Acca aaa s21 Notes

AUDITING ASPECTS OF INSOLVENCY 
(UK SYLLABUS ONLY)
1. Meaning of insolvency
A company is insolvent if the value of its assets is less than its liabilities (i.e. the statement of financial 
position shows a position of net liabilities). If all the company’s assets were sold at carrying amount 
(‘book value’), the existing liabilities could not be paid. This is a more fundamental problem than 
simply being short of cash. 
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Management’s responsibility for monitoring financial position and performance is especially 
important when the company has financial difficulties, as cash flow problems can quickly result 
in insolvency. 
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When facing insolvency, management must consider the interests of lenders and other 
creditors, shareholders and other stakeholders. 
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Management must, therefore, prepare and monitor financial statements and cash flow and 
profit forecasts on a regular basis. 
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The auditor may be asked to advise on whether a company is insolvent, or to review historic or 
projected financial information. 
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Having up-to-date financial information and taking professional advice may also help to protect 
directors from legal claims such as wrongful or fraudulent trading. 
2. Administration or liquidation?
The directors of an insolvent company face a difficult decision. Should the company continue to trade, 
in the hope of improvement, or ‘cut its losses’ and cease to trade and be wound up? The auditor may 
be asked to help resolve this dilemma by evaluating the advantages and disadvantages of the options 
available, and considering the impact of each on the relevant stakeholders. The auditor may also be 
asked to explain the procedures involved in placing a company into administration or liquidation, as 
directors will usually have limited knowledge in this area.
See Chapter 14 of our 
ACCA Corporate and Business Law (LW) (ENG) notes
for a summary of points 
which are relevant to AAA.