Now it’s true that I could be wrong here but

Third, I’d like them to actually make clear that audit is about ensuring companies are solvent when at present this fundamental requirement of UK law, implicit in the duty of an auditor to check that a company is able to pay a dividend without prejudicing its creditors, is ignored by the FRC.

I am under the impression – mistaken no doubt given that I appear to disagree with the Egregious Professor – that it is the duty of directors to ensure that a company is a going concern, is solvent.

I can’t really see any other way of this being done either. Audit is a once a year procedure, taken after year end. Companies go bust throughout the year….

15 comments on “Now it’s true that I could be wrong here but

  1. As usual he displays his ignorance and lack of practical knowledge. The relevant standard says

    ISA (UK and Ireland) 570
    4
    an explicit management assessment specify the period for which management is
    required to take into account all available information.
     The size and complexity of the entity, the nature and condition of its business and
    the degree to which it is affected by external factors affect the judgment regarding
    the outcome of events or conditions.
     Any judgment about the future is based on information available at the time at
    which the judgment is made. Subsequent events may result in outcomes that are
    inconsistent with judgments that were reasonable at the time they were made.
    Responsibilities of the Auditor
    6. The auditor’s responsibility is to obtain sufficient appropriate audit evidence about the
    appropriateness of management’s1a use of the going concern assumption in the
    preparation and presentation of the financial statements and to conclude whether there is
    a material uncertainty about the entity’s ability to continue as a going concern. This
    responsibility exists even if the financial reporting framework used in the preparation of
    the financial statements does not include an explicit requirement for management to
    make a specific assessment of the entity’s ability to continue as a going concern.
    7. However, as described in ISA (UK and Ireland) 200,2
    the potential effects of inherent
    limitations on the auditor’s ability to detect material misstatements are greater for future
    events or conditions that may cause an entity to cease to continue as a going concern. The
    auditor cannot predict such future events or conditions. Accordingly, the absence of any
    reference to going concern uncertainty in an auditor’s report cannot be viewed as a
    guarantee as to the entity’s ability to continue as a going concern.
    Effective Date
    8. This ISA (UK and Ireland) is effective for audits of financial statements for periods
    ending on or after 15 December 2010.
    Objectives
    9. The objectives of the auditor are:
    (a) To obtain sufficient appropriate audit evidence regarding the appropriateness of
    management’s1a use of the going concern assumption in the preparation of the
    financial statements;
    (b) To conclude, based on the audit evidence obtained, whether a material uncertainty
    exists related to events or conditions that may cast significant doubt on the entity’s
    ability to continue as a going concern; and
    (c) To determine the implications for the auditor’s report.

    2
    ISA (UK and Ireland) 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
    Accordance with International Standards on Auditing.”

  2. Diogenes is right – those are the relevant standards for the year-end audit.

    As you’d expect, Mud has spuddled up two concepts into a dribbling melange of almost-facts.

    Firstly there’s the year-end audit, in which auditors must follow ISA 570 on going concern and must follow other relevant professional requirements. For a listed company, that’s on the consolidated financial statements and is nothing to do with paying dividends.

    Secondly there’s paying dividends. This happens during the financial year. UK company law requires that the directors demonstrate that there are adequate distributable reserves from which to pay dividends. The rules on what all that jargon means is established by a consensus between the large accountancy bodies, but it basically means “IFRS + a few things – a few things”.

    The notion, commonly spread around by Spud and his idiot friends that IFRS means you can just distribute an unrealised gain willy nilly, is plain wrong. I seem to recall that UK company law also requires that public companies wishing to pay a dividend must file “audited accounts” that show there are distributable reserves from which to pay. Now that’s not audited accounts as per the year-end audit but more of a down-to-date reconciliation between last year’s audited financial statements and dividend day, signed by the auditor. Companies aren’t always very good about remembering to do this and, as you point out, the auditors aren’t necessarily in the business every day to be able to stop them.

  3. AIUI ‘trading while insolvent’ may remove limited liability protection for directors, rendering them liable for debts incurred.

  4. I can’t really see any other way of this being done either. Audit is a once a year procedure, taken after year end. Companies go bust throughout the year

    Isn’t this a bit like claiming the MOT testing station is responsible for the road-worthiness of your car throughout the year?

  5. Yes its directors responsibility and if they trade while insolvent then at that point they will lose the protection of the company, becoming personally liable for actions and debts from then on.

    An investigation would look at why and how such a thing happened – an investigation done by any insolvency practitioner appointed though they are not needed in every case of a company becoming insolvent.

    I can think of a number of companies that went under due to insolvency – and each had passed audits.

  6. An independent expert assessor body for UK companies already exists and its remit could be extended to cover verification of dividend payments?

    The Fair Tax Mark

  7. This was auditing basics when I did it 30 years ago, sure there’s new standards but the fundamental principles of what an audit is and it’s scope etc. haven’t substantially changed.
    Going concern has long been recognised as a tricky subject and that it to some degree depends on the representations of management.
    I worked somewhere that had extremely complex revenue recognition on supply install and maintain capital equipment built to to order and while there was a lot of paperwork and ticking boxes there was a subjective knowledge element and auditors couldn’t ever be familiar enough with the business to know all the details and issues.
    Come to that going concern also included order book and can be hard to predict a major customer going under or restructuring and cancelling future orders leaving you with a very big gap in 6 months time

  8. Hmmm. But to be fair to Murph, for all the reasons canvassed above, I’ve often wondered what was the point of audits – other than as a job creation scheme for accountants.

  9. The auditor’s job is to determine if the ledgers are correct. Not his concern whether good or bad.

  10. The key phrase is ‘true and fair view’ so they are not misleading, doesn’t mean they are right just that they are accurate enough.
    The other thing they tell you on the first day of the audit course is that the auditors have no duty in relation to fraud and the court case that established that.
    It’s very hard to sue auditors, look at the entire HP/alchemy deal where it’s primarily the directors they are gong after not the auditors who signed off the accounts or the due diligence review.

  11. As a reporting accountant I prepare our accounts using IFRS and under the Going Concern method (if applicable, which it always has been).

    Our auditors will audit the accounts and also audit whether Going Concern is the correct method to use. Auditors tend to define Going Concern as “will they still be around in the next year”.

    The way that our auditors tend to do this is to look at our budget and forecast to see if we are making money, if we have adequate debt facility headroom, and if we are forecasting to breach our covenants.

    My forecast for this year had us breaching our covenants due to high capex on growth assets; but were already in discussions with the bank 6 months out from the breach and we could avoid the breach by slowing down our capital expenditure programmes. The auditors therefore took comfort in this and signed off on the accounts.

    As for paying dividends – the auditors only look at this as part of Going Concern for any dividend declared after year-end but before the accounts are signed (do we have the ability to pay the year-end dividend without breaching solvency). Before we physically pay any dividends the Board have to check solvency (including paying creditors); but this declaration isn’t audited.

  12. The other thing they tell you on the first day of the audit course is that the auditors have no duty in relation to fraud and the court case that established that.

    Er, I really hope they don’t tell you that. There’s now an entire standard on the auditor’s responsibilities in relation to fraud: ISA 240 and other references to fraud in other standards. For instance, the auditor must consider the risk of fraud on revenue recognition to be a significant risk.

  13. M’lud, you have to view the audit in relation to the size of the company. At one end of the scale, you have, say, BP operating in hundreds of countries with many hundreds of subsidiaries and joint ventures. It is all too easy for the insiders to lose track of the complete picture and it is helpful to get an independent agency to check that things are not going wrong. BT, for example, recently discovered a fraud in the Italian operation. This was probably uncovered by the auditors, either internal or external, asking awkward questions about why reported revenues were not turning into cash, which made management dig further into the issues etc. It will be interesting to see what the FRC makes of the conduct of KPMG with regard to Carillion, especially because the last reported balance sheet showed clear signs of financial strain.

    At the other end of the scale, you have husband and wife companies, which are not audited but generally require professional help to produce statutory accounts for filing at Companies House. Any professional firm is going to do some level of audit on the figures they help the company to produce, in effect acting as an unofficial finance director to the company.

    In between there is a continuum of, hopefully, ever-increasing complexity and in-house financial expertise. The audit is there to check that insiders are not making free with the shareholders’ money. Just the fact that outsiders will come along to ask questions serves to remind the insiders that they need to keep their act together. And in any case, some financial and legal reporting requirements are so complex and recondite that even the best in-house teams welcome outside assistance to get them right or at least acceptable.

    That is the theory and, for the most part, it works well enough although there will always be corporate failures.

    However you are right to flag that it is moot whether “audit” as such should be considered in the way that it is. So much attention is placed on laying out the past history in ways that are of interest to very few people – have you ever read a Remuneration Report in a recent set of accounts? – that it arguably diverts way too much attention from the future in which the company hopes to operate.

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