Coronavirus: Going concern considerations – a guide for FRS 102 preparers
This ICAEW Know-How article was created by the Financial Reporting Faculty.
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. The guide is aimed primarily at entities preparing accounts in accordance with FRS 102 but includes considerations that can be broadly applied to all entities.
While small entities applying Section 1A of FRS 102 are not required to provide going concern disclosures, they are encouraged to disclose material uncertainties that might affect the entity’s ability to continue as a going concern. Furthermore, Section 1A accounts must give a true and fair view. Judgement will therefore be required to decide whether further disclosures, over and above those specifically required by Section 1A of FRS 102, will be needed in order for the accounts to give a true and fair view.
Micro-entities applying FRS 105 should refer to the faculty’s guidance, Checklist: implications of COVID-19 on the preparation of micro-entity accounts (FRS 105) and Coronavirus: Going concern considerations – a guide for FRS 105 preparers.
This guide draws on the advice set out in the Financial Reporting Council’s (FRC) Company Guidance Update issued in March 2020.
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.
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. There are no set procedures required for a going concern assessment. The approach generally depends upon the business, its size, complexity and history of profitable operations. Typically, management focuses on liquidity (i.e. availability of cash for the business to pay its way over the coming months) and performance.
If, having completed the assessment, 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, those uncertainties must be disclosed. 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.
In its Company Guidance Update, the FRC state that, when assessing whether material uncertainties exist, boards should consider both the uncertainty and the likely success of any realistically possible response to mitigate the uncertainty.
If management conclude that the entity is not a going concern, the financial statements should not be prepared on the going concern basis.
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. In its Company Guidance Update, the FRC indicated that is ‘likely more companies will disclose material uncertainties at the moment.’
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 are likely to no longer be fit for purpose and need revisiting. For example, an entity with a year-end of 31 December 2019 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.
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.
What should I consider when carrying out the going concern assessment?
There are no set procedures for a going concern assessment. 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. Key issues to bear in mind when preparing the going concern assessment are considered below.
Given the rapidly changing environment and level of uncertainty, preparing detailed forecasts will often be challenging. Forecasts should reflect the current economic environment and recent post-balance sheet activity. It will be important to review and update forecasts regularly until the financial statements are authorised for issue.
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 given the current environment. 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 second wave of outbreaks and associated lockdown measures
- differing forms of economic recovery, for example, a quick V-shaped recovery, a slow L-shaped one or, in the case of a second wave of outbreaks, a W-shaped 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.
When considering different scenarios, it may be helpful to refer to projections for economic activity produced by bodies such as the UK Office for Budget Responsibility or the International Monetary Fund.
Reverse stress testing, more commonly associated with certain financial institutions, might be useful to enhance the robustness of the going concern assessment. This involves testing what scenarios would make a business model unworkable so that management can explore ways to mitigate them. Guidance on this topic is available here.
When preparing forecasts and performing other procedures as part of the going concern assessment, management will need to consider a broad range of factors. Outlined below are some suggested questions for boards to consider as part of this process. This is not a comprehensive list of matters and considerations; these will be unique to each entity and its individual circumstances.
- How has the business been impacted to date by COVID-19?
- Can the entity continue to operate if staff are not able to be physically present and, if so, for how long?
- Has the business had to change its operational model, for example, moving from physical sales to online sales and delivery?
- What impact are social distancing measures having on demand for the entity’s products and services in the countries in which it operates? Have any restrictions been imposed which have reduced or suspended trade? Is the business able to trade as normal or adapt, for example, by moving to online sales?
- How will demand for the entity’s products and services be affected in different scenarios, for example, if social distancing measures are in place longer than anticipated or are reduced gradually over a period of time?
- If higher revenues are forecast, possibly due to a short-term increase in demand for particular products and services, is the entity able to realistically meet these demands, given any restrictions on staff availability or issues in the supply chain?
- If businesses in the supply chain are at risk, are alternative suppliers readily available?
- Will the entity’s insurance policies cover any losses arising from the coronavirus and if so, how long it might take for a pay-out to be received?
- Are there additional costs to account for as a result of the pandemic or related to social distancing measures, for example, increased cost of supplies, redundancy costs, new equipment costs for staff working from home? Are there potential penalties arising from missed payments or from renegotiating or breaking contracts? Will there be restart costs once the crisis is over?
- Are there any anticipated cost-savings to account for? Are there reductions in travel or printing expenses while social distancing measures are in place? Are staff costs being reduced, for example, by removing bonus payments, moving staff from full-time to part-time positions, furloughing or reducing pension contributions? Will the business be able to benefit from business rate reliefs or from renegotiating of leases?
On working capital:
- What is the financial health of the entity’s key customers? Will they be able to pay their outstanding debts as they fall due? Can credit terms with customers be changed?
- Is the entity able to meet its current liabilities? If not, is it possible to extend credit terms with suppliers?
- What levels of cash does the entity have? Does the entity have access to an overdraft facility if required?
- Has the entity taken advantage of relevant government schemes in the countries in which operates, for example, the VAT deferral scheme or job retention scheme for furloughed staff in the UK? If so, when is receipt of this income anticipated, and for how long?
On financing and investing:
- Does the entity have access to additional funding, if required, either from existing finance providers or other sources?
- Is the entity eligible for any of the government’s lending schemes, for example, the UK Coronavirus Business Interruption Loan Scheme (CBILS) and, if so, has an application been made? How long does the entity forecast support for?
- If loans are due for renewal, is it likely that the business will be able to renegotiate the loans and if so, on what terms?
- Is the entity part of a group structure? Does the entity rely on the support of a parent, or other group entity, and can that entity continue to provide financial support, or additional support, if required? Does the entity rely on its parent, or other group entity, as sole customer or supplier?
- Is the entity at risk of breaching any loan covenants, for example, due to asset write-downs, a decline in earnings or material uncertainties on going concern? If so, are finance providers enforcing or waiving the covenants given current circumstances?
- Are there any future capital expenditure commitments? If so, can they be delayed or cancelled, if required?
- What will the longer-term impact be on solvency of any new financing taken out?
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 needed as support for associated disclosures and as evidence for the auditors and, in future, for regulators.
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 entity is a going concern; that there are material uncertainties about the entity’s ability to continue as a going concern; or that the entity is not a going concern.
In all cases, openness and transparency are paramount considerations. Providing clear, candid, well-explained and not excessively-detailed disclosures on key judgements and assumptions applied during the assessment will be critical for users, given the current levels of social and economic uncertainty. Disclosures relating to the entity’s access to finance, terms of facilities and any covenants or restrictions will also be important to users.
Financial reporting implications when the entity is a going concern and there is no material uncertainty
If management conclude that the entity is a going concern, the financial statements should be prepared on a going concern basis. If, in reaching this conclusion, management had to apply significant judgement, then this judgement should be disclosed.
In light of the pandemic, it may also be helpful to users to disclose briefly how management determined that there are no material uncertainties in relation to going concern, even if significant judgement was not required to reach this conclusion.
Financial reporting implications when there is a material uncertainty about the going concern status of the entity
If management conclude that there are material uncertainties which may cast significant doubt upon the entity’s ability to continue as a going concern, those uncertainties should be disclosed in the financial statements. The financial statements should be prepared on the going concern basis but include these additional disclosures.
Disclosures on material uncertainties should be specific to the entity’s circumstances. Users will 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.
Management may also wish to consider whether the uncertainties would be mitigated by delaying completion of the accounts, and perhaps take advantage of filing extensions or changing the reporting date. For example, an entity might apply for a filing extension in order to confirm receipt of anticipated income from a government scheme. The benefits of making full use of the time available should be high on the board’s agenda. More information on filing extensions can be found here.
Entities subject to a statutory audit of the financial statements may want to understand the various impacts that material uncertainties can have on the auditors’ report. More information on audit reports can be found in ICAEW’s Audit and Assurance Faculty publication, Coronavirus: understanding Audit reports.
Financial reporting implications when the entity is not a going concern
If management conclude that the entity is not a going concern, the financial statements should not be prepared a going concern basis. This is likely to remain an unusual outcome, but there may be more examples of such accounts than we are used to seeing. The entity (including small entities) should 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.
While it is expected that assets and liabilities will be measured differently, FRS 102 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.
Our thoughts are with everyone affected at this challenging time. We encourage all parties to stay up to date with the latest public health advice in their country.
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