Audit Method: Going Concern Assessment

ISA 570 requires an auditor to obtain and evaluate management’s assessment of the entity’s ability to continue as a going concern. Issues to consider by the auditor while evaluating the going concern assumption by management are as follows.

Are any events or conditions which may cast significant doubt on the entity’s ability to continue as a going concern has been identified? Examples of conditions and events can be traced from paragraphs A2 of ISA 570.

Based on our inquiries of management and our review of their assessment, were any events or conditions noted that may occur shortly beyond the management assessment that were so significant that they may cast doubt on the entity’s ability to continue as a going concern?

If audit team answer to the above two questions is “NO” then the evaluation is complete but if the answer is “YES” then the following additional audit procedures need to be undertaken.

Evaluate management’s plans for future actions in relation to its going concern assessment, whether the outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the circumstances.

Stated plans: Obtain and discuss with management its plans to deal with the identified risks. Indicate the individuals interviewed.

Supporting evidence overcoming substantial doubt: Indicate below the elements of management's plans that are particularly significant to overcoming the substantial doubt about the entity’s ability to continue as a going concern. Examine and describe evidence that supports those elements. Elements include Third-party guarantee, Debt restructuring or new borrowings, Liquidation of assets, Reduction or delay of expenditures, Increase in revenues, Increase in equity etc.

Third party guarantees and other financial restructuring agreements: If there are significant guarantees of financial support from a third party (such as the entity’s parent company, another shareholder, an affiliate or a general partner of a limited partnership):

Prospective financial information: Although this information is not as persuasive as evidence provided by third parties, we usually consider it as necessary to support management's plans.

Management's representation: Obtain written representation from management and where appropriate from those charged with governance regarding management's plans and conclusion about the appropriateness of the going concern assumption and the reasonableness of related disclosures in the financial statements.

Practice

Based on the audit evidence obtained, conclude whether a material uncertainty exists relating to events or conditions, that individually or collectively, and may cast significant doubt on the entity's ability to continue as a going concern. A material uncertainty exists when the magnitude of its potential impact and likelihood of occurrence is such that, in our judgment, appropriate disclosure of the nature and implications of the uncertainty is necessary for the fair presentation of the financial statements.

Other articles on related topic:

New Regulations for Auditors: European Revolt

Audit Method: Oil & Gas Industry

The Oil & Gas Industry comprises of three sectors:

The Upstream sector: This is also called the exploration and production sector (E&P). It involves the search for potential underground or underwater crude oil and natural gas.

The Midstream sector: This sector involves the transportation, storage and marketing of petroleum products.

The Downstream sector: this sector is involved in the refining of crude petroleum products and processing and purification of the raw natural gas.

Accounting for oil and gas companies is a bit complicated because it has to reflect the company’s principal assets; the oil and gas reserves, with ownership rights often based on contractual relationships between the oil and gas producing entities and the owners of the mineral rights. 

Some of the specific accounting issues which arise in the Oil and gas sector are as follows: 

• Joint Arrangements: It is a common term for oil & gas companies to share the risks and costs of exploration and production activities. A separate Joint Venture Account statement is prepared which shows the advances received from working interest owners and how the amount is spent.
• Revenue recognition: The revenue arising from each transaction is recognized based on the terms of the underlying sales agreement.
• Exploration & Evaluation Assets and Development Assets: IFRS 6 - Exploration for and Evaluation of Mineral Resources explain the complete accounting for these assets.
• Depletion, depreciation and amortization (DD&A): The unit of production method is most commonly used to deplete upstream oil and gas assets.
• Impairment of non-financial assets: IFRS 6 relaxed the rules of annual impairment testing for exploration and evaluation (E&E) assets. IFRS 6 requires these assets to be tested for impairment only when the facts and circumstances suggest that the carrying amount may exceed its recoverable amount and on the transfer of E&E asset to development assets. 
• Reserves Reporting: The purpose of reserve reporting is to make available information about the oil and gas reserves which are controlled by the company. This information helps to assess the companies’ current performance and future prospects.
• Provisions for Decommissioning Costs: Due to exploration and evaluation activities oil and gas companies often are required to create a provision for meeting the costs of site restoration, decommissioning and dismantling of assets. It is covered by IAS 37.

Practice

While conducting the audit of oil & gas companies, the auditor should gain thorough and deep understanding of the industry and the practices followed by the oil & gas companies. Audit requirements may vary depending on whether the company is operating in an upstream, midstream or downstream sector. Moreover audit procedures in upstream sector also vary depending on whether the company is an operator or non-operator of and oil or gas well or lease. 

Audit Method: Telecom, Media and Entertainment

Media and Entertainment business include companies for movie studios, TV station groups, Cable distribution companies, Radio broadcasting companies, Advertising companies, Interactive gaming companies, Book publishing companies, Newspaper publishing companies and Internet companies. Media and Entertainment businesses live or die based on how well they identify and manage trends.

Telecommunications is a general term and include a vast array of technologies that transmit and receive voice, data, and video information over varying distances through electronic means. Telecommunications is a huge industry, comprising companies that make hardware, produce software and provide communication services.

The main area of concern for auditors while conducting the audit of a telecom media or entertainment company is to verify their revenue. Telecom operators continue to lose billions of dollars every year due to revenue and fraud leakage. Most telecom companies principally obtain revenue from providing the following telecommunication services: access charges, airtime usage, messaging, interconnect fees, data services and information provision, connection fees and equipment sales. Products and services may be sold separately or in bundled packages. The fast pace of change and intense commercial competition increase the likelihood of mistakes. There is significant complexity in determining the combined effect of interacting systems and processes; and the high-volume, low-value nature of transactions amplifies the financial implications of "small" errors.

Another area of concern for auditor is to verify the license fee paid by media and telecom companies to the government and compliance of companies with the regulations imposed under the provisions of these licenses by the government.

Fixed assets verification particularly in telecom service provider companies is also an area which requires auditor’s significant attention. Telecommunications is a very capital-intensive industry, with the fixed assets of network infrastructure forming a large part of a telecom company’s balance sheet whether it is a fixed line, mobile or fiber network. Fixed assets management remains an important competitive differentiator as it presents significant operational and internal control challenges. Auditor should be diligent in reviewing asset lives manually, as well as in a more sophisticated manner with the use of client integrated ERP systems generated reports.

Additional Thoughts

While conducting the audit of a telecom media or entertainment sector company; the principal rules remain the same for the auditor. The auditor should understand the entity and its environment, in which it is operating and identify and assess the risks of material misstatement. On the basis of this understanding the auditor should frame audit procedures to minimize the audit risk to an acceptable level. 

Chinese Companies Need Vigilant Audit

Some of my readers have shown their interest to the assurance services in BRIC in the comments to the last post. And guess what? The recent issue of The Economist contains the article “Accounting in China”, which reflects my concerns about audit of companies from BRIC in general (see link). The beginning of the article is quite appealing:

“CAN you trust Chinese accounts? Many investors fear (and several short-sellers are betting) that the answer is “no”. Sino-Forest, a big forestry firm listed in Toronto, is a case in point. Last year Muddy Waters, a short-seller, accused it of running a Ponzi scheme, which it denies. On January 31st Sino-Forest released the final report of independent investigators into the charge. Insiders crow that the gumshoes found no smoking gun. The gumshoes grumbled that, lacking access to all the evidence, they were “not able to reach definitive conclusions”.

America’s SEC is trying to force the Shanghai office of Deloitte Touche Tohmatsu, a big Western accountancy firm, to hand over papers related to Longtop, a Chinese software firm that was delisted by the New York Stock Exchange last year. Deloitte refuses, saying this would violate Chinese laws on “state secrets”. Deloitte may have a point. If it co-operates, its local staff could be jailed under Chinese law.”

So, this is the question, which had to be raised sooner or later: can be the companies transparent while operating in the conditions of non-transparent political system? There are no big traditions of Chinese government accountability to citizens of China. The market incentives to provide true and fair financial statements are seem to be not enough.

How to deal with this issue?

China need not take all the blame for the failure to provide true financial statements. The problem is common for all emerging markets. It could be said that the reason for that is not necessarily deliberate misrepresentation. Errors might happen due to lack of knowledge, the absence of open communication tradition.

According to the article in The Economist one of the Big4 bosses acknowledged the issue and insisted that “the Big Four have greatly increased their vigilance in China”. To generalize this comment one can state an implicit rule for the audit of financial statements in emerging markets: the financial statement risk for all companies originated from emerging markets should be assessed as "high" at the beginning of audit unless otherwise could be proven. The proof of lower risk assessment could be obtained after one or two years of audit, which would provide evidence about low susceptibility of systems to errors and effective control system.

I agree that this proposal could be viewed as a strict and reactionary one, but I stated it to initiate discussion of what could be done regarding accounts provided by BRIC and other emerging markets. I expect you to share your valuable ideas in the comments, and we might discuss them.

PS Please, do not forget to vote for your top 3 favorite subjects. The polls are going on the right-hand side of the blog. The rules and explanations regarding subject are here.