The prospects of growth of the global economy in 2020-21 remains negative and that of the Indian economy is abysmally low at 1.8 to 2 per cent. The world is faced with the worst economic recession since the 1930 Depression. Virgin Australia is the first big corporation to collapse and go into liquidation due to a pandemic. Considering the gravity of the problem many more companies may collapse even before the pandemic is over.
The Companies Act 2013 requires the Board of Directors of a Company to report that financial statements are prepared on the premise that it would remain a going concern for the next 12 months. In the accounting domain, ‘going concern’ means the company has the ability to run its operations for the foreseeable future which is typically 12 months unless specified otherwise.
Industry has been expressing difficulty to assess going concern risks considering the severe impact of COVID-19 and the lockdown on liquidity, turnover, profit and profitability for Q4 of FY 2019-20. As per a report, half of the top 500 companies listed on the National Stock Exchange could find themselves strapped for cash to even make routine payments in the aftermath of COVID -19 lockdown.
This is exacerbated by the fact that uncertainty continues on lockdown and control over coronavirus is not yet in sight. The prospects of growth of the global economy in 2020-21 remains negative and that of the Indian economy is abysmally low at 1.8 to 2 per cent. The world is faced with the worst economic recession since the 1930 Depression. Virgin Australia is the first big corporation to collapse and go into liquidation due to a pandemic. Considering the gravity of the problem many more companies may collapse even before the pandemic is over.
The auditors may find it difficult to obtain sufficient audit evidence to assess management’s judgement on inherently uncertain future outcomes of events or conditions. The ability of the current balance sheet and the support of the promoters to withstand the crisis is important and not too difficult to assess.
If the directors themselves are in doubt or the auditors express doubt on the going concern view reported by the directors, it shall be difficult for the entity to get any kind of funding or credit support and to make commercial arrangements. Investors and lenders becoming aware of the situation can act to protect and salvage their interest.What is extremely difficult is to estimate and assess the cash flows with some sense of reasonableness over the next 12 months. How the relief measures from the government/s and the RBI may unfold in the coming months and up to what extent these measures would be able to restore sustainable viability, is also extremely uncertain. The concerns of the industry and auditors are thus not unfounded.
The requirement as aforesaid is however of paramount importance for various stakeholders. Ability of a company to remain a going concern is fundamental for the shareholders to invest or for the lenders to lend .The concept of going concern indicates the ability of a company to continue with its operations.
If the directors themselves are in doubt or the auditors express doubt on the going concern view reported by the directors, it shall be difficult for the entity to get any kind of funding or credit support and to make commercial arrangements. Investors and lenders becoming aware of the situation can act to protect and salvage their interest.
Financial statements are designed to reflect the economic reality of an entity. Accordingly, it should not matter that on the balance sheet date stock markets are depressed or highly volatile or there are uncertainties looming at large on future operations .The financial statements should fairly reflect the true state of affairs for appreciation and prudent judgment of the investors and lenders. The auditors are expected to suitably vouch for the same under the law.
Companies faced with acute stress because of COVID -19 impact and not adequately supported by timely revival of economic activity, liquidity support and fiscal measures, may move toward bankruptcy and liquidation like Virgin Australia. The investors are entitled to know whether given the current situation of COVID-19 the company has the ability to continue its operations for next 12 months.
Admittedly this is challenging and may require a significant level of estimation. The auditor has onerous responsibility to ask from the management’s view on going concern, and critically review the same for adequacy and material misstatement, if any, on its ability to arrange funds to restart operations, meet working capital requirement and debt obligations, restore supply chain logistics and the like.
Auditor should qualify the audit report in case he is not satisfied with management‘s view with relevant details and justification. Even otherwise going concern concepts under the current situation being most significant to the audit auditor should deal with this in his report as a Key Audit Matter.-
Going concern concept is a fundamental accounting principle since ages under the companies act. It was first mandated in the UK in 1985.
In India the Companies Act 1956, a wide amendment made in 2000, laid responsibility on the directors to report that they have prepared financial statements following the going concern basis. Post financial crisis 2008, apart from punitive action that followed on auditing firms, relevant auditing standards were made more prescriptive and stringent.
Recently, in India auditors of IL&FS were questioned for not reporting doubts on going concern.
Auditors have to be extremely careful as aforesaid lest they might be questioned on their assessment and reporting on going concern basis in respect of companies moving into bankruptcy or liquidation during or post COVID-19.Since the primary responsibility under the law is cast on the board of directors, independent directors in particular may be equally called to justify prudence exercised by them.
Ashok Haldia, Former Secy, ICAIAbout the author: Ashok Haldia, Former Secretary, Institute of Chartered Accountants of India
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