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2020/21 reporting season: going concern lessons from COVID-19

24 November 2020: The Financial Reporting and Audit and Assurance faculties’ going concern and resilience event highlighted some of the issues preparers and auditors are facing in relation to going concern.

The COVID-19 pandemic has created an unprecedented challenge for auditors and preparers. Businesses are facing uncertainty on a scale beyond even the financial crisis and there are no standard sets of information that businesses or auditors could use to model or forecast potential impacts.

“If you have a business that has suddenly been required to close its operations, and it doesn’t know when it might reopen or how it might reopen, how it is supposed to come up with high-quality forecasts and clear and helpful disclosures is a real challenge?” said Mark Babington, executive director of Regulatory Standards for the Financial Reporting Council (FRC) in his keynote address at ICAEW’s recent going concern event, which ICAEW members can view on-demand here.

The pandemic and current economic climate is a “faultline for audit”, said Babington. Recent, high-profile cases of company failures – following a clean audit opinion – is part of that. “There has been a lot of pressure around going concern, the evaluation that an auditor makes and how they report,” he said.

The sector needs to think about the expectations of stakeholders around going concern, Babington argued. He believes that going concern is often seen by those using financial statements as an absolute term, rather than a judgmental one.

FRC issued a revised standard to address going concern standards, which Babington said is based around three ‘r’s: risk, rigour and report. “We have brought in a much more rigorous risk assessment to drive the work,” he explained. “We have put in requirements that require greater work effort on the part of the auditor. And we’re also looking at enhanced reporting basically for large entities the auditor reporting on why they agree with the manager’s assessments that the entity is a going concern and what work they’ve done to support that.”

The lack of certainty puts a greater expectation on companies to say more about material uncertainties, he said. “However, in order to make it as valuable and relevant as possible, it needs to draw on all available facts and circumstances. There is no value in auditors reporting generically on material uncertainty.”

Later at the event, a panel discussion chaired by Stephanie Henshaw, partner at Francis Clark and chair of ICAEW’s Financial Reporting Faculty Board, looked at the various going concern issues that businesses of all sizes face this year.

“Auditors are really thinking about the business model of the company and making sure that the narrative that they're providing reflects the way the business model works,” said Henshaw. Business models, she notes “might need to change in the face of the pandemic.”

Thomas Toomse-Smith of the FRC’s Financial Reporting Lab spoke about the work that the Lab has done on going concern this year. “There isn't a business model, strategy, set of risks or risk tolerance that hasn't changed – or should be changing – to reflect the exhilaration of trends through the coronavirus crisis,” he said. “Like working at home and digitisation, but also what it has shown companies about the resilience of their own business model and their own components; be that supply chain, their ability to access customers, their liquidity. So, this is a learning opportunity to look at what's happened and really assess how that then needs to reflect into business strategy.”

We need to think about the users of accounts, explained Matthew Howells, partner and head of national assurance technical group, Smith and Williamson. “That will affect the nature and the level of disclosure that has to be given. And of course, that's going to vary depending on if you're a listed company. For example, if there is a clear public interest, therefore you're probably going to give a greater level of disclosure than perhaps if you're at the other end of the scale when you’re an owner-managed business.”

Eve sleep is a growing business that is yet to achieve profitability. Because it has been in a cycle of raising and spending investor capital, a cautious approach to cashflow and forecasting has been in place from day one, explained Tim Parfitt, the company’s CFO, who was also on the panel. Back in January, when management did their going concern review, they put together a model for the next 12 to 24 months. By March, when the company finalised its accounts, the world had changed. Its board and executive team immediately worked on new models – not just to measure the impact but explore different scenarios to extend its going concern review.

“Our approach throughout the pandemic and our approach for the 2020 accounts is going to be no different to what it has been in the past,” said Tim Parfitt eve sleep’s CFO. “We'll be looking at how much cash would go in the bank at the end of the year, our cash burn rate, what assumptions and sensitivities that we need to apply to our predictions to see how long that cash is going to last and at what point we might need to raise more or when we will start generating cash.”

At the small and micro end of the scale, Sophie Parkhouse, technical and training partner at Albert Goodman, spoke of concerns around what to include in disclosures. There is a lot of judgment involved in what to include, she explained. Encouraged disclosure around material uncertainty is not mandatory. “That can cause a lot of issues in itself, and at times, a potentially unlevel playing field, because we do have that judgment we exercise as to whether or not we feel that disclosure is needed ... how somebody intends the message to be relayed with regards to going concern may land with somebody, very differently.”