A client is experiencing significant recurring operating losses and negative cash flows from operations. Management has prepared a detailed plan to mitigate these going concern uncertainties, which includes selling a non-core business unit and securing new debt financing. Which of the following audit procedures would be MOST critical for the auditor to perform regarding management's plan?
- APerform analytical procedures comparing the client's current financial ratios to industry benchmarks.
- BInquire of management about the status of the sale of the non-core business unit and intentions for new debt.
- CObtain and review financial forecasts and cash flow projections supporting management's plan, and evaluate the underlying assumptions.
- DObtain written representations from management regarding their assessment of the entity's ability to continue as a going concern.
Show answer & explanationAnswer & explanation
Correct answer: C. Obtain and review financial forecasts and cash flow projections supporting management's plan, and evaluate the underlying assumptions.
When management has a plan to mitigate going concern uncertainties, the auditor's most critical procedure is to evaluate the feasibility and effectiveness of that plan. Reviewing financial forecasts and cash flow projections, along with their underlying assumptions, directly assesses whether the plan is realistic and likely to succeed.
Why the other options are wrong
- A. Comparing ratios might confirm the going concern issue but does not directly evaluate the effectiveness of management's *mitigation plan*.
- B. Inquiry is a necessary step but is not sufficient on its own to evaluate the *feasibility* and *effectiveness* of the plan.
- D. Written representations provide management's assertion but are not independent audit evidence to support the viability of the plan itself.
Auditing Going Concern Mitigation Plans
When substantial doubt about an entity's ability to continue as a going concern exists, and management develops a plan to mitigate this doubt, the auditor must evaluate the feasibility and effectiveness of that plan, typically by reviewing financial forecasts and underlying assumptions.
- Auditor must evaluate management's mitigation plans.
- Key focus is on the feasibility and effectiveness of the plan.
- Often involves reviewing cash flow projections and underlying assumptions.
- Helps determine if substantial doubt is alleviated.
Memory trick: To trust a GOING CONCERN plan, you need to see the NUMBERS WORK.