This article discusses substantive testing, audit completion and reporting issues. 

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This article was first published in the January 2010 edition of Accounting and Business magazine.                

The specific items affected by the credit crisis will vary from client to client but are likely to include:


Many companies will need to reduce the price of inventory to achieve sales, possibly resulting in net realisable value being less than cost. At the year-end it may not be obvious which items need to be reduced in value, and overstating the inventory is a risk. More work than usual is likely to be required on the inventory provision.


Many clients will have customers in financial difficulties and so unable to pay amounts outstanding. More allowances to reduce receivables to their realisable values will be required but, as is always the case, the real difficulty lies in predicting which debts may not be recoverable and estimating the amount of the allowances.

Non-current assets

If companies are selling fewer items and generating less profit, this will cause a reduction in value in use. Carrying values of assets may therefore exceed recoverable amounts and impairment losses will need to be provided. Property values have fallen in many parts of the world. Since property valuations are subjective, this creates risk for the auditor.


If companies are rationalising and restructuring their operations, then additional liabilities may need to be provided. Provisions may be required to cover such events as redundancy, penalties for lease cancellations, and onerous contracts.


Companies' net pension liabilities may increase if the value of the fund assets in the company pension scheme has declined relative to the pension obligation.

Fair values

The area that has caused most concern for accountants and auditors is that of financial instruments, especially those which have become illiquid.

IAS 39, Financial Instruments (and its equivalents), requires the valuation at fair value of certain categories of assets, including those which are intended to be sold soon ('held for trading') and which are 'available for sale' in that they are not intended to be held to maturity.

Fair value is intended to be the price that would be charged in an orderly, arm's-length transaction. When markets are active, actual traded prices are likely to represent fair value.

For certain financial assets, volumes of trade have fallen to such an extent that the market has become inactive. Actual transaction prices will not be as good an indicator of fair value as many transactions will be sales by companies facing financial difficulties and prepared to accept a lower price due to their straitened circumstances (and so are not orderly transactions).

Directors may therefore be required to use valuation models rather than market inputs to determine prices, but these present their own problems.

As an illustration, the Black-Scholes model, widely known for its use in the valuation of options, has certain underlying assumptions which limit its accuracy in the real world. For example, it assumes that the risk-free rate is known and constant and that the volatility of the underlying asset is known and constant. With falling interest rates in most developed economies and high volatility of stock markets, these assumptions cannot currently be justified.

Auditors must be aware of the limitations of such models and ensure that adequate disclosure is made of assumptions made in using such models which could affect the calculated valuations.

It should also be noted that directors are unlikely to use such valuation models themselves and are likely to rely on a specialist valuer, for example a chartered financial analyst.

Due to the difficulties of valuing financial assets traded in inactive markets, IAS 39 was revised in October 2008 to allow financial assets held for trading and assets available for sale to be reclassified into other categories.

In order to reclassify:

  • the asset must meet the definition of the category into which it is to be transferred at the date of reclassification (for example, if it is to be reclassified as 'loans and receivables' it must meet the definition of loans and receivables)
  • the entity must have the intention and ability to hold the asset for the foreseeable future or until maturity
  • the asset must not be a derivative or one that the company opted to designate as held for trading at initial recognition.

If a client has opted to reclassify financial assets, the auditor should check that these three criteria have been met and review evidence that the company plans to - and has the financial ability to - hold the asset for the foreseeable future.

IFRS 7, Financial Instruments: Disclosures, was amended in March 2009 and now requires a 'tiered' approach to disclosure of fair values. Financial assets valued using models require substantially more disclosure than those valued using quoted prices in active markets.

Although the detail of these amendments is beyond the scope of this article, it is obviously important that auditors are aware of the revised IAS 39 and IFRS 7.

Management bias

If companies are performing poorly and yet there is pressure on management to achieve particular results - for example, if the company is listed or if managers are given performance-related bonuses - there is an increased risk of management bias. Auditors should be aware of this possibility in assessing all estimates made by management.

The review stage

Going concern

The second article in this series considered risk factors relating to going concern which auditors need to consider as part of their planning. Auditors need to continue to monitor going concern issues right up to the date they sign the audit report. Accordingly, they should scrutinise management accounts and board minutes for indications that performance is worse than was expected at the planning stage.

Subsequent events

Auditors should enhance their scrutiny of subsequent events as there could be indications of going concern problems.

Management representations

Auditors should ensure that the management representation letter states that:

  • all material subsequent events have been disclosed to the auditor
  • management believes the going concern basis to be appropriate and has revealed any issues that would cast doubt on the company's ability to be a going concern
  • management intends to hold reclassified financial assets for the foreseeable future.

Review for GAAP

Auditors should ensure their GAAP checklists are updated to take account of the revisions to IAS 39 and IFRS 7.


Most audit reporting issues are likely to relate to going concern.

Going concern basis appropriate

If the auditor considers that the going concern basis is appropriate and that any necessary disclosures are adequate, an unqualified and unmodified report should be given - there is no need to add an emphasis of matter paragraph to refer to the disclosures about going concern.

If the disclosures about going concern issues are considered inadequate, the auditor will qualify on the grounds of disagreement. It is likely that disagreement with the adequacy of disclosure will be material but not pervasive.

Uncertainties about going concern

If there are significant or material uncertainties about whether the going concern basis is appropriate, the company should disclose the nature of the uncertainties and doubts about its ability to continue as a going concern.

If auditors consider the disclosures to be adequate, they should add an emphasis of matter paragraph to the audit report drawing attention to the note produced by the company.

If the disclosures are absent or inadequate, the auditor should qualify on the grounds of a disagreement with the adequacy of disclosure. Again, it is likely that such a disagreement will be material but not pervasive.

Going concern basis inappropriate

If the auditor considers the financial situation so bad that the company is not a going concern yet the going concern basis has been used to prepare the financial statements, the auditor should qualify on the grounds of a disagreement with the basis used. Since the use of the wrong basis is likely to affect the true and fair view given by the financial statements as a whole, this will probably be considered a pervasive disagreement.
It is possible, although unlikely, the company will use the forced sale basis to produce its financial statements. In this case, because the financial statements give a true and fair view, the audit report will be unqualified but the auditor should use an emphasis of matter paragraph to draw attention to the note detailing the basis used.

Limitation of scope

If auditors are unable to conclude whether the going concern basis is appropriate, perhaps because the directors have not considered and cannot provide evidence relating to a period at least one year after the year-end, then they may need to qualify due to a limitation of scope. Since the impact of not being a going concern is so severe, this is likely to be a pervasive limitation of scope and result in a disclaimer.
Other reporting issues

Auditors may disagree with clients over issues arising from the credit crisis - for example, the recoverable value of impaired assets or the net realisable value of inventory - requiring a qualified or adverse opinion.
There may also be a lack of audit evidence available to support amounts in the financial statements - for example, the valuation of certain assets, resulting in a qualified opinion or a disclaimer.

ISA 570, Going Concern, states there may be cases where multiple uncertainties mean that, even though an auditor has obtained sufficient appropriate evidence in relation to each of them, they are unable to form an opinion on the financial statements due to the potential interaction of the uncertainties and their possible cumulative effect. A disclaimer of opinion may be appropriate here.

Disclaimer of liability

Given the potential increase in claims against auditors in a recession, audit firms may wish to add disclaimers to their audit reports restricting their legal responsibility to their clients only. ACCA's recommendation is that adding blanket disclaimers is unnecessary and will do nothing to enhance the reputation of the profession.

Communication with those charged with governance (ISA 260)

Auditors are required by this standard to communicate important issues to those charged with governance - the audit committee in most cases. Any problems in gathering audit evidence, concerns about going concern or accounting policies or disclosures should be communicated.


The current crisis is unprecedented in the professional lives of most of us. Although the obvious issues to consider are going concern and fair value, auditors need to adopt a holistic approach and consider the implications at all stages of the audit.

Connie Richardson is an auditing and accounting lecturer at Kaplan Financial in Singapore