Feedback for Text 12.37 Final review issues — going concern and reporting

Required

(a) Are there any going concern issues for MSHG? Explain. If so, what are the mitigating circumstances?

(b) How will you recommend the issue be handled in the financial report and the audit report?

(a) The factors indicating a going concern issue are:

• post balance date fire in the cafeteria which was uninsured, creating a substantial loss for the company
• major borrowings due for refinancing, but the refinancing is not yet arranged, and poor economic conditions increasing the likelihood that refinancing will not be possible
• significant changes in senior personnel making it difficult to conclude the refinancing arrangements
• suppliers are requesting cash on delivery rather than the usual credit terms, suggesting that they are experiencing difficulty in being paid in a timely manner by the client
• lawyers for MSHG reveal that the hospital is unlikely to have adequate professional indemnity insurance to meet the current risks of several malpractice cases that have been brought against the hospital in the last 12 months

Mitigating factors:

• New senior finance controller appointed who has been renegotiating with some key MSHG suppliers regarding payment terms
• Consider if MSHG has any plans to cut costs
• Lawyers may suggest that the client has sufficient grounds for defending malpractice claims
• Suppliers are still making deliveries, even though they are demanding cash on delivery, therefore, business is able to continue to get sufficient supplies
• Any idle assets may be sold to generate cash

(b) The mitigating factors appear to be relatively weak compared with the factors indicating doubt about the going concern assumption. The auditors must perform procedures to test the strength of the mitigating factors and discuss with management their plans to deal with the issue.

If management recognise the issues with the going concern assumption and make adequate disclosure of all factors (including mitigating factors) the auditor would issue an unqualified audit report with a section “Material Uncertainty Related to Going Concern” to draw reader’s attention to the relevant note disclosures in the financial report (ASA 570.22). However, if the auditor decided that despite the disclosures that management was willing to make, the business is not a going concern, the financial report should be prepared on a liquidation basis.

If management do not agree to make the relevant disclosures, the auditor would issue an adverse audit opinion for inadequate disclosure (ASA 705.8), unless they thought the matter was not pervasive, in which case they would issue a qualified opinion for inadequate disclosure (ASA 705.7(a)).

If the management refuse to cooperate and extend their assessment of the company’s ability to continue as a going concern to cover the period when the debt is due for refinancing, the auditor could issue a disclaimer of opinion due to limitation of scope (ASA 705.7(b) or 9).

You see … it is all about context and circumstance … and your ability to recognise and argue for options, NOT just list them!