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John Selwood's Q&As

This time, John looks at a selection of FRS 102 questions he has been asked over the past month and revisits one of his previous Q&As on ethics.

Q) After the year-end it has been discovered that my audit client is in breach of a bank covenant. I have asked management to restate their financial statements to show all bank liabilities as repayable on demand, in accordance with the agreement with the bank. Management have refused and continue to present the loans as long-term liabilities.

This happened a few years ago and I had to qualify the audit report. Back then, I found a very specific reference in old UK GAAP to breaches of bank covenants, which I used to try to persuade management to restate the accounts and ultimately, as the basis for my disagreement. I cannot find anything similar to this in FRS 102. Has the position changed?

A) Welcome to FRS 102: proof that making a standard shorter does not necessarily make it simpler.

Nothing has changed in FRS 102 in your client’s situation. This is simply the application of one of the most fundamental accounting ideas – the balance sheet is prepared based on the conditions existing at the balance sheet date.

FRS 102 Section 32 Events after the end of the reporting period, does address these sorts of issues. While there are many examples in this section, unfortunately none of them specifically refer to a breach of banking covenants discovered after the year-end. However, there are enough similar examples to convince reasonable people that this principle should be applied to breaches of bank covenants.

Also, do not forget the specific requirement in Section 11 of FRS 102 relating to disclosure of a breach of covenants. If management are again unpersuaded to change the financial statement you should similarly consider qualifying your audit report.

This is an extract from an article in the July/August 2016 edition of Audit & Beyond, the magazine of the Audit and Assurance Faculty.

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