CPA Exam — AUDPerforming Further Procedures and Obtaining EvidenceHard
A client is struggling financially, with recurring operating losses, negative cash flows from operations, and covenants violations on its debt. The auditor determines that the going concern assumption is highly questionable. Which of the following audit procedures would be most effective in evaluating management's plans to mitigate these conditions?
- AAnalyzing subsequent events for evidence of new financing or asset sales.
- BReviewing cash flow forecasts and comparing assumptions to economic conditions and industry trends.
- CObtaining written representations from management about their intent to continue operations.
- DConfirming lines of credit with banks and reviewing debt agreements for default clauses.
Show answer & explanationAnswer & explanation
Correct answer: B. Reviewing cash flow forecasts and comparing assumptions to economic conditions and industry trends.
To evaluate management's plans, the auditor needs to assess the feasibility and realism of those plans. Reviewing cash flow forecasts and corroborating the underlying assumptions against external factors (economic conditions, industry trends) provides strong evidence about the viability of management's mitigation strategies.
Why the other options are wrong
- A. Analyzing subsequent events is crucial, but it looks at what has already happened, not the effectiveness of management's *plans* for the future that haven't yet materialized or been fully executed.
- C. Written representations provide management's assertion but are not sufficient audit evidence on their own for complex matters like going concern.
- D. Confirming lines of credit and reviewing debt agreements are important for understanding the current financial position but do not directly evaluate the effectiveness of management's future plans.
Auditing Going Concern Mitigation Plans
Procedures performed to evaluate the feasibility and effectiveness of management's strategies to alleviate substantial doubt about an entity's ability to continue as a going concern.
- Focus on management's future-oriented plans (e.g., financing, asset sales, cost cuts).
- Requires scrutinizing underlying assumptions for realism.
- Often involves reviewing cash flow forecasts and comparing to external data.
Memory trick: PLAN: Plans, Liquidity, Assumptions, Need for disclosure.