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Going Concern — Audit Considerations

Imagine you lend ₹10 lakhs to a friend who runs a small factory. Before you do, you'd naturally ask: is this business going to survive long enough to pay me back? That instinct is exactly what the going concern assumption is about. When a company prepares its financial statements, it assumes it will continue operations for the foreseeable future — generally at least 12 months from the balance sheet date. This assumption changes everything: assets are valued at cost (not liquidation price), liabilities are split between current and non-current, and the whole accounting picture looks very different from a company that's about to shut down.

As an auditor, your job under SA 570 (Revised) — Going Concern is to evaluate whether management's going concern assumption is reasonable. You're not just taking their word for it. You actively look for events or conditions that might cast serious doubt — these are your red flags. Financial red flags: negative net worth, recurring losses, loan defaults, inability to pay creditors. Operational red flags: key management leaving, loss of a major customer or licence, natural disasters disrupting production. External red flags: new regulations killing the business model, a supplier monopoly cutting off supply. When you spot these, you assess management's plans (raise capital? sell assets? restructure debt?) and decide if those plans are realistic.

Here's where reporting comes in — and this is the exam-heavy part. Three outcomes are possible: (1) Going concern basis is appropriate, risk is disclosed adequately → add an Emphasis of Matter paragraph (SA 706) but give a clean opinion. (2) Going concern basis is appropriate but disclosure is inadequate → qualified or adverse opinion (SA 705). (3) Going concern basis is NOT appropriate (company should be reporting on a break-up basis) → adverse opinion. If management refuses to do a going concern assessment at all, that's a limitation of scope → qualified or disclaimer of opinion. This is asked frequently as a 4-mark or 8-mark question — either listing indicators, or walking through the reporting decision tree.

📊 Worked example

Example 1: Spotting the Red Flags

You are auditing Sunshine Textiles Pvt. Ltd. for the year ended 31 March 2025. During audit, you find:

  • Net loss of ₹85 lakhs for the current year (prior year: ₹40 lakhs loss)
  • Bank overdraft of ₹1.2 crores is overdue and bank has issued a notice
  • Trade payables outstanding for more than 180 days: ₹60 lakhs
  • The company's biggest customer (contributing 40% of revenue) has shifted to a competitor

Working:

Step 1 — Identify events/conditions: All four items above are going concern indicators (financial + operational).

Step 2 — Evaluate management's response: Management says they plan to raise ₹2 crores via a rights issue within 6 months. You check: Is there board approval? Is the promoter committed? Are there any regulatory hurdles? Assume management provides a signed commitment letter and SEBI approval is in process.

Step 3 — Is the plan adequate? ₹2 crores > overdue bank + payables (₹1.8 crores). Looks adequate IF it materialises.

Step 4 — Reporting decision: Going concern basis remains appropriate. Disclose the material uncertainty. Add an Emphasis of Matter paragraph in your audit report referencing the note in the financial statements.

Final Answer: Unmodified opinion + Emphasis of Matter paragraph.

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Example 2: When Disclosure Is Missing

Same company. But this time, management insists there is no going concern issue and refuses to add any disclosure note in the financial statements.

Working:

Step 1 — Going concern doubt exists (same red flags as above).

Step 2 — Management's assertion that there is no issue is NOT reasonable given the evidence.

Step 3 — Financial statements are misleading without disclosure.

Step 4 — Reporting decision: The omission is material and pervasive.

Final Answer: Adverse opinion under SA 705 (statements do not give a true and fair view).

⚠️ Common exam mistakes

  • Students confuse 'foreseeable future' with 'forever'. The going concern assumption does NOT mean the company will live forever — it means at least 12 months from the balance sheet date (or financial statement approval date, whichever SA 570 refers to). Use this specific period in answers.
  • Don't say 'the auditor checks if the company is profitable.' Profitability is just one indicator. A profitable company can still have going concern doubts (e.g., severe liquidity crunch, loan default). List financial, operational, AND external indicators separately in exam answers.
  • Students mix up Emphasis of Matter and Modified Opinion. An Emphasis of Matter (SA 706) does NOT change the opinion — it's still unmodified, just drawing attention to a disclosed uncertainty. A Modified Opinion (SA 705) changes the opinion type. Get the distinction sharp.
  • Forgetting that SA 570 applies even when there are NO red flags. The auditor must remain alert throughout the audit, not just when something looks wrong. Even in a healthy company, post-balance-sheet events (SA 560) could trigger going concern concerns.
  • Writing vague answers like 'auditor should report appropriately'. In exams, always state the specific outcome: unmodified + EOM, or qualified, or adverse, or disclaimer — and justify it in one line. Vague answers lose marks even if the concept is right.
📖 Reference: Going Concern — Institute of Chartered Accountants of India
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