ISA 570, Going Concern
Proposed redrafted International Standard on Auditing issued for comment by the International Auditing and Assurance Standards Board of the International Federation of Accountants
Comments from ACCA
May 2007
Executive Summary
ACCA welcomes the opportunity to comment on the proposed International Standard on Auditing ISA 570 (Redrafted) Going Concern (proposed
ISA 570), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants.
Our comments are restricted to the changes proposed as a result of applying the Clarity project drafting conventions to extant ISA 570.
We consider that the objectives of the auditor stated in proposed ISA 570 are acceptable and welcome the clarification of the document, which will be reasonably practical to use.
We are concerned, however, that many of the proposed requirements are confusingly worded and without sufficient justification. The proliferation of requirements will add costs to audits, which will fall disproportionately on smaller entities.
We are specifically concerned that the redrafting has disguised significant revision, as such changes may not receive appropriate scrutiny. In particular, guidance to consider information that is in the auditor's possession has been altered into a requirement to determine whether additional facts or information exist (paragraph 16(c)).
Objectives
We consider that the objectives of the auditor are acceptable. It is important to separate the two objectives to identify the different nature of the auditor's approach to material uncertainty where the going concern assumption is appropriate.
Taken together with the way the requirements are arranged, this presentation will assist in avoiding an expectation gap in respect of what the auditor can reasonably achieve.
Changes Made to Enhance the Clarity of Proposed ISA 570
Scope of the ISA: entities where the Going Concern assumption is clearly appropriate
As we have commented separately in relation to proposed ISA 610 The Auditor's Consideration of the Internal Audit Function , the Clarity project redrafting changed a preliminary test of relevance of that ISA into something that could only be decided after complying with its requirements in all audits. We recognise, however, that proposed ISA 570 covers an aspect of an audit that is of considerable importance and is generally applicable.
Nevertheless, we note that paragraph A3 of the Application and Other Explanatory Material (A&OEM) section refers to public sector entities where there is no doubt about continuing existence. That material should be extended to the many other circumstances where, to all intents and purposes, the application of proposed ISA 570 is not wholly relevant because of the profitability, financial strength or resources of an entity.
Guidance material should promote consistency by indicating how, in such circumstances, the auditor determines the relevance of requirements where the circumstances envisioned in the requirement do not exist (in accordance with proposed ISA 200 Overall Objective of the Independent Auditor, and the Conduct of an Audit in Accordance with International Standards on Auditing). Guidance could also usefully indicate the necessary extent of procedures and associated documentation in such cases. For example, for smaller entities, guidance could highlight the advantage of using the single working paper (discussed in paragraph A15 of proposed ISA 230 Audit Documentation ).
Requirements
We do not agree with the wholesale elevation of guidance material to requirements that has been effected in proposed ISA 570. As set out in our detailed comments below, the result often reduces the clarity of the document while potentially adding costs to all audits that will fall disproportionately on smaller entities.
In the Appendix to this response, we provide further information on the deficiencies that we identify in the requirements of this and other proposed ISAs issued in the Clarity project.
Paragraph 10
The introductory wording of paragraph 10 is intended to indicate that the auditor needs to consider going concern issues when performing risk assessment procedures, rather than solely at a later stage. However, the nuance of this, which appears clear to the drafter may be other than clear to the user, especially in translation.
As presented, the wording can be interpreted as a condition precedent that makes the requirements in the bullet points conditional on whether the auditor is involved in a process of ‘performing risk assessment procedures to obtain an understanding of the entity'.
The auditor may be involved in other processes and during such processes the auditor will not be required to comply with paragraph 10 because the condition to make that an applicable requirement is not present. For example, the auditor may be carrying out procedures in response to the requirement in paragraph 12 ‘ The auditor shall evaluate management's assessment of the entity's ability to continue as a going concern. ' Those procedures will be considered to be part of a process of evaluating management's assessment (as that is the relevant heading) rather than performing risk assessment procedures. During that process, the auditor will not be required to comply with, for example, paragraph 10(b) because the condition to make that an applicable requirement is not present.
It may be argued that the auditor will necessarily perform ‘risk assessment procedures to obtain an understanding of the entity' because that is required by the core ISAs. However, while extant ISA 315 (and indeed extant ISA 520 Analytical Procedures ) uses this wording, ISA 315 (Redrafted) Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment does not.
While the above argument may seem pedantic, it should be recognised that the precise wording of the requirements in ISAs are of vital importance because auditors will be judged against them. This is ultimately why we recommend ways in which the wording of the Requirements section can be made as simple and precise as possible.
As discussed further in the Appendix to this response, under the heading Timing of requirements , the preferred timing of a requirement is a matter that should be considered on a consistent basis for all ISAs.
Paragraph 10
The bullet points of paragraph 10 are repetitious and the either/or construction of 10(b) and 10(c) is not highlighted by appropriate numbering. Taken together with the issue discussed immediately above, we believe that the material should be simplified to improve its clarity. Moreover, the proposed level of detail arises through elevation of present-tense statements and we do not believe that it is necessary to specify such matters as they are implicit in the inquiry of management.
Paragraph 11
The heading for paragraphs 10 and 11 is ‘ Performing Risk Assessment Procedures' . This is misleading as the requirement in paragraph 11 is to remain alert throughout the audit. For the reasons set out in the Appendix to this response under the heading Basic principles and essential procedures, we recommend that this requirement be identified as one that cannot simply be performed and documented.
We recommend changing the heading of paragraphs 10 and 11 to ‘ Risk Assessment' .
Paragraph 13
Paragraph 13 contains a requirement that is placed on ‘the auditor's evaluation'. As discussed in the Appendix to this response, under the heading Simple construction , it would be better to use a construction under which requirements are placed on ‘the auditor'.
Paragraph 14
This paragraph should not be a requirement. It explains one aspect of the evaluation required by paragraph 12 and should be transferred to the A&OEM section.
If retained as a requirement; f or the reasons set out in the Appendix to this response, under the heading Basic principles and essential procedures, we recommend that this requirement be identified as one that cannot simply be performed and documented.
Paragraph 16
The bullet points go into considerable detail and include elevations of present-tense statements that will not generally be applicable. The related paragraphs in the A&OEM section deal with procedures that may be relevant. We suggest that more could be done to utilise the A&OEM section to ensure that requirements are applicable only to the general case.
Paragraph 16 ( c) requires the auditor to ‘Determine whether any additional facts or information have become available since the date on which management made its assessment.' This is a substantive revision and not simple redrafting. The extant guidance states that ‘The auditor also considers whether any additional facts or information are available since the date on which management made its assessment.' This proposed requirement should be transferred to the A&OEM section and reworded to accord with its status as guidance.
Paragraph 17
The wording ‘A material uncertainty exists when the magnitude of its potential impact is such that, in the auditor's judgment, appropriate disclosure of the nature and implications of the uncertainty is necessary for the fair presentation of the financial statements in accordance with a fair presentation financial reporting framework, or in the case of a compliance framework, for the financial statements not to be misleading.' is not a requirement. It is explaining what is meant by ‘a material uncertainty'. Such wording should either be in the Definitions section or the A&OEM section.
Paragraph 18
Paragraph 18 contains, as requirements , considerations that will inform the auditor's expression of an opinion as required by paragraphs 19 and 20. As such, the requirements are duplications and should be eliminated. They may be usefully transferred to the A&OEM section.
Paragraph 21
We do not agree with the inclusion of the explanatory words ‘regardless of whether or not appropriate disclosure has been made.' As the requirement is not conditional on disclosure, the words are unnecessary; instead, paragraph A26 should be used to emphasise this matter.
Paragraph 22
The wording ‘It is not the auditor's responsibility to rectify the lack of analysis by management. In some circumstances, however, the lack of analysis by management may not preclude the auditor from being satisfied about the entity's ability to continue as a going concern.' is not a requirement. It is explanatory material principally pointing out a matter that is not within the auditor's responsibility. It should be transferred to the A&OEM section.
Paragraph 23
The requirement in paragraph 23 duplicates that in paragraph 22 in those circumstances where the auditor's consideration is that the particular circumstance do give rise to a need for a qualified or disclaimed opinion. This is unnecessary duplication which should be eliminated by transferring paragraph 23 (appropriately rewritten) to the A&OEM section.
Paragraph 24
The requirement in paragraph 24 is conditional. The auditor is already required to consider circumstances that include the condition precedent and would take appropriate action. Delay in approval of financial statements was not considered to be sufficiently important to feature in proposed ISA 560 Subsequent Events , so it is out of keeping with its low significance to highlight it by imposing a related requirement in proposed ISA 570. Circumstances when there is significant delay in the approval of the financial statements will be relatively rare and we do not believe that there is sufficient justification for elevating this guidance to a requirement.
The requirements in paragraph 24 are, in any case, duplicative of those in paragraphs 16 and 17. This material should be transferred to the A&OEM section.
Paragraph 25
The conforming change arising from proposed ISA 260 Communication of Audit Matters with Those Charged with Governance is presented wholly as a requirement. We do not agree with elevating the detail in the bullet points to a requirement. This material should properly be in the A&OEM section. That section could also be used to draw attention to the provision in proposed ISA 260 in relation to the matter discussed below.
The requirement to communicate with those charged with governance should be amended to take account of the circumstance when all of those charged with governance are involved in managing the entity. The form of such reference affects several proposed ISAs and a consistent method of recognising such circumstances is needed for the Clarity project. We discuss this further in the Appendix to this response, under the heading Communication of audit matters with those charged with governance .
Translations
Earlier in this response, we drew attention to the difficulty of using, in paragraph 10, wording that can be interpreted as making the requirements in the bullet points conditional on whether the auditor is involved in a process of ‘performing risk assessment procedures to obtain an understanding of the entity' . The nuance of meaning, which appears clear to the drafter may be other than clear to the user, especially in translation.
To reduce the possibility of potential translation issues arising we continue to suggest that the Requirements section be kept as simple as possible. The ways in which this may be achieved are discussed in the Appendix to this response.
Appendix: Common Deficiencies in Requirements
This Appendix provides further information on the deficiencies that we identify in the requirements of this and other proposed ISAs issued as part of the Clarity project. Our comments are collected under three headings:
- Growth in the number of requirements
- Presentation of requirements
- Other significant issues
Growth in number of requirements
There seems to be no external economic or social justification, suddenly to increase the degree of specificity of ISAs; nevertheless, many proposed ISAs exhibit a substantial growth in the number and detail of specific requirements. We are not convinced that the implementation of the guidelines adopted for deciding on the requirements to be included in an ISA is correct.
We are concerned that the proliferation of requirements will promote a ‘tick box' mentality. Each extra requirement introduced is another box to tick, another factor that can reduce the quality of an audit, and another cost that bears disproportionately on smaller audits and deters the more widespread application of ISAs.
The cost of including a single requirement should not be underestimated. Even if that requirement is conditional and is not relevant in the circumstances, it requires consideration by every auditor on every audit and that gives rise to a considerable cost, which includes the related training and changes to audit manuals, programmes or software.
Our detailed analysis concludes that hardly any of the changes from a present-tense statement to a requirement are justified. We recommend that the proposed requirements be reconsidered on an individual basis and that each remains as a requirement only if a strong case can be made for that.
The ‘requirement' is really guidance on another requirement
Many new requirements deal with the same subject as another but in greater detail: the auditor is required both to do something and also to carry out the steps in that process. This is a simple duplication, which should be eliminated.
Such secondary requirements are best treated as explanatory material that auditors can refer to in relation to the primary requirement.
Requirements that are only relevant in rare circumstances
Extant ISAs contain some present-tense statements that provide guidance to the auditor when facing uncommon circumstances. The general Clarity project guideline for inclusion of requirements is that the requirement is expected to be applicable in virtually all engagements to which the ISA is relevant. Ordinarily, therefore, such present-tense statements should not be elevated to requirements.
We accept that certain requirements are of sufficient importance that this guideline can be disregarded. For example, although audits of public interest entities form only a small minority of audits, it is sometimes necessary to include requirements that will be relevant only to such entities. This may be done by restricting the application of the requirement by the use of a condition precedent.
We do not believe that it is appropriate, however, to make wider use of conditions as a device to justify inclusion of requirements for uncommon circumstances. Although a requirement will ensure that the auditor, when facing the specific conditions, will act in an appropriate manner, a balance has to be struck between that and the additional burden placed on every audit. Every conditional requirement requires consideration by every auditor on every audit and that gives rise to a considerable cost burden, which falls disproportionately on smaller entities.
We recommend, therefore, that any such proposed elevation be supported by an assessment of the frequency with which the condition for its use is met and the additional benefit (if any) to the quality of the audit that arises through inclusion as a requirement. We would not ordinarily expect such assessments to show that the benefit of elevation outweighed its cost.
Presentation of Requirements
We do not find the Requirements sections of proposed ISAs easy to understand. As well as the proliferation of requirements, many of which are overlapping, as discussed above under the heading Growth in number of requirements, t here are two main reasons for this:
- explanatory material is interspersed with the requirements, and
- the requirements are not constructed in a simple fashion.
Explanatory material
We do not support splitting the supplementary material providing explanation and guidance between the Application and Other Explanatory Material (A&OEM) section and the Requirements section. Such an approach forces users to carry out a detailed analysis of the text of the Requirements section to identify the ‘essential explanatory material' and discover which parts of the text are actual requirements. Rather than improving clarity, explanatory material adds unnecessary length and detracts from the reader's understanding. Instead, we strongly suggest that the ‘essential explanatory material' and the ‘supplementary material providing further explanation and guidance' both be presented only in the A&OEM section (or its appendices).
Simple construction
We do not find the requirements easy to understand because they are not always drafted in a simple fashion. As a result, auditors who need to know when a requirement applies, and when it does not, have to be very diligent and analytic readers.
In our February 2006 response to the redrafting proposals ‘Improving the Clarity of IAASB Standards' we proposed the adoption of a structure that clearly showed:
- any conditions precedent
- on whom a requirement was placed
- the action required, and
- the object of that action.
The Appendix to that response included an example of an appropriate tabular layout to achieve that result. As ISAs have now been issued without such a method of presentation, we see no point in continuing to argue against the use of prose to convey the requirements. We believe that more should be done, however, to address the difficulties of presenting requirements in prose so that there is less doubt about the meaning of the various ‘shall' statements.
Conditions precedent
Requirements with multiple conditions precedent are particularly difficult to understand when written in prose. The complexity of the material also makes translation difficult. Where possible, we recommend keeping conditions precedent close to the requirement so that the auditor does not have to refer back to earlier material.
Some apparent conditions precedent are intended to place the requirement at a particular stage of the audit or identify it as relevant in particular circumstances . We recommend avoiding such constructions by positioning words after the ‘shall' statement unless they are clearly an explicit condition precedent.
On whom the requirement is placed
Sometimes, instead of the auditor being required to do something, the requirement is placed on a document or earlier action. A typical construction being ' The auditor's evaluation shall cover the same period as that used by management . . . ‘. Such indirect requirements are less clear than ones written to apply directly to the auditor.
Other significant issues:
Basic principles and essential procedures
The bold type in extant ISAs identifies basic principles and essential procedures. These are substantially different in nature, but the Clarity project has combined the two as ‘requirements'. We do not agree with this approach, which leads to confusion, as auditors may attempt to treat a principle as an action. The corresponding and perhaps greater danger is that auditors who correctly interpret some of the ‘shall' statements as principles will treat as principles some that are intended as active requirements.
We recommend separating the principles with which the auditor is required to comply from the required procedures and other actions. This could be achieved by separating requirements into two sub-sections but it could also be achieved through explanation in the A&OEM section for each requirement that is a basic principle. Such explanation could also refer to the fact that it is unnecessary for the auditor to document separately compliance with matters for which compliance is self-evident within the audit file.
Limitation or clarification of the auditor's responsibility
Statements apparently limiting or clarifying the auditor's responsibility are present in several ISAs. These should be considered individually to determine the best way to present them when redrafting an ISA. As a general rule we do not favour introducing such statements into the Requirements section as they are neither requirements nor form conditions precedent and, if included there as explanatory material, they detract from the clarity of the requirements.
Statements that are sufficiently important should be included in the Introduction section where that is necessary to elaborate on the scope or context of the particular ISA. Other statements should be included in the A&OEM section.
Timing of requirements
We have commented above, under the heading Conditions precedent that wording intended to place a requirement at a particular stage of the audit could be interpreted as a condition precedent and restrict its application.
The preferred timing of a requirement is a matter that should be considered on a consistent basis for all ISAs. If sufficiently important, the timing of a requirement should itself be a requirement; if timing is not critical, the preferred timing should be indicated by guidance material or left unstated. It should be remembered that many of the requirements depend on others and that the introduction of explicit mention of timing (or similar rephrasing of a requirement) should not be undertaken lightly.
Communication of audit matters with those charged with governance
Several ISAs include requirements to communicate with those charged with governance. Proposed ISA 260 Communication of Audit Matters with Those Charged with Governance contains wording to take account of the circumstance when all of those charged with governance are involved in managing the entity.
An appropriate method of recognising such circumstances is needed for the Clarity project. Consistent with our view on the exclusion of explanatory material from the Requirements section, we suggest that a cross-reference be made in the A&OEM section to the related material in ISA 260.
For example, in our April 2007 response to proposed ISA 230 Audit Documentation we explained the difficulty of using the words 'in exceptional circumstances' in paragraph 10 of that proposed ISA.