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Home » » Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(i)(c)

Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(i)(c)

Written By Admin on Sunday, 1 April 2012 | Sunday, April 01, 2012

Clause 4(i)(c)

if a substantial part of fixed assets have been disposed of during the year, whether it has affected the going concern.


1) This clause requires the auditor to comment, in case where a substantial part of the fixed assets has been disposed off during the year, whether such disposal has affected the going concern status of the company.

2) Accounting Standard (AS) 1, “Disclosure of Accounting Policies” states, “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 its operations”.

3) The auditor, in the normal course, when planning and performing audit procedures and in evaluating the results thereof,
is required to consider the appropriateness of the going concern assumption underlying the preparation of financial statements in accordance with the requirements of Auditing and Assurance Standard (AAS) 16, “Going Concern”. As a result of such audit procedures and evaluation, if the auditor is of the opinion that there exists any indication of risk that the going concern assumption might not be appropriate, the auditor should gather sufficient appropriate audit evidence to resolve, to his satisfaction, the question regarding the company’s ability to continue operations for the foreseeable future. It may be noted that the sale of substantial part of fixed assets is one of the several such indications of risk. This clause of the Order pre-supposes the existence of such risk and, therefore, requires the auditor to examine whether the company has disposed off substantial part of fixed asset(s) during the period covered by his report and, if yes, whether the disposal of such part of the fixed assets has affected the going concern status of company. It should also be noted that this requirement of the Order does not absolve the auditor from his responsibilities regarding the appropriateness of the going concern assumption as a basis for preparation of financial statements. Since there could be several other indications of such a risk, the auditor, notwithstanding his comments under the clause, should also comply with the requirements of AAS 16, “Going Concern” while discharging his attest function.

4) Sale of substantial part of fixed assets should be construed to have affected the going concern if the auditor is not able to resolve, to his satisfaction, the question regarding the entity’s ability to continue in operation for the foreseeable future keeping in view the sale of substantial part of fixed assets or if the auditor comes to a conclusion that sale of substantial part of fixed assets has rendered the going concern assumption inappropriate.

5) The Order does not define the word “substantial”. The response to the issue as to what constitutes “substantial part of fixed assets” depends primarily upon the facts and circumstances of each case. The auditor should use his professional judgement to determine whether an asset or group of assets sold by the company is a substantial part of fixed assets. In this case, the auditor may note that section 293(1)(a) of the Act deals with the sale, lease or otherwise disposal of the whole or substantially the whole, of the undertaking of the company. It may be noted that such a situation may not necessarily tantamount to sale of substantial part of the fixed assets of the company. However, such an approval of the shareholders might be an indication that the company has sold or has the intention of selling substantial part of its fixed assets. The audit procedures, in such a case, would also include examination of the minutes of the general meeting(s) where the matter was discussed and the resolution passed by the shareholders in this regard.

6) The auditor should carry out audit procedures to gather sufficient appropriate audit evidence to satisfy himself that the company shall be able to continue as a going concern for the foreseeable future despite the sale of substantial part of fixed assets. These procedures may include:

(i) discussion with the management and analysis as to the significance of the fixed asset to the company as a whole;

(ii) scrutiny of the minutes of the meetings of the board of directors and important committees for understanding the entity’s business plans for the future (for example, replacement of the substantial part of the fixed asset disposed off with another fixed asset having more capacity or for taking up a more profitable line of business);

(iii) review of events after the balance sheet date for analysing the effect of such disposal of substantial part of fixed asset on the going concern.

7) The auditor should also obtain sufficient appropriate audit evidence that the plans of the management are feasible, are likely to be implemented and that the outcome of these plans would improve the situation. The auditor should also seek written representation from the management in this regard.
 
8) Where the company has disposed off substantial part of fixed assets, the auditor should consider whether the disposal of such part of fixed assets has triggered the risk of going concern assumption being no longer appropriate. It is possible that such risk is mitigated by factors such as those referred to in (6)(ii) above. If, in the auditor's judgement, the going concern assumption is appropriate because of mitigating factors, in particular because of management's plans for future action, the auditor, apart from reporting that sale of substantial part of fixed assets has not affected the going concern, should also consider whether such plans or other factors need to be disclosed in the financial statements. Where the auditor concludes that such plans or other factors need to be disclosed in the financial statements, but have not
been adequately disclosed in the financial statements, the auditor should express a qualified or adverse opinion, as appropriate in accordance with the requirements of Auditing and Assurance Standard (AAS) 28, “The Auditor’s Report on Financial Statements”, issued by the Institute of Chartered Accountants of India.

9) An auditor might also come across a situation where the assets have not been put to use but are being held for sale or have been abandoned because of non viability of the project or for any other reason and, therefore, excluded from the schedule of fixed assets and accordingly, shown under the head sales/ adjustments. Such abandoned or held for sale fixed assets are shown separately in the financial statements in terms of paragraph 24 of Accounting Standard (AS) 10, Accounting for Fixed Assets. The, auditor in such a case, should examine the records maintained in respect of these assets in terms of paragraph 44(c) of the Statement and should consider such assets also while commenting upon this clause of the Order. It should, however, be noted that these assets may form substantial part of fixed assets but their disposal or sale might not affect the going concern.

10) Another peculiar situation that might be faced by the auditor in reporting on this clause is where, say, a substantial change in the nature of activities being carried on by the company, requiring it to dispose off its plant and machinery etc. For example, where a manufacturing company has closed down its manufacturing operations, sold off its plant and equipment and has converted itself into a trading company, whether it can still be considered as a going concern. In resolving this issue, guidance can be drawn from Accounting Standard (AS) 1, Disclosure of Accounting Policies, which states that “the enterprise is normally viewed as a going concern, that is as continuing its 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 its operations.” Thus, in such a scenario, though the company has disposed off its plant and equipment, it is still a going concern in the form of a trading company. The auditor in such cases would also draw guidance from the principles laid down in the Auditing and Assurance Standard (AAS) 16, Going Concern, for assessing the appropriateness of the going concern assumption.

11) In case the company has sold a substantial part of the fixed assets and the going concern question is not resolved to the satisfaction of the auditor, the auditor should, while commenting on the clause, state that sale of substantial part of fixed assets has affected the going concern status of the company. In so far as the opinion of the auditor on the financial statements is concerned, the auditor should ordinarily express an unqualified opinion if adequate disclosures in regard to the going concern problem not having been resolved are made in the financial statements. However, he should, in his report, add a paragraph that highlights the going concern problem by drawing attention to the notes to the financial statements. The following is an example of such a paragraph:

"We draw attention to Note X in the financial statements. The Company has sold a substantial part of its fixed assets during the year covered by our report. The company has so far not made any plans to replace the fixed assets that have been sold. These factors, along with other matters as set forth in Note X, raise substantial doubt about the company’s ability to continue as a going concern in the foreseeable future."

12) In case the going concern question is not resolved to the satisfaction of the auditor and adequate disclosure is not made in the financial statements, the auditor should express a qualified or adverse opinion, as appropriate. The following is an example of the explanation and opinion paragraphs when a qualified opinion is to be expressed:

“The Company has sold a substantial part of its fixed assets during the year covered by our report. According to the information and explanations given to us, the company has so far not made any plans to replace the substantial part of fixed assets that have been sold. There exists a substantial doubt that without replacement of such substantial part of fixed assets, the company will be able to continue as a going concern for the foreseeable future. Consequently, adjustments may be required to the recorded amounts of assets and classification of liabilities. The financial statements (and notes thereto) do not disclose this fact.

In our opinion, subject to the omission of the information dealt within the preceding paragraph, the financial statements give a true and fair view of the financial position of the Company at March 31, 20XX and the results of
its operations for the year then ended.” 

13) If, based on the additional procedures carried out and the information obtained, including the effect of mitigating circumstances, the auditor's judgment is that the entity will not be able to continue in operation for the foreseeable future, i.e., going concern assumption considered inappropriate, the auditor should comment that the sale of substantial part of fixed assets has adversely affected the going concern status of the company. Further, the auditor would also conclude in main report that the going concern assumption used in the preparation of the financial statements is inappropriate. If the result of the inappropriate assumption used in the preparation of the financial statements is so material and pervasive as to make the financial statements misleading, the auditor should express an adverse opinion.
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