Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.23  Query: 

   Going concern assumption.

 

1.  A company is engaged in the business of financial services. It is a wholly owned subsidiary of a nationalised bank. The company is undergoing tight liquidity position, since most of the assets of the company are blocked in various claims/petitions in the Special Court.

 

2.  The company has deployed majority of its funds with ABC Ltd. Its operations were taken over by a custodian appointed by the Special Court. In order to facilitate the speedy recovery of funds from ABC Ltd., and also to concentrate on all the legal cases, the management has focussed all its attention towards recovery of claims and has been redressing the issue in all the other legal claims. Neither the management of the company nor the management of the bank have ever decided to stop the business. Since all the claims are sub judice and complicated, the management is not able to assess with reasonable accuracy about the recoverability of the claims. The company has already disclosed by way of a note, the existence of uncertainty about assumption of going concern in the year 1995-96. The company has repaid Inter Corporate Deposits (ICDs) amounting to Rs. 45 Crores during the year 1994-95. The aforesaid note is reproduced below:

 

“Schedule 15 – Notes to Accounts

 

The company has not carried out any fresh business during the year. The company was refused registration by Reserve Bank of India during the year as Non-Banking Financial Company. On account of large accumulated losses, the net worth of the Company had eroded. Many claims and counter claims have been filed by/against the Company which are pending. Pending discharge of the cases, the accounts of the Company have been prepared on the going concern basis, although there exists an uncertainty about the future activities”.

 

3. The company is confident, according to the querist, that profit and loss account and balance sheet, read with notes, disclose a true and fair view of the financial position of the company. In the absence of any decision of the management to the contrary or any specific directive from the bank and in the absence of any specific requirement under Indian laws and under the generally accepted accounting principles, the company has prepared the accounts on a going concern basis.

 

4. The company has received interest and lease rentals from various parties. ABC Ltd., has also come forward to negotiate for settlement of its dues to the company. The company has referred all the disputes to the Ministry of Finance, Government of India, and is willing to repay all the ICDs as per the agreed terms. The company has already submitted a proposal to the Ministry of Finance, Government of India, as to how it is going to settle the due ICDs. The management of the company is confident that, by recovering its dues, the company will be able to pursue fresh business. As the company is engaged in the business of financial services, non-carrying of fresh business does not make the company, a non-going concern. Thus, the management foresees continuity in the operations of the company and is of the opinion that the company is a going concern. But, C&AG is of the opinion that, as the company has stopped all fresh business activities since September, 1992, the SEBI has cancelled the authorisation granted to the company for Merchant Banking activities in December, 1993 and RBI has refused registration of the company as a Non-Banking Financial Company during 1994-95, the company cannot be considered as a going concern and in view of the above the annual accounts do not reflect a true and fair view of the state of affairs of the company.

 

5. The querist has referred to Schedule Q, Notes forming part of the accounts, for the year 1995-96 of another financial company which is a subsidiary of a nationalised bank (hereinafter referred to as XYZ Ltd.) that their current assets – Stock of Securities- include tainted shares of Book Value of Rs. 786.04 Crores acquired through the notified parties for which claims are outstanding in the Special Court. There are several suits pending for disposal against the company. It may be seen from the Director’s Report of XYZ Ltd., that the company had applied to RBI for registration under the revised NBFC guidelines and the same was not favorably considered by RBI. The principal activities of XYZ had also been suspended and the company did not undertake/recommence the suspended activities (Directors’ Report, Business Performance). While in respect of the company in question, C&AG made a comment that the company cannot be considered as a going concern, they did not make any comment in respect of XYZ Ltd., even though the circumstances about continuity of the business are similar in both the companies in the view of the querist.

 

6. According to the querist, as per the International Standard on Auditing-23, if, in the auditor’s judgement, the going concern question is not satisfactorily resolved, the auditor would consider whether the financial statements –

 

(a)        Adequately describe the principal conditions that raise substantial doubt about the entity’s ability to continue in operation for the foreseeable future.

 

(b)        State that there is a significant uncertainty that the entity will be able to continue as a going concern and, therefore, as appropriate may be unable to realise its assets and discharge its liabilities in the normal course of business.

 

(c)        State that the financial statements do not include any adjustments relating to the recoverability and classification of recorded assets amounts or to amounts and classification of liabilities that may be necessary if the entity is unable to continue as a going concern.

 

Provided the disclosure is considered adequate the auditor would not express a qualified or adverse opinion.

 

7. Under the stated circumstances, the querist has sought the opinion of the Expert Advisory Committee as to whether-

 

(a)        under the circumstances, can it be said that the company is a “non-going concern”?

 

(b)        the disclosure made in the financial statements represents true and fair view of the state of affairs of the company;

 

(c)        if it is decided that the company  is not a going concern, then what should be disclosure in the financial statements.

 

                                                                      Opinion                                   December 31, 1996

 

1. The Committee notes that para 10(a) of Accounting Standard (AS) 1 on ‘Disclosure of Accounting Policies’, defines the fundamental accounting assumption of ‘Going Concern’, as follows:

 

“The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.”

 

2. The Committee also notes paras 6, 7 and 8 of International Standard on Auditing (ISA) 23 on ‘Going Concern’, which are reproduced below:

 

“6.  Indications of risk that continuance as a going concern may be questionable could come from the financial statements or from other sources. Examples of such indications that would be considered by the auditor are listed below. This listing is not all-inclusive nor does the existence of one or more always signify that the going concern assumption needs to be questioned.

 

                        Financial Indications

 

                        *          Net liability or net current liability position.

 

*          Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive reliance on short-term borrowings to finance long-term assets.

 

                        *          Adverse key financial ratios.

 

                        *          Substantial operating losses.

 

                        *          Arrears or discontinuance of dividends.

 

                        *          Inability to pay creditors on due dates.

 

                        *          Difficulty in complying with the terms of loan agreements.

 

                        *          Changes from credit to cash-on-delivery transactions with suppliers.

 

*          Inability to obtain financing for essential new product development or other essential investments.

 

                        Operating Indications

 

                        *          Loss of key management without replacement.

 

                        *          Loss of a major market, franchise, license, or principal supplier.

 

                        *          Labour difficulties or shortages of important supplies.

 

                        Other Indications

 

                        *          Noncompliance with capital or other statutory requirements.

 

*          Pending legal proceedings against the entity that may, if successful, result in judgments that could not be met.

 

                        *          Changes in legislation or government policy.

 

7. The significance of such indications can often be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counterbalanced by management’s plans to maintain adequate cash flows by alternative means, such as by disposal of assets, rescheduling of loan repayments, or obtain additional capital. Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply.

 

            Audit Evidence

 

8. When a question arises regarding the appropriateness of the going concern assumption, the auditor should gather sufficient appropriate audit evidence to attempt to resolve, to the auditor’s satisfaction, the question regarding the entity’s ability to continue in operation for the foreseeable future.”

 

3. The Committee is of the view that whether going concern assumption is appropriate in given facts and circumstances is basically a matter of judgement. In making the judgement, apart from the factors stated in the query, the factors such as those mentioned in paras 6 and 7 of ISA 23 (reproduced in para 2 above) would have to be considered, along with their financial impact. Such a judgement based on detailed consideration of various factors has to be made by the management itself. Similarly, the auditor of the enterprise also arrives at his judgement in this regard based on the various indications available to him and the sufficient appropriate audit evidence gathered by him. Since it is fundamentally a matter of opinion, the conclusions of the management and the auditor may or may not coincide. Accordingly, the disclosures to be made in the accounts by the management and in the audit report by the auditors would depend upon their own perception of the situation.

 

4. On the basis of the above, the Committee is of the following opinion in respect of the issues raised in para 7 of the query.

 

                        (a)        please see para 3 above.

 

                        (b)        please see para 3 above.

 

(c)        In case it is decided that the going concern assumption is not appropriate in the facts and circumstances of the case, the accounts may have to be prepared on liquidation basis.

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