Could Brexit put going concern clients at risk?
Philip Fisher reviews the likely business issues Brexit may present, including the implications on clients who operate on a going concern basis and stock valuation.
Before starting this piece, this correspondent would like to emphasise that he is not an auditing expert and therefore can do no more than raise issues that might be of concern, without necessarily being able to offer concrete advice on how to resolve them.
However Brexit unfolds over the next few weeks/months/years, it is going to make a significant difference to the way in which auditors operate. Indeed, one of the government’s no-deal advisory notes covers this specific area, although it is currently quite too vague to be of much use.
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It does promise “that, as far as possible, the same laws and rules that are currently in place continue to apply”. The italics are mine and present a cause for potential concern given the lack of clarity more generally.
Ignoring changes to rules and regulations that will only become clear in the longer term, there are still some business issues that are likely to arise as a direct consequence of the decision to leave the EU, particularly if this is carried out on a cliff-edge no deal basis.
The first, inevitably, is a requirement on all auditors to ensure that when they are presenting accounts in which they confirm that the underlying companies or groups can continue to operate on a going concern basis.
The ramifications of Brexit may throw this into doubt for some clients that would otherwise have been perfectly healthy. Any organisation that has a business which mostly comprises exports to Europe could be in trouble if it is suddenly faced with tariffs that must either increase the selling price or reduce profit margins, potentially turning the latter into hefty loss margins.
Similarly, a company that imports fresh produce from the European mainland may struggle to keep business going and could face cash flow difficulties as soon as the beginning of April.
As in almost every piece in this series, the Irish conundrum must rear its ugly head. If you have any audit clients that are based in Northern Ireland, it must be incumbent upon your practice to carry out some kind of detailed exercise to ascertain whether there are connections with the South that could be severed or damaged and throw your client’s future into jeopardy.
Having satisfied yourself that a client will continue to be a going concern, it is also going to be necessary to consider whether other significant factors will come into play on Britain’s exit.
One obvious area on which to focus is stock valuation. Using the example above, if a manufacturing company exports most of its output to one or more European countries then the imposition of tariffs will have a direct adverse consequence on the value of the stock. It is even conceivable that some stock might become completely redundant and valueless, particularly if rivals in other territories seize the opportunity.
Picture a scenario in which a company from Britain has been desperately trying to maintain sales in Europe in the teeth of what it feels to be unfair competition from a rival in what better remain an unnamed country based somewhere in Asia.
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If that rival was feeling particularly vindictive and saw a chance to make what it regards as a short-term investment, it could cut prices at the same time as your client was obliged to raise its own as a result of tariffs. The consequences could well be fatal and feedback into the debate about going concern.
The value of property could also fluctuate a great deal over the next few years, which means that companies that own their own buildings could find balance sheets and by extension P&L accounts hit by what could, in effect, be a recession leading inevitably to a downward revaluation. Property companies that rely on high rental values to pay off loans will face their own challenges if, as seems distinctly possible, both commercial and residential sale prices and rentals plummet.
These problems could then be exacerbated by any hitch that the UK economy might face on its own account and as a result of what appears to be a global economic downturn, not to mention any exchange rate fluctuations. Every one of these factors adds to the work required before signing off a clean audit report.