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- 10 Marks
Question
Pinto Ltd (Pinto) provides analytical services to a wide range of clients. Typical assignments range from testing food for illegal additives to providing forensic analysis on items used to commit crimes to assist law enforcement officers.
The annual audit is nearly complete. As Audit Senior, you have reported to the Engagement Partner that Pinto is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases, where Pinto’s services to assist the prosecution were found to be in error. Not only did this provide adverse publicity for Pinto, but a number of clients did not renew their contracts. A senior employee then left Pinto, stating lack of investment in new analysis machines thus increasing the risk of incorrect information being provided by the company.
A cash flow forecast prepared internally showed Pinto requiring significant additional cash within the next 12 months to maintain even the current level of services and operations. Pinto’s auditors have been asked to provide a negative assurance report on this forecast.
Required:
i) Define going concern and discuss the auditor’s responsibilities in respect of going concern.
(4 marks)
ii) State FIVE (5) audit procedures that may be carried out to determine whether or not Pinto is a going concern.
(6 marks)
Answer
i) Definition of Going Concern:
Going concern refers to the assumption that an entity will continue its operations for the foreseeable future without the intention or necessity of liquidation or ceasing trade. It is a fundamental accounting concept used in the preparation of financial statements as per IAS 1 – Presentation of Financial Statements.
(2 marks)
Auditor’s Responsibilities in Respect of Going Concern (ISA 570):
The auditor has three key responsibilities regarding going concern:
- Evaluate Management’s Use of the Going Concern Assumption:
The auditor should evaluate whether management’s use of the going concern assumption in the preparation of financial statements is appropriate. - Perform Appropriate Audit Procedures:
The auditor must carry out procedures to assess whether the organization can continue as a going concern. - Report on the Going Concern Assumption:
If the auditor believes that management’s use of the going concern assumption is inappropriate or that there are material uncertainties, the auditor must modify their audit report accordingly.
(2 marks)
ii) Audit Procedures to Assess Going Concern:
- Review the Cash Flow Forecast:
Obtain and review Pinto’s cash flow forecast for the next 12 months, analyzing assumptions and discussing with management to assess liquidity issues. - Inquire of Management:
Discuss with management their plans to obtain additional financing or take other measures to address the cash shortfall and evaluate the feasibility of these actions. - Review Interim Financial Statements:
Obtain and review interim financial statements to evaluate post-year-end performance and whether sales or income levels align with the forecast. - Examine Legal Claims:
Obtain a solicitor’s letter and review the details of legal claims against Pinto, assessing their potential financial impact. - Review Post-Year-End Orders and Contracts:
Review Pinto’s order book and contracts with clients to determine whether future revenue streams are sufficient to support continued operations. - Assess Capital Investment and Equipment Needs:
Consider whether lack of investment in new machines or equipment may further weaken Pinto’s financial position and ability to generate revenue.
- Tags: Audit Procedures, Financial difficulties, Going Concern, ISA 570
- Level: Level 2
- Topic: Completion Procedures and Reporting
- Series: AUG 2022
- Uploader: Theophilus