QUESTION THREE

(a) Define going concern and discuss the directors and auditors responsibilities in respect of going concern. (6 Marks)

(b) You are in charge of the audit of Clean Ltd (Clean) for the year ended 31 March 2021. Clean principally provides drain and sewer clearance services under fixed price short-term contracts. The majority of the company's business is conducted on a subcontract basis for major water companies many of which use Clean on a regular basis. It is common practice in this industry sector for water companies to pay 90% of the contract value on completion with 10% of the balance being retained by the customer for six months as security against potential problems with the work undertaken. Clean also has retail outlets through which it sells consumables used in the trade. However, management is currently negotiating the sale of the retail operation and plans to use the proceeds to repay a loan falling due in December 2023. Following the disposal of the retail operation, Clean will continue to buy consumables used in its contract work from the existing suppliers but in smaller quantities. Clean Ltd made an operating loss for the year ended 31 March 2021. This is mainly due to a substantial provision for rectification work relating to a contract for Homes plc (Homes), one of Clean's major customers. The contract was to fit a brand new sewage system on a new housing estate, and was completed in early March 2021. However, the sewage system built failed to meet the customer's specification. Furthermore, in April 2021, Clean received notification that Homes had lodged a claim against the company for substantial compensation for alleged reputational damage to the customer's business. No provision has been made for this compensation as the directors of Clean have instructed the company's legal advisors to fight the claim. The company is currently trading at its overdraft limit and the directors have been negotiating with the company's bankers in order to increase its borrowings. The directors have prepared profit and cash flow forecasts for the three years ending 31 March 2024 in support of the request for funding. The company's bankers require this information to be reviewed by independent accountants and the board of directors has requested that your firm undertakes this review.

REQUIRED: Identify SIX (6) matters that indicate going concern risk for Clean Ltd and explain why each of these matters are important? Present your answers in a Table with the following TWO (2) headings: Matters indicating going concern risk, Importance. (12 Marks)

(c) Explain why an auditor would obtain a Letter of Representation from Management and discuss the actions you may take if the directors of Clean Ltd decide not to sign the Letter of Representation. (7 Marks) Answers should cite relevant standards and provide examples, where appropriate.