The concept of going concern is not just an audit-specific issue and there are a number of key issues accountants and clients need to be aware of around it, writes Steve Collings.
Going concern has certainly moved up the ranks in the accounting profession in recent years, particularly in light of some well-publicised corporate collapses.
The concept of going concern applies to financial statements and is not just an audit-specific issue. Therefore, directors have certain responsibilities in respect of going concern, particularly where the financial statements are concerned.
This article aims to clarify some of the issues outside audit which accountants and clients need an awareness of and applies to entities reporting under UK GAAP.
Going concern defined
The glossary to FRS 102 defines ‘going concern’ as follows:
‘An entity is a going concern unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so.’
This definition is also in FRS 102 (March 2018), paragraph 3.8 which then goes on to state that in assessing whether an entity is a going concern, management must take into account all available information about the future. This must be at least, but is not limited to, 12 months from the date on which the financial statements are authorised for issue.
FRS 102, paragraph 3.8 requires management to take into account ‘… all available information about the future.’
Mr and Mrs Price run a successful business. The business prepares financial statements under FRS 102 to 31 March each year. The financial statements for the year ended 31 March 2019 are due to be authorised for issue on 31 August 2019.
In May 2019, Mr and Mrs Price decided they were going to close the business in February 2021 when Mr Price reaches the age of 70 and retire to the south of France where they have a house.
In this example, Mr and Mrs Price intend to cease trading in 18 months from the date on which the financial statements are due to be authorised for issue. It would not be appropriate, therefore, for the financial statements for the year ended 31 August 2019 to be prepared on a going concern basis.
FRS 102 is clear that management must take into account all available information about the future and the going concern assessment must be at least, but is not limited to, 12 months from the date on which the financial statements are authorised for issue.
As discussed above, management’s assessment of going concern must be for a period of at least 12 months from the date on which the financial statements are authorised for issue.
Even where management conclude there are no material uncertainties relating to going concern and the financial statements are to be prepared under the going concern basis of accounting, this is not absolute assurance that the entity will be able to continue as a going concern.
Management’s assessment will depend on the size and complexity of the business. Smaller entities will generally be subject to less rigorous procedures to assess going concern than a large multinational. Indeed, a profitable business with virtually no external financing which is cash-rich will invariably be a going concern. In other cases, management will need to carefully consider if the company is capable of meeting its liabilities as they fall due and whether borrowing facilities are likely to be renewed.
Management may need to be provided with detailed cash flow forecasts and budgets before they can conclude on the entity’s ability to continue as a going concern.
Going concern basis is appropriate but there are material uncertainties
FRS 102 would require an entity to prepare its financial statements on a going concern basis, even if the business is in serious financial difficulty. FRS 102, paragraph 32.7A states:
‘An entity shall not prepare its financial statements on a going concern basis if management determines after the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so.’
FRS 102, paragraph 32.7A only refers to the entity entering liquidation or ceasing to trade. There may be other situations which may present as going concern uncertainties and these will need careful consideration based on facts.
Essentially, even when there is significant uncertainty about whether an entity will be a going concern for the foreseeable future, FRS 102 requires the directors to adopt the going concern basis of accounting and make appropriate disclosures within the financial statements in order to comply with FRS 102, paragraph 3.9. Small entities choosing to report under FRS 102, Section 1A Small Entities are encouraged to make such disclosures.
It should be noted that the FRC made amendments to paragraph 1AE.1(c) as part of the triennial review amendments to clarify that small entities are encouraged to disclose material uncertainties related to events or conditions that cast significant doubt upon the small entity’s ability to continue as a going concern.
Where there are doubts about the entity’s ability to continue as a going concern and the financial statements are prepared under the going concern basis of accounting, management must also consider whether any assets are impaired (hence may need writing down to recoverable amount) as well as whether any provision is required for contracts which may become onerous.
Going concern basis is not appropriate
FRS 102, paragraph 3.9 states that when an entity does not prepare its financial statements on a going concern basis, it must disclose that fact, together with the basis on which the financial statements have been prepared and the reason why the entity is not regarded as a going concern.
Many accountants are familiar with the concept of the ‘break-up’ basis (a concept which has never been defined nor is mentioned in FRS 102). Under this basis, assets are restated to their recoverable amount, long-term liabilities are restated as current and provisions are made for unavoidable costs under onerous contracts and provisions for winding-up costs.
Therefore, the accruals concept becomes secondary because under the break-up basis, the financial statements reflect a forecast of future realisation rather than how the business has performed up to, and its financial position as at, the balance sheet date.
The break-up basis is inconsistent with the principles of FRS 102 and therefore would not be an appropriate basis under that standard, except in very rare circumstances. FRS 102 requires the financial statements to reflect the transactions, events and conditions which have arisen up to, and exist as at, the reporting date.
Also, under the break-up basis, fixed assets are generally reclassified to current assets and long-term liabilities are reclassified as current liabilities. If the financial statements are being prepared under FRS 102, but on a basis other than the going concern basis, it would usually only be appropriate to reclassify fixed assets as current assets if their role within the ongoing business has changed. Long-term liabilities may need to be reclassified as current if, for example, there has been a breach in loan covenants which has triggered immediate repayment of borrowings.
FRS 102 does not set out the basis on which the financial statements should be prepared in the event that the going concern basis of accounting is not considered appropriate. In any event, if the entity wishes to state compliance with FRS 102 then the financial statements must be prepared on a basis which is consistent with FRS 102, but amended to reflect the fact that the going concern basis is not appropriate.
A company will cease to trade on 31 August 2019. The financial statements for the year ended 31 July 2019 have been prepared and include the following note relating to the basis of preparation paragraph:
‘As explained in note 13 to the financial statements, the company will cease trading on 31 August 2019 and the financial statements have been prepared on a basis other than that of the going concern basis. This basis includes, where applicable, writing the company’s assets down to net realisable value. Provisions have also been made in respect of contracts which have become onerous at the reporting date. No provision has been made for the future costs of terminating the business unless such costs were committed at the reporting date.’
While most businesses will prepare their financial statements under the going concern basis of accounting, consideration does have to be given to material uncertainties which may impact on the entity’s ability to continue as a going concern.
Companies that are not small are required to make going concern disclosures in their financial statements. Small companies choosing to report under FRS 102, Section 1A are encouraged to make such disclosures (and would be advised to in order to give a true and fair view).
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.