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Unit 6: Laws and Regulations in Audit

However, a fund flow statement would also be of great value as then the various sources Notes
of funds would also have been revealed and also indicate how the same have been utilized.
If short-term funds have been used for long-term purposes, then that would amount to
diversion of funds. The impact of such diversion would then have to be studied in terms of
SAP-16 to ascertain whether such diversion would affect the liquidity of the company on
a long-term basis. As far as negative working capital is concerned, there are a few issues
which are rather complicated. The fact that there is negative working capital may not
always be an indication of sickness. Many businesses today work on trust. There are units
which have been technically sick nut have the backing and confidence of creditors, workers,
bankers, etc. They continue to get credit and bankers have reposed their faith on the units
due to either the ingenuity of the promoters, honesty, work ethics, etc. Any adverse report
by the Auditor under SAP-16 would have a negative impact on the units such as these. The
role of the Auditor in such a situation becomes very tricky as the aim is not to threaten the
very existence of the company. As far as non-financial indicators are concerned, they are to
be looked into with great care as any mistaken reading of the same may result in the
devastation of the business of the company. It is thus, critical that the Auditor after having
applied his mind to the indicators has a discussion with the management and seeks
explanations from them and to see what measures are being taken to reverse any adverse
situation which may have arisen.
6.9 Four Stages on Scale of Assessment

The validity of the going concern status may be judged on the following scale:
Going concern status being appropriate;
Going concern status being questionable and resolved by management explanations;
Going concern status being questionable and managements explanations being inadequate;
Going concern status being inappropriate.
6.9.1 Going concern Status being Appropriate

This being a basic accounting assumption, if in the opinion of the Auditor, an entity is found to
being a ‘going concern’ then the Auditor need not qualify so in the Report.

6.9.2 Going concern Status being Questionable and Resolved by
Management Explanations

The Auditor has to exercise his judgment as to the factors, which point to the entity’s stature as
a non-going concern. If he thinks that the company may have a chance to recover and will not
become insolvent then he may not have it in the report

6.9.3 Going concern Status being Questionable and Managements
Explanations being Inadequate

In case the explanations given by the management are not found to be adequate by the Auditor, he
should consider whether the financial statements: Adequately describe the principal condition
that raises substantial doubt about the company’s ability to continue in operation for the foreseeable
future; State that there is significant uncertainty that the entity will be able to continue as a going
concern and therefore, may be unable to realize its assets and discharge its liabilities in the normal
course of its business. State that the financial statements do not include any adjustments relating to
recoverability and classification of recorded assets and classification of liabilities that may be

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