(a) Defi ne the going concern assumption. (2 marks)
Medimade Co is an established pharmaceutical company that has for many years generated 90% of its revenue through the sale of two specifi c cold and fl u remedies. Medimade has lately seen a real growth in the level of competition that it faces in its market and demand for its products has signifi cantly declined. To make matters worse, in the past the company has not invested suffi ciently in new product development and so has been trying to remedy this by recruiting suitably trained scientifi c staff, but this has proved more diffi cult than anticipated.
In addition to recruiting staff the company also needed to invest $2m in plant and machinery. The company wanted to borrow this sum but was unable to agree suitable terms with the bank; therefore it used its overdraft facility, which carried a higher interest rate. Consequently, some of Medimade’s suppliers have been paid much later than usual and hence some of them have withdrawn credit terms meaning the company must pay cash on delivery. As a result of the above the company’s overdraft balance has grown substantially.
The directors have produced a cash fl ow forecast and this shows a signifi cantly worsening position over the coming 12 months.
The directors have informed you that the bank overdraft facility is due for renewal next month, but they are confi dent that it will be renewed. They also strongly believe that the new products which are being developed will be ready to market soon and hence trading levels will improve and therefore that the company is a going concern. Therefore they do not intend to make any disclosures in the accounts regarding going concern.
Required:
(b) Identify any potential indicators that the company is not a going concern and describe why these could impact upon the ability of the company to continue trading on a going concern basis. (8 marks)
(c) Explain the audit procedures that the auditor of Medimade should perform. in assessing whether or not the company is a going concern. (6 marks)
(d) The auditors have been informed that Medimade’s bankers will not make a decision on the overdraft facility until after the audit report is completed. The directors have now agreed to include going concern disclosures.
Required:
Describe the impact on the audit report of Medimade if the auditor believes the company is a going concern but a material uncertainty exists. (4 marks)