The Financial Reporting Council (FRC) has revised its going concern standard, ISA UK 570, in response to a string of corporate failures where auditors failed to warn that companies were on the brink of collapse
The regulator claims that UK auditors will now have to follow significantly stronger requirements than those set out in the auditing international standards.
The standard, ISA UK 570 Going Concern, has beeen extensively revised following criticism of the quality and rigour of audit, particularly in light of cases where the auditor’s report failed to flag concerns about the viability of entities which collapsed shortly after, such as Carillion, BHS and Thomas Cook. It increases the work auditors are required to do when assessing whether an entity is a going concern.
The definition of going concern has been strengthened to apply to any entity unless its management intends to liquidate the entity or to cease trading, or has no realistic alternative to liquidation or cessation of operations. The term ‘ability to continue as a going concern’ is equivalent to the term ‘ability to continue to adopt the going concern basis of accounting’ in the future.
The revised standard requires greater work on the part of the auditor to more robustly challenge management’s assessment of going concern, thoroughly test the adequacy of the supporting evidence, evaluate the risk of management bias, and make greater use of the viability statement.
However, recent FRC Audit Quality Inspection (AQI) reports have criticised the inability of auditors to robustly challenge senior management at their audit clients, so it is not clear how the standard will embolden firms to question underlying financial risks.
The auditor's responsibilities are to obtain sufficient appropriate audit evidence to be able to conclude whether a material uncertainty related to going concern exists; and the appropriateness of management's use of the going concern basis of accounting in the preparation of the financial statements.
These responsibilities exist even if the financial reporting framework used in the preparation of the financial statements does not include an explicit requirement for management to make a specific assessment of the entity's ability to continue as a going concern.
Auditors are also required to evaluate management's plans for future actions in relation to the company’s going concern assessment, including determining whether the outcome of these plans is likely to improve the situation and whether the plans are feasible in the circumstances.
Assessment period
If management's assessment of the entity's ability to continue as a going concern covers less than 12 months from the date of approval of the financial statements as defined in ISA (UK) 560, the auditor is required to ask management to extend its assessment period to at least 12 months from that date.
In circumstances where the auditor considers that it may be necessary to include a ‘material uncertainty related to going concern’ paragraph in the auditor's report or issue a qualified, adverse or disclaimer of opinion in respect of matters related to going concern, there is a requirement to report to an appropriate authority outside the entity.
The revised standard lays out details of the audit documentation which should be provided. These include key elements of the auditor's understanding of the entity and its environment, including the entity's internal control related to going concern and indicators of possible management bias related to going concern, if any, and the auditor's evaluation of the implications for the audit.
Auditors are also required to set out significant judgments relating to the auditor's determination of whether or not a material uncertainty related to going concern exists; the appropriateness of management's use of the going concern basis of accounting in the preparation of the financial statements; and the appropriateness of management's disclosures in the financial statements.
The FRC says the changes will improve transparency with a new reporting requirement for auditors of public interest entities (PIEs), listed and large private companies to provide a clear, positive conclusion on whether management’s assessment is appropriate, and to set out the work they have done in this respect.
There will also be a ‘stand back’ requirement to consider all of the evidence obtained, whether corroborative or contradictory, when the auditor draws their conclusions on going concern.
Stephen Haddrill, FRC chief executive, said: ‘High-quality audit protects the public interest, meets the needs of users of financial statements and underpins investor confidence.
‘Recent corporate failures have, for good reason, adversely affected that confidence.
‘Our own enforcement work has demonstrated a need to strengthen existing going concern standards, which is a fundamental aspect of audit, so that investors can have confidence in audited financial statements and businesses’ financial prospects.’
ISA (UK) 570 is effective for audits of financial statements for periods commencing on or after 15 December 2019. Early adoption is permitted.
