Coronavirus: Going concern considerations – a guide for FRS 105 preparers
In this guide we summarise management’s responsibilities for assessing going concern and the associated practical implications for financial reporting, in light of the coronavirus pandemic. This guide is aimed primarily at preparers of micro-entity accounts in accordance with FRS 105 The Financial Reporting Standard applicable to Micro-entities.
This ICAEW Know-How article was created by the Financial Reporting Faculty.
Further information and resources on FRS 105 can be accessed at icaew.com/frs105
When is an entity a going concern?
The accounting concept of going concern is based on the assumption that a business will continue to operate into the foreseeable future. For UK entities, this is a minimum of 12 months from the date that the financial statements are authorised for issue. (FRS 105.3.3)
Accounting standards set a high threshold for departing from the going concern basis. An entity is a going concern unless management either intends to liquidate the entity or cease trading or has no realistic alternative but to do so.
What are management’s responsibilities in relation to going concern?
Management are required to carry out an assessment to ascertain whether the entity is a going concern. The assessment should take into account all available information about the future, which is at least, but is not limited to, 12 months from the date when the financial statements are authorised for issue.
For more information about management’s responsibilities, read our guide, written in collaboration with ICAS, COVID-19 and going concern – guidance for directors of SME businesses.
Does the coronavirus pandemic change management’s responsibilities for going concern?
No. The definition of going concern and management’s responsibilities relating to going concern have not changed. However, given the adverse impact of coronavirus 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, particularly for entities operating in industries which have been affected significantly, such as travel and hospitality.
- Some companies may find that there are no realistic alternatives to liquidation or ceasing trading. However, accounting standards set a high threshold for departing from the going concern basis. For this reason, most accounts are, and likely will continue to be, prepared on a going concern basis, despite 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. In particular, going concern assessments developed prior to the pandemic, or in the early stages of the pandemic, are likely to no longer be fit for purpose and need revisiting. For example, an entity with a year-end in late 2019 or early 2020 may have been a going concern at its balance sheet date; however, this position may have changed after the reporting period date, due to the actual or potential impact of coronavirus. If the entity is no longer a going concern, and the financial statements have not yet been authorised for issue, the going concern basis would no longer be appropriate.
What should I consider when carrying out the going concern assessment?
There are no set procedures for a going concern assessment. The approach generally depends upon the business, its size, complexity and history of profitable operations. However, the availability of cash is central to an entity’s survival and management will typically consider cash flow forecasts to be a key component of their assessment. Examples of matters to be considered during the assessment might include:
- availability of cash and access to short-term borrowing facilities
- ability of customers to pay debts as they fall due
- the entity’s ability to meet its current liabilities and, if necessary, to renegotiate credit terms
- eligibility and access to funding from relevant government schemes
- risk of breaching loan covenants, for example, due to a decline in earnings, and the finance providers willingness to waive the covenants or enforce them
- access to additional funding from existing finance providers or other sources of long-term finance.
Given the rapidly changing environment and level of uncertainty, preparing detailed forecasts will often be challenging. Careful attention should be paid to key judgements and assumptions used in the preparation of the forecasts to ensure that they are reasonable and supportable. A greater range of scenarios than usual will need to be assessed when forecasting. This will not be a straightforward task, requiring consideration of both sector specific and broader economic issues. Examples of scenarios that might be considered include the impact of:
- travel bans and other social distancing measures over various lengths of time
- any resurgence of the disease and associated lockdown measures
- differing forms of economic recovery
- the availability of various government relief mechanisms that the entity is eligible for, over varying lengths of time
- changes in consumer tastes longer term, for example a move towards working from home rather than commuting to offices.
In conducting the going concern assessment, it will be important to capture and document thought processes and assumptions made in sufficient detail. This documentation will be useful when assessing whether assumptions have changed throughout the financial reporting process. This information may also be helpful if the entity chooses to include going concern disclosures in the financial statements (further information provided below).
What are the implications of the going concern assessment on financial reporting?
The implications for financial reporting will depend on the outcome of the going concern assessment and whether management conclude that the going concern basis of accounting is, or is no longer, appropriate.
Financial reporting implications when the going concern basis of accounting is considered appropriate
If management conclude that the going concern basis of accounting is appropriate, the financial statements should be prepared on a going concern basis.
If, in reaching this conclusion, management had to apply significant judgement, then it may be helpful to disclose these judgements to the user (further information provided below).
Financial reporting implications when the going concern basis of accounting is no longer considered appropriate
If management conclude that the going concern basis of accounting is no longer appropriate, the financial statements should not be prepared on a going concern basis. (FRS 105. 26.8) This is likely to remain an unusual outcome, but there may be more examples of such accounts than we are used to seeing.
While it is expected that assets and liabilities will be measured differently, FRS 105 does not specify the basis on which the accounts should be prepared when the accounts are not prepared on the going concern basis.
When a business ceases to be viable, directors should also be aware of their additional responsibilities as directors, for example, in relation to insolvency and wrongful trading. ICAEW’s guide to directors’ responsibilities provides further information on this topic
What disclosures might be helpful to users?
FRS 105 requires very limited disclosures and, provided these and other basic legal requirements are complied with, the accounts are presumed by law to give a true and fair view. However, in these times of significant uncertainty it is likely to be useful to the users of the accounts to be transparent about risks faced and the assumptions used, and making disclosures which are as specific to the business as possible.
Disclosures may therefore be helpful if management conclude that:
- there are material uncertainties related to events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern. Uncertainties are considered material if their disclosure could reasonably be expected to affect the economic decisions of shareholders and other users of the ﬁnancial statements. Users may want to understand how management reached their conclusion (including the basis of any assumptions used in their assessment) and how the uncertainty would impact the entity’s resources, liquidity and solvency.
- the entity is not a going concern. For the benefit of users, the entity may choose to disclose this fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.
Given the current levels of social and economic uncertainty, even if management conclude that the company is a going concern and that there are no material uncertainties, it may be helpful to disclose briefly how management reached this conclusion, even if significant judgement was not required to reach this conclusion.
If the entity does choose to include additional information, over and above that required by FRS 105 and the law, it must refer to the relevant requirements of Section 1A Small Entities of FRS 102 regarding that information (FRS 105.1.3).
Section 1A of FRS 102 does not require entities to provide going concern disclosures but does encourage them to disclose material uncertainties that might affect the entity’s ability to continue as a going concern (FRS 102 1AE.1).