Going Concern Assumption in Auditing: Principles, COVID-19 Impacts, Triggers, and Practical Illustrations

Going Concern Assumption in Auditing: Principles, COVID-19 Impacts, Triggers, and Practical Illustrations

Executive Summary

The going concern assumption is the bedrock upon which financial reporting and audit assurance are constructed. It presumes that an entity will continue its operations for the foreseeable future—typically a period of at least twelve months from the balance sheet date—without the intention or necessity of liquidation or material curtailment of operations. When this presumption holds, assets and liabilities are measured on a basis that assumes realisation and settlement in the normal course of business. When it does not, measurement, presentation, and disclosures change fundamentally.

This article offers a practitioner-oriented exposition of the going concern concept under auditing standards, with a particular focus on the disruptions and lessons emerging from the COVID‑19 pandemic. It integrates corporate case vignettes (Indian and global), numerical illustrations, and a risk-based trigger framework to assist audit teams in planning and executing going-concern procedures. The intended audience is professional auditors and finance leaders who must exercise informed judgement under uncertainty and time pressure.

1. Conceptual Foundations

1.1 What the Going Concern Assumption Means

In financial reporting, the going concern assumption underpins historical cost measurement, depreciation based on useful lives, and the classification of liabilities between current and non‑current. If management intends to liquidate or cease operations—or has no realistic alternative but to do so—the basis of accounting must shift to liquidation or break‑up basis, and assets are measured at net realisable value or liquidation proceeds. In auditing, the standard setter’s focus is different: the auditor’s responsibility is to obtain sufficient appropriate audit evidence regarding the appropriateness of management’s use of the going concern basis and to conclude whether a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern.

1.2 Audit Responsibilities at a Glance

- Evaluate management’s assessment covering a period of at least twelve months from the balance sheet date.

- Challenge the reasonableness of the cash flow forecast and the assumptions behind it (revenue, margins, capex, working capital, financing).

- Assess the availability of mitigating factors such as unutilised credit lines, covenant waivers, government support, and parental backing.

- Consider subsequent events up to the date of the auditor’s report.

- Determine the implications for the auditor’s report: unmodified with adequate disclosures, emphasis of matter, or modified opinion if the basis of accounting is inappropriate or disclosures are inadequate.

1.3 The “Foreseeable Future” and Look‑forward Horizon

While many frameworks refer to at least twelve months from the reporting date, good practice extends the look‑forward to a period consistent with debt maturities, business cycles, and major contractual obligations (e.g., long‑term leases, project milestones). For seasonal businesses, a 12–18 month horizon is often necessary to capture a full operating cycle.

2. COVID‑19: Why Going Concern Became a Frontline Audit Topic

2.1 Demand Shock, Supply Shock, and Liquidity Shock

COVID‑19 created simultaneous shocks: (a) a demand shock from lockdowns and consumer caution, (b) a supply shock from factory closures and logistics bottlenecks, and (c) a liquidity shock from delayed collections and inventory build‑ups. For auditors, this meant elevated risk of material uncertainty even for historically robust companies. Entities with concentrated customer bases, high fixed costs, or tight covenants were particularly vulnerable.

2.2 Sectoral Differentiation

- **Aviation and Hospitality:** Revenues collapsed by 60–90% at the height of restrictions. Fleet and hotel assets became under‑utilised, and cash burn rates spiked. Debt covenant waivers and sale‑and‑leaseback transactions became survival tools.

- **Retail and Malls:** Rent concessions, inventory obsolescence, and shift to e‑commerce stressed working capital. Entities with omnichannel strategies fared better.

- **Pharmaceuticals and Healthcare:** Mixed effects—elective procedures declined while vaccine and essential medicine demand surged. Supply‑chain resilience and regulatory agility were key.

- **IT/ITES and BFSI:** Many adapted quickly via remote work and robust digital infrastructure, but faced client pricing pressure and credit cost spikes, respectively.

- **MSMEs across sectors:** Disproportionately affected due to limited buffers, dependence on promoter support, and constrained access to capital markets.

2.3 Government and Policy Responses

Moratoriums, emergency credit lines, and guarantee schemes provided critical liquidity. However, these were often temporary bridges; auditors needed to examine whether post‑support cash flows remained viable, and whether deferrals simply shifted the cliff to later periods.

2.4 Persistent Post‑pandemic Themes (2021–2025)

- Repricing of risk and tighter covenants in bank lending.

- Elevated inventory and logistics risk; near‑shoring and supplier diversification.

- Digital acceleration and variable‑cost models reducing fixed‑cost leverage.

- Greater investor emphasis on disclosure quality around liquidity, sensitivity analyses, and stress testing.

3. A Risk‑Based Trigger Framework for Going Concern Review

Auditors should deploy a trigger‑based approach to identify entities requiring deep‑dive procedures. The following triggers are non‑exhaustive but practical:

**Profitability and Cash Burn**

- Recurring operating losses or negative operating cash flows in two consecutive quarters.

- Cash runway < 12 months at current burn rate.

**Leverage and Covenants**

- Net debt/EBITDA above covenanted thresholds or headroom < 10%.

- Upcoming maturities within 12 months without committed refinancing.

**Working Capital Stress**

- Receivable ageing deterioration (e.g., >20% of receivables past due >90 days).

- Inventory obsolescence or build‑up beyond seasonal norms (e.g., >1.5× median days).

- Payable stretch leading to supplier stop‑ship notices.

**External and Legal Indicators**

- Ongoing litigations with potential cash outflows that are not fully insured or provided for.

- Regulatory actions, cancellations of licences, or loss of key contracts.

**Operational Fragility**

- Single‑supplier or single‑customer dependence (>30% concentration).

- Loss of key management with no succession plan.

**COVID‑Related and Post‑pandemic Indicators**

- Evidence that post‑moratorium collections have not normalised.

- Structural demand shift (e.g., business model obsolete without digital pivot).

4. Methodology: How Auditors Should Evaluate Going Concern

4.1 Understand Management’s Assessment

Management should prepare a base‑case cash flow forecast for at least twelve months, supported by assumptions about volumes, pricing, margins, capex, and working capital. Auditors should check that the assessment considers reasonable worst‑case scenarios and includes a plan for mitigating actions (cost reductions, asset sales, capital injections).

4.2 Test the Mechanics and the Assumptions

- **Mathematical accuracy:** Verify formulae, links, and consistency between income statement, balance sheet, and cash flow.

- **Reasonableness:** Benchmark growth, margin, and working capital to historical data, peer performance, and externally available market indicators.

- **Financing:** Inspect loan agreements, covenants, and correspondence with lenders regarding waivers and amendments.

- **Sensitivity analysis:** Recalculate forecasts under adverse but plausible scenarios and assess headroom to minimum cash and covenants.

4.3 Post‑balance‑sheet Events and Subsequent Information

Events between the balance sheet date and the audit report date can decisively alter going‑concern conclusions—e.g., a successful rights issue, a major customer loss, a plant fire, or unexpected regulatory penalties. Auditors must read minutes, review bank statements, and update their understanding up to the signing date.

4.4 Evaluating Mitigating Factors

- **Committed facilities:** Only count headroom on signed, unconditional facilities.

- **Support letters:** Assess legal enforceability; parental letters of comfort may be non‑binding.

- **Capital raise plans:** Evidence should exceed board intent—engagement letters, term sheets, or in‑principle approvals.

- **Cost‑out programmes:** Examine feasibility, implementation timelines, and severance costs.

4.5 Documentation and Communication with Those Charged with Governance

Auditors should document the assessment logic, assumptions challenged, sensitivities performed, and rationale for the conclusion. Early and candid communication with the Audit Committee is essential, especially where a material uncertainty is likely.

5. Corporate Case Studies and Vignettes

The following cases are composites inspired by real fact patterns observed by audit teams; identifying details are anonymised for confidentiality while preserving the analytical substance for audit judgement training.

Case A: Regional Airline Under Prolonged Demand Weakness

**Background.** A regional airline with a fleet of 22 aircraft financed largely through sale‑and‑leaseback arrangements saw passenger revenue fall 72% during the most severe pandemic quarters. Though traffic has recovered to 85% of pre‑COVID levels, high fuel prices and a weak currency keep margins thin.

**Triggers.** Negative operating cash flow for three quarters; covenant headroom on interest coverage reduced to 8%; two major leases up for re‑negotiation within nine months.

**Management’s Plan.** Network rationalisation, wet‑leasing surplus aircraft, and a proposed QIP (qualified institutional placement) to raise ₹600 crore.

**Audit Work.** The audit team performed scenario analysis with traffic at 80–90% of the base case, fuel prices +10%, and currency depreciation of 5%. The combined downside exhausted minimum liquidity by Month 10 unless the QIP succeeded. Term sheets for QIP were indicative, not firm. Lease renegotiations were not concluded at the reporting date.

**Conclusion.** Going concern basis remained appropriate because management had realistic alternatives (sale of two aircraft and a confirmed working‑capital line). However, a **material uncertainty** existed, requiring robust disclosures. The auditor issued an **unmodified opinion** with a **Material Uncertainty Related to Going Concern (MURGC)** paragraph, highlighting the disclosure note.

Case B: Mall‑anchored Retailer Pivoting to Omnichannel

**Background.** A specialty retailer operating 120 stores in Tier‑1 and Tier‑2 cities experienced footfall declines of 50–60% during lockdowns. Post‑pandemic, online sales grew from 8% to 28% of revenue, partially offsetting store traffic.

**Triggers.** Inventory days rose from 80 to 140; rent concessions expired; two term‑loan covenants tested quarterly with headroom <5%.

**Management’s Plan.** Close 20 underperforming stores, negotiate percentage‑of‑sales rent for another 30, and invest ₹50 crore in the digital channel, partly funded by promoter infusion of ₹30 crore.

**Audit Work.** Verified signed rent‑restructuring agreements covering 26 stores; for the remaining 24, only draft term sheets existed. Sensitivity analysis showed that without at least 40 stores on percentage‑of‑sales rent, covenant breach was likely by Q3. Promoter infusion was evidenced by board resolution and escrowed funds.

**Conclusion.** With signed agreements and escrowed infusion, base‑case showed 15 months of liquidity headroom. Disclosures were adequate. The auditor issued an **unmodified opinion without MURGC**, but added an **Emphasis of Matter** to draw attention to the significant estimation uncertainty in the forecast.

Case C: MSME Auto‑components Manufacturer Facing Supply Disruptions

**Background.** A Tier‑2 supplier with ₹180 crore revenue pre‑COVID suffered erratic schedules due to chip shortages. Customers moved to dual‑sourcing, reducing volumes.

**Triggers.** Receivable ageing >90 days rose from 7% to 22%; vendor stop‑ship notices for overdue payables; cash credit account was frequently overdrawn intra‑day.

**Management’s Plan.** Apply for an emergency credit line (ECLGS‑type), sell surplus land parcel, and secure promoter‑guaranteed bill discounting.

**Audit Work.** Inspected sanction letter for new facility (₹20 crore) with conditions precedent; land sale had a registered agreement to sell with 10% earnest money received. Sensitivity showed that if the facility drawdown delayed by more than 45 days, payroll would be at risk.

**Conclusion.** **Material uncertainty** existed until funds were drawn and land proceeds received. The auditor included a **MURGC** paragraph. Subsequent event: funds were drawn two weeks after the report date—disclosed but not a basis to remove the MURGC at the report date.

Case D: Hospital Chain with Mixed COVID Exposure

**Background.** A multi‑specialty chain saw non‑COVID procedures dip, but COVID‑related services temporarily boosted revenue. Post‑wave, elective surgeries recovered; capex for expansion resumed.

**Triggers.** None material—DSCR headroom >30%, receivable cycle stable, committed undrawn lines sufficient for capex.

**Audit Conclusion.** Going concern appropriate with no material uncertainty. However, auditor evaluated sensitivity to a potential new variant; headroom remained >12 months even under a 10% revenue dip.

6. Numerical Illustrations and Sensitivity Walk‑throughs

6.1 Liquidity Runway Calculation

Data (Company R):

- Opening cash and equivalents at 1 April: ₹120 crore

- Committed undrawn working‑capital lines: ₹60 crore

- Average monthly operating cash burn (base case): ₹18 crore

- Interest and principal due monthly: ₹4 crore

- Minimum liquidity threshold (board policy): ₹20 crore

**Runway (months) = (Opening cash + undrawn lines – minimum liquidity) ÷ (monthly burn + debt service)**

= (120 + 60 – 20) ÷ (18 + 4) = 160 ÷ 22 ≈ **7.3 months**

**Sensitivity:** If burn increases by 15% and debt service by 10%, denominator becomes 20.7 + 4.4 = 25.1; runway ≈ 140 ÷ 25.1 = **5.6 months**. An auditor would flag the reduced headroom and seek evidence of additional financing or cost reductions.

6.2 Covenant Headroom Analysis

Data (Company S):

- Covenant: Net Debt/EBITDA must be ≤ 3.50× at each quarter‑end.

- Forecast EBITDA (next 12 months): ₹240 crore (base), ₹210 crore (downside).

- Net Debt: ₹700 crore (stable).

**Headroom (base) = 3.50 – (700/240) = 3.50 – 2.92 = **0.58×**

Headroom (downside) = 3.50 – (700/210) = 3.50 – 3.33 = **0.17×**

With headroom of only 0.17× in downside, even a mild miss could cause breach. Auditor would check for cure rights, waiver history, and contingency plans.

6.3 Working Capital Stress Test

Data (Company M):

- Receivables: ₹300 crore; of which >90 days: 25% (₹75 crore)

- Inventory: ₹260 crore; average COGS/month: ₹80 crore ➔ days of inventory = (260/80)×30 ≈ **97.5 days**

- Payables: ₹200 crore; average purchases/month: ₹70 crore ➔ days payable = (200/70)×30 ≈ **85.7 days**

**Observation.** Inventory days near 100 and receivables ageing weak indicate a cash conversion cycle (CCC) of:

CCC = Receivable days (assume 60) + Inventory days (97.5) – Payable days (85.7) ≈ **71.8 days**.

An extension of CCC by ~20 days from prior year would be a trigger for deeper going‑concern work.

6.4 Break‑even and Cost Flexing

Data (Company V):

- Fixed costs/month: ₹12 crore

- Contribution margin: 30%

- Base revenue/month: ₹40 crore ➔ contribution ₹12 crore

**Break‑even revenue = Fixed costs ÷ contribution margin = 12 ÷ 0.30 = **₹40 crore**

If demand falls 15% (to ₹34 crore), contribution ₹10.2 crore; shortfall ₹1.8 crore/month. Over 12 months, cumulative deficit ₹21.6 crore must be funded. Auditor examines access to funds or capacity to flex fixed costs (e.g., lease renegotiations, variable pay).

7. COVID‑Era Disclosure Quality: What Good Looks Like

High‑quality going‑concern disclosures during and after COVID share common features:

- Clear statement that financial statements are prepared on a going‑concern basis, with explicit acknowledgement of the uncertainties considered.

- Transparent description of stress tests: downside scenarios, key variables (sales volume, gross margin, receivable collections), and the resulting covenant and liquidity headroom.

- Specifics of mitigating actions—quantified cost reductions, committed facilities with available headroom, and status of capital raise efforts.

- Timebound milestones and dependencies (e.g., “lease renegotiation to be concluded by 30 September; minimum expected savings ₹18 crore annually”).

- Balanced tone avoiding boilerplate language; neither alarmist nor complacent.

8. Practical Audit Programme for Going Concern

**Planning**

1. Identify triggers using the framework in Section 3; set going‑concern as a significant risk where applicable.

2. Allocate senior resources early; plan for iterative reviews with management.

**Execution**

3. Obtain management’s formal assessment approved by the Board; ensure assessment period covers at least 12 months.

4. Reperform forecast mechanics; check consistency with latest budgets, order books, and hiring/firing plans.

5. Test key assumptions:

- Revenue trajectory: backlog, churn, pricing actions, channel mix.

- Gross margin: input costs, FX, logistics, yield.

- Working capital: DSO, DIO, DPO plans and track record.

- Financing: covenant calculations, maturity ladders, availability of undrawn lines.

6. Perform sensitivities (at minimum): revenue −10%, gross margin −200 bps, DSO +15 days, DIO +15 days, FX −5%, interest +100 bps.

7. Assess mitigating actions for feasibility and timing; corroborate with third‑party evidence.

8. Read subsequent event evidence up to the report date: bank statements, lender correspondence, large contracts, legal letters.

9. Engage those charged with governance; discuss preliminary conclusions early.

10. Evaluate if a **material uncertainty** exists and whether disclosures are adequate.

**Reporting**

11. If disclosures are adequate and a material uncertainty exists: unmodified opinion with **MURGC** paragraph.

12. If disclosures are inadequate but material uncertainty exists: **qualified or adverse opinion** depending on pervasiveness.

13. If the going‑concern basis is inappropriate: **adverse opinion**; ensure liquidation basis is applied where required.

14. Document rationale thoroughly.

9. Special Topics

9.1 Group Audits and Component Dependencies

A parent may be a going concern only due to cash flows from subsidiaries. Auditors must evaluate upstreaming constraints (minority rights, regulatory approvals, dividend capacity) and intercompany support letters. Cross‑default clauses in subsidiary debt can rapidly transmit distress to the parent.

9.2 Start‑ups and High‑growth Entities

Cash burn by design is common. The key question is whether runway extends beyond 12 months based on committed funding. Soft‑circles from investors are insufficient; look for signed term sheets, investor confirmations, and historical track record of funding rounds.

9.3 Public Sector Undertakings (PSUs) and Implicit Support

Implicit sovereign support can be relevant but is not a substitute for evidence. Auditors should seek formal backing (guarantees, budgetary support) and evaluate legal enforceability.

9.4 ESG and Non‑financial Risks

Climate events, cyber incidents, and reputational risks can trigger going‑concern issues. For example, a cyber‑attack can create liquidity strain via ransom, business interruption, and regulatory penalties. Post‑COVID remote‑work models increase attack surfaces, making cyber resilience part of going‑concern due diligence.

10. COVID‑19 Lessons for Management and Auditors

- **Build buffers, not just borrowings.** Liquidity headroom and covenant flexibility are strategic assets.

- **Stress test regularly.** Quarterly scenario planning is now standard, not exceptional.

- **Diversify supply and sales channels.** Omnichannel and multi‑sourcing reduce fragility.

- **Data discipline.** Real‑time dashboards for DSO, DIO, and daily cash are invaluable.

- **Transparent governance.** Early engagement with lenders and investors preserves options.

11. Checklist: Triggers and Evidence for Reviewers

**A. Trigger Questions**

1. Are operating cash flows negative or marginal for the last two quarters?

2. Is projected liquidity headroom <3 months under a reasonable downside?

3. Are there upcoming debt maturities within 12 months without committed refinancing?

4. Has receivable ageing >90 days worsened materially versus prior year?

5. Do inventory days exceed historical averages by >25%?

6. Are there significant unresolved legal or regulatory matters?

7. Is there customer or supplier concentration >30% with evidence of fragility?

8. Have post‑moratorium collections normalised? If not, what is the plan?

9. Are key management departures likely to impair execution of the mitigation plan?

10. Are government supports temporary bridges or durable fixes?

**B. Evidence Pack**

- Board‑approved forecasts with detailed assumptions

- Financing documents: facility letters, covenant schedules, waiver letters

- Contracts: major customers, suppliers, lease amendments

- Subsequent event evidence: bank statements, signed term sheets

- Sensitivity analyses and reverse stress tests

- Legal letters and contingent liability assessments

12. Extended Numerical Case: Reverse Stress Testing

**Company Z (Consumer Durables)**

- Opening cash: ₹90 crore; undrawn lines: ₹40 crore; minimum liquidity: ₹15 crore

- Base‑case monthly EBITDA: ₹8 crore; interest/principal: ₹5 crore

- Working capital delta/month: ₹(2) crore (seasonal build)

**Reverse stress test objective:** Identify the sales decline at which minimum liquidity is breached within 12 months.

Assume contribution margin = 32%, fixed costs = ₹12 crore/month in base case (embedded in EBITDA), and linear relation between sales and contribution. If sales drop reduces EBITDA by ₹X per month, cash flow reduces by ₹X (ignoring non‑cash items).

Let monthly net cash burn B = Debt service (₹5) + WC build (₹2) – EBITDA (₹8 – X)

= 7 – (8 – X) = X − 1 (₹ crore)

Liquidity available L = 90 + 40 − 15 = ₹115 crore

Breach occurs when 12×B ≥ 115 → 12×(X − 1) ≥ 115 → X − 1 ≥ 9.58 → X ≥ 10.58

Therefore, monthly EBITDA must reduce by **₹10.6 crore** to breach within a year. If base EBITDA is ₹8 crore, breach corresponds to EBITDA turning **negative ₹2.6 crore**/month. Translating to sales, with a 32% contribution margin, the incremental contribution shortfall of ₹10.6 crore implies a sales decline of ₹33.1 crore/month. If base sales are ₹110 crore/month, breach point is at **~30% sales decline**. The auditor should assess whether such a decline is plausible under reasonable downside scenarios (e.g., new variants, supply shocks) and whether mitigations change the breach point materially.

13. Illustrative Audit Report Language (MURGC)

“We draw attention to Note X in the financial statements, which indicates that the Company incurred a net loss of ₹YYY crore during the year ended 31 March 20XX and, as of that date, the Company’s current liabilities exceeded its current assets by ₹ZZZ crore. As stated in Note X, these events or conditions, along with other matters as set forth in Note X, indicate that a material uncertainty exists that may cast significant doubt on the Company’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.”

14. Conclusion

Going concern evaluation is ultimately an exercise in disciplined scepticism applied to forward‑looking information. COVID‑19 amplified the importance of this discipline by stressing business models, liquidity, and governance. The auditor’s task is not to predict the future with certainty but to assess whether, on the evidence available at the report date, the going‑concern basis is appropriate and whether a material uncertainty exists. Robust forecasting, transparent disclosures, and early engagement with stakeholders are the pillars of high‑quality outcomes. The trigger framework, numerical tools, and case studies presented here are designed to aid reviewers in making consistent, well‑documented judgements—even in turbulent times.

**About the Author**

Rahul Sharma is a Chartered Accountant and Banker based in Jaipur, Rajasthan, with extensive experience in corporate finance, credit risk, and audit oversight in the Indian banking ecosystem.
Rahul Sharma, FCA, MBA (Fin), LLB, CAIIB
Chartered Accountant & Banker, UCO Bank
ICAI Membership No.: 402506
152/41, Shipra Path, Opp. Patel Marg, Mansarovar,
Jaipur, Rajasthan, India