conditions are identified

Sep-2022

OAG Guidance

Note that in some cases, the procedures we perform to respond to going concern risks are primarily substantive in nature. In many cases, we limit ourselves to those procedures and do not attempt to obtain controls evidence. A situation where we may need to obtain controls evidence is the reliability of an entity’s system for generating analysis of cash flows if such analysis is a significant factor in considering the future outcome of events or conditions related to evaluating going concern.

The following guidance supplements the guidance above:

1. Business issues and audit risks associated with refinancing

Auditing Standards require management and the auditor to assess if there are any material uncertainties about a company’s ability to continue as a going concern for at least 12 months after the balance sheet date. Therefore, if a client has debt that is due in the next 12 to 15 months, engagement teams need to assess whether there is a potential risk related to the client’s inability to refinance and the associated consequences on the going concern assumptions.

Example of factors that might lead to a higher risk of not being able to refinance are:

• Uncertain economic times
• Request for new or additional collateral to compensate for higher risk
• Difficulties maintaining covenant compliance

If engagement teams conclude that there is a higher risk of not being able to refinance, engagement teams should

• Obtain management’s plans to mitigate the effects of their possible inability to refinance.
• Assess the likelihood that these plans can be implemented effectively.

To obtain a better understanding of management’s plans for refinancing, audit teams may ask their clients the following questions.

• What is management’s assessment of the entity’s liquidity at the expected time of refinancing?

• Have any preliminary agreements or discussions occurred?

• What has been the substance of those discussions?

• If negative operating trends exist, how does management plan to turn them around?

• Where within the bank is the loan account domiciled? i.e. Does it remain with its regular relationship manager or has it been elevated in the risk hierarchy of the bank?

• What is the plan to maintain or increase the liquidity of the balance sheet?

• Have they considered other refinancing alternatives (such as asset based lending)?

• Have they considered subordinate debt where there is a possibility of amortization of payment?

• Is an equity injection a possibility?

In addition to inquiries of the client, the engagement team can perform the following additional procedures to ensure sufficient appropriate audit evidence is obtained:

• Examine correspondence with banker

• Assess whether balance sheet and business plan appear sustainable

• Consider how the forecast compares to when the loan was originally granted

• Review recent trends for companies in similar situations and industries

• Understand the client’s ability to provide additional collateral or pay higher interest rates

• Consider recent history of meeting debt covenants and/or bank’s willingness or ability to provide waivers or renegotiate

Engagement teams should exercise judgment and carefully consider when additional evidence is required. Following are some examples of when more evidence should be obtained:

• Debt is due closer to year-end date
• Client appears not to have taken the necessary planning steps
• Client’s projections do not appear realistic

2. Required level of work over a cash flow forecast prepared by management

The required level of work over a cash flow forecast prepared by management generally depends on the facts and circumstances.

In cases where the financial statements included a going concern note in the prior year and the engagement team expects that there will be one again in the current year, engagement teams might not need to perform extensive work over the cash flow forecast. When the going concern note is routine, engagement teams instead might be able to focus on:

• the factors that create a material uncertainty about going concern,
• why the going concern assumption is still appropriate to use (compared to a liquidation basis of accounting), and
• whether the going concern note disclosure follows the guidance in OAG Audit 7525.

More extensive audit work on cash flow forecasts is expected in cases where analysis of the cash flow forecast is a significant factor in considering the outcome of events or conditions in the evaluation of management’s plans for future action (CAS 570.16). For example, it would be expected that engagement teams perform more work over the cash flow forecast where there are some indicators of a material uncertainty, such as substantial current year losses and operating cash outflows, but management has assessed that there is no material uncertainty based on its forecasted sales and profits over the next few years, and therefore, has not included note disclosure about going concern. If there are uncertainties related to the future events included in the cash flow forecast, it would be expected that procedures in these areas to be more extensive and considerate of the fact that engagement teams may no longer be able to evaluate the reliability of management’s forecasts by performing lookbacks.

If the mitigation of the going concern matter includes an assessment of management’s cash flow projections (or similar projections), the auditor should "stress test" management’s projections to determine that they are not so fragile that any significant change from plan would be problematic. For example, in connection with an audit of financial statements for the year ended 31 December 20X0, if management estimates that it can meet its liquidity needs through February 20X2, the auditor’s sensitivity analysis would probe the likelihood that serious liquidity issues may arise earlier. If there are such issues, the auditor likely would conclude that significant doubt has not been alleviated. Further guidance related to testing cash flow models can be found in OAG Audit 7073.5.

If the auditor becomes aware of factors which are not reflected in the prospective financial information, the auditor should discuss those factors with management and, if necessary, request that management revise the prospective financial information.

If there is significant uncertainty with regard to future events or if different actions that can be taken by management will result in significantly different results, it may be necessary for management to prepare multiple scenarios. In these cases, the auditor should determine if procedures are required on all of the scenarios, or just on the most likely outcome based on their expectations and knowledge of the client. In some cases having multiple scenarios from management is preferred when there are significant assumptions or dependencies that cannot be resolved through sensitivity. In such circumstances, each of the scenarios would likely have to be corroborated with available evidence and undergo stress testing as described above.

OAG Guidance

It will often be desirable to consult with others, including Legal Services and other specialists in situations where going concern issues exist, in order to better understand prevailing economic or industry conditions or to evaluate circumstances relevant to the entity.

As required by policy, when we identify a going concern risk, this is treated as a significant matter. However, whether or not the risk is also treated as a significant risk, is a matter of the engagement team’s judgment. See OAG Audit 7522 for guidance on the factors we may consider when deciding if the risk is significant.

The significant matter may include the following:

• The conditions or events that led us to believe that there is a significant doubt about the entity’s ability to continue as a going concern for the period of management’s assessment (or the period required by the applicable reporting framework, law, or regulation).

• The elements of management’s plan that we considered to be particularly significant to overcoming the adverse effects of the conditions or events.

• The audit procedures performed and evidence obtained to evaluate the significant elements of management’s plan.

• Our conclusion as to whether significant doubt about the entity’s ability to continue as a going concern for the period of management’s assessment (or the period required by the applicable reporting framework, law, or regulation) remains or is alleviated. If significant doubt remains, document the possible effects of the conditions or events on the financial statements and the adequacy of the related disclosures. If significant doubt is alleviated, document the conclusion as to the need for disclosure of the principal conditions and events that initially led us to believe there was significant doubt.

• Our conclusion as to whether we include an Emphasis of Matter paragraph in the audit report when the disclosures with respect to an entity’s ability to continue as a going concern are adequate. If disclosures are inadequate, document the conclusion as to whether to express a qualified or adverse opinion for the resultant departure from GAAP.

• Our conclusion as to whether we report an “other matter” in the section Report on Other Legal and Regulatory Requirements of the auditor’s report when there is uncertainty about the entity’s ability to continue operating as a going concern or to deliver its mandate;

• Consultations, where appropriate.

See OAG Audit 1141 for guidance on identifying significant matters.

OAG Guidance

Considerations when assessing management’s plans for future actions

In order to evaluate management’s plans, engagement teams should identify those elements of the plans that are particularly significant to overcoming the effects of the conditions and events that led to the going concern issue, and then perform procedures to obtain evidence about them. More rigorous work should generally be done in cases where these actions either: Alleviate the uncertainty, such management determines that going concern disclosure is not required; or are vital to support the continued use of the going concern assumption at all. Following are some examples of what considerations should be made for various types of management plans:

1. Plans to dispose of assets

• Any restrictions on disposal of assets, such as debt covenants or any liens on assets;
• Apparent marketability of assets that management plans to sell. If it is doubtful anyone will buy the assets in the near future for the expected price, then this plan is not feasible to avoid a going concern issue. Our audit documentation should address the risks related to not being able to complete the dispositions in the time frames required; and
• Possible direct or indirect effects of disposal of assets.

2. Plans to borrow money or restructure debt

• Availability of debt financing, including existing or committed credit arrangements such as lines of credit, arrangements for factoring receivables or sale‑leaseback of assets. Be alert to any escape clauses in "committed" debt agreements. Obtain and review any completed debt agreements;
• Existing or committed arrangements to restructure or subordinate debt or guarantee loans to the entity; and
• Possible effects on management’s borrowing plans of existing restrictions on additional borrowing or the sufficiency of available collateral.

3. Plans to reduce or delay expenditures

• Apparent feasibility of plans to reduce overhead or administrative expenses, to postpone maintenance or R&D projects or to lease rather than purchase assets; and
• Possible direct or indirect effects of reduced or delayed expenditures.

4. Plans to increase ownership equity

• Apparent feasibility of plans to increase ownership equity, including existing or committed arrangements to raise additional capital; and
• Existing or committed arrangements to reduce current dividend requirements or to accelerate cash distributions from affiliates or other investors.

OAG Guidance

Evaluate the adequacy of support for significant assumptions underlying the prospective financial information based on our knowledge of the entity, its business, and its management. Give particular attention to assumptions that are:

• Material to the prospective financial information.
• Especially sensitive or susceptible to change.
• Inconsistent with historical trends.

If the mitigation of the going concern matter includes obtaining waivers or modifications of debt covenants, review management’s projections of compliance with the debt arrangements for each applicable period during management’s assessment (or longer as applicable).

If the mitigation of the going concern matter includes an assessment of management’s cash flow projections (or similar projections), “stress test” the projections to determine that they are not so fragile that any significant adversity from plan would be problematic. For example, in connection with an audit of financial statements for the year ended 31 December 20X0, if management estimates that it can meet its liquidity needs through February 20X2, our sensitivity analysis would probe the likelihood that serious liquidity issues may arise earlier (say, by November 20X1). If there are such issues, we likely would conclude that significant doubt has not been alleviated.

If we become aware of factors which are not reflected in the prospective financial information, discuss those factors with management and, if necessary, request management to revise the prospective financial information.