Explain five factors which would indicate to the auditor that the going concern assumption of the business entity he is auditing is threatened

  • According to ISA 570, factors which would indicate that the going concern assumption of the business entity that he is auditing is threatened include:
  • Financial Indicators

    Net liability or net current liability position i.e. liabilities exceed assets.

  • Net current liability position i.e. where current liabilities exceed the current assets;
  • Fixed term borrowings approaching maturity without realistic prospects of renewal or repayment or excessive reliance on short-term borrowings to finance long term assets.
  •  Adverse key financial ratios e.g. current ratio of less than one.
  • Substantial operating losses
  • Arrears or discontinuance of dividends
  •  Inability to pay creditors on due dates
  •  Difficulty in complying with the terms of loan agreements
  •  Change from credit to cash on delivery transactions with suppliers.
  •  Inability to obtain financing for new essential product development and other essential investments

Operating Indicators

  • Loss of key management without replacement
  •  Loss of a major market, franchise, license or principal supplier
  •  Labour difficulties or shortages of important supplies
    Other indications
  • Non-compliance with capital or statutory requirements
  •  Pending legal proceedings against the entity that may, if successful, result in judgments that could not be met
  •  Changes in legislation or government policy
    NB: The significance of such indications can often be mitigated by other factors e.g. the effect of an entity being unable to make its normal debt repayments may be counterbalanced by management‘s plans to maintain adequate cash flows by alternative means, such as by disposal of assets, rescheduling of loan repayments or obtaining additional capital.

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