Activity Based Risk Evaluation Model of Auditing

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Ability of the client to continue as a going concern

In broad terms, an entity is considered a "going concern" if it is able to pay its debts as and when they fall due. The going concern assumption (GCA) concept is relevant to auditors because in many jurisdictions the GCA is implicit in the application and interpretation of accounting policies and, unless otherwise stated, this assumption is assumed in the preparation of the financial statements. (However, see the CPA Journal article entitled Weighing the Public Interest Is the Going Concern Opinion Still Relevant?).

Where the GCA does apply, an auditor needs to satisfy him or herself that it is appropriate for management to prepare financial statements on the going concern basis. Therefore, when the auditor forms an overall opinion on the financial statements, the auditor considers the potential for going concern problems ^[fn].

Matters that an auditor may consider include ^[fn]:

• financial indications, such as a deteriorating accounts payable ratio, a deteriorating current ratio, fixed term borrowings approaching maturity without any prospect of replacement financing being available.
• operating indications, including loss of key management without replacement, loss of a major market segment, correspondence from suppliers requesting more stringent credit terms such as COD.
• litigation, and in particular, whether there are any pending legal proceedings that could result in a judgement that may be incapable of being met.

In forming an opinion on the appropriateness of the GCA, the auditor considers events that may occur (or have occurred) in the 18 month period following the current balance date ^[fn].

In order to form an opinion about the appropriateness of the GCA, auditors gather evidence using a combination of the following audit procedures:

• inspection of: correspondence files, minutes of directors' meetings and meetings of the audit committee, current management accounts, cash flow forecasts, submissions for capital expenditure.
• inquiry of senior management regarding future plans.
• analytical procedures, especially ratio analysis.
• management representation letter.
• legal representation letters.

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