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ICAEW releases RST and going concern for preparers guides

26 May 2020: In light of the continuing economic uncertainty caused by the coronavirus pandemic, ICAEW has published guides on going concern considerations for those preparing accounts and on reverse stress testing.

The economic upheaval caused by the government’s effort to contain the virus has meant that an increasing number of companies will have going concern issues to contend with, and in its most recent guidance on COVID-19, the Financial Reporting Council noted that it expects more companies to disclose material uncertainties relating to going concern.

To help in these difficult times, ICAEW’s Financial Reporting and Audit and Assurance faculties have prepared guidance to help those preparing accounts, and on reverse stress testing, a potentially useful tool for a wide range of entities.

Going concern for preparers

Going concern considerations – a guide for preparers is aimed primarily at entities preparing accounts in accordance with FRS 102 but includes considerations that can be broadly applied to all entities.

One crucial point the guidance is at pains to emphasise is that the definition of going concern and management’s responsibilities in relation to going concern have not changed, in spite of the coronavirus pandemic. However, given the adverse impact of the virus on society and the economy, the following points should be borne in mind:

  • Management may find that they now reach different conclusions than would have been the case prior to the pandemic
  • Due to the rapidly evolving nature of the pandemic, it will be important to review the going concern status of the business right up to the point at which financial statements are authorised for issue
  • Given the current level of economic and social uncertainty, where entities conclude that material uncertainties exist, users are more likely to be more interested in the underpinning disclosures related to the material uncertainty rather than the fact that there is a material uncertainty.

The guidance also discusses the challenging nature of detailed forecasting during this rapidly changing business environment. It calls on those preparing such analyses to pay careful attention to key judgments and assumptions to ensure that they are reasonable and supportable given the current environment.

It also adds that reverse stress testing, the subject of a separate guide outlined below, might be useful to enhance the robustness of the going concern assessment.

To read the full guide click here.

Reverse stress testing

Put together by the Financial Reporting and Audit and Assurance faculties, Coronavirus: Introducing reverse stress testing explains what reverse stress testing is, and how it can be a useful tool for management of a wide range of entities.

Reverse stress testing (RST) is a requirement for some financial institutions but is not currently used widely by other entities. However, it can provide management with a different lens through which to view going concern and risk assessments and enhance their robustness. It also provides auditors with persuasive evidence to support their conclusions on going concern.

While stress testing is a forward-looking analysis technique that many entities carry out to some degree, a reverse stress test starts from the opposite end – with the identification of a pre-defined outcome. This might be the point at which an entity can be considered as failing, or the entity’s business model becomes unviable.

RST broadly involves exploring three questions in the following order: 

  1. What would it take for the entity to fail?
  2. What individual event, or sequence of events, could lead to this outcome?
  3. What can be done now to avoid this?

The extent of RST should be proportionate to the nature, size and complexity of the entity's business and its risks. 

But why might entities find RST useful? There are several reasons listed by the ICAEW guide, which include:

  • One of the criteria for the UK government’s Coronavirus Business Interruption Loan Scheme is that “your business has a borrowing proposal which the lender would consider viable, if not for the coronavirus pandemic”. RST may assist in demonstrating that an entity’s borrowing proposal is viable.
  • The lockdown may have led to temporary or more lasting effects on consumer behaviour, including patterns of home working and travel. An entity might, therefore, use RST as part of its business planning in the short term and for when restrictions start to be lifted.
  • RST can overcome the limitations of an entity’s risk model, which can break down in periods of crisis. 
  • It helps to identify, for example, low-probability but high-impact risks.
  • RST can reveal hidden vulnerabilities and scenarios not identified by traditional stress testing.

The guidance then goes on to outline how RST is done, including a worked example of a coffee shop: a relatable business which will be experiencing the effects of lockdown on its consumers, whilst developing alternative revenue streams as mitigations.

Finally, the guide explains how management can use RST to drive quantified going concern disclosures, and how RST can be useful to auditors in building up sufficient, appropriate audit evidence.

To read the full reverse stress testing guide click here.

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