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Going concern considerations – a guide for FRS 105 preparers

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Published: 06 Sep 2022 Updated: 06 Sep 2022 Update History

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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. This guide is aimed primarily at preparers of micro-entity accounts in accordance with FRS 105 The Financial Reporting Standard applicable to Micro-entities.

Guidance for those preparing accounts under IFRS or FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland is available as follows:

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.  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 (FRS 105.3.3).

What are management's responsibilities in relation to going concern?

Management is 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 (FRS 105.3.3).

There are no set procedures required for a going concern assessment. The approach generally depends upon the entity, its size, complexity and history of profitable operations, as well as how the entity might be affected by changes in the social, political and/or economic environment. Typically, management focuses on liquidity (ie. availability of cash for the entity to pay its way over the coming months) and performance. Management’s intentions regarding future operations and use of available mitigating actions against adverse conditions should also be taken into account.

What should management consider when carrying out the going concern assessment?

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. Forecasts over the entity’s performance and position are also important to gain a full understanding of the entity’s financial health as well as allowing the testing of performance and balance sheet covenant ratios and hence of the availability of facilities. Key issues to bear in mind when preparing the going concern assessment are considered below.

Forecasting

Preparing detailed forecasts will often be challenging, particularly in rapidly changing environments. Forecasts should reflect the current economic outlook 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, supportable and consistent with forecasts used in other areas of the financial statements, for example value in use calculations. This will not be a straightforward task, as it will require consideration of both sector specific and broader economic issues, as well as any actions or decisions taken by management.

Reverse stress testing may be useful to enhance the robustness of the going concern assessment.

Events and conditions to be considered in the assessment

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 matters 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.

In conducting the going concern assessment, it is 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. It may also be helpful if the entity concludes it is appropriate to include going concern disclosures in the financial statements (further information provided below).

Factors to consider related to performance might include: 

  • how the business has been or may be impacted by any national or global events;
  • if the entity needs to change its operational model in response to external events;
  • whether operations have been or will be affected by any imposed restrictions or sanctions;
  • how demand for products and services has and may change;
  • if the entity is exposed to any supply chain risks; and
  • exposure to any unusual costs or penalties.

Factors to consider related to working capital might include:

  • the financial health of an entity’s key customers;
  • availability of cash balances and access to committed undrawn borrowing facilities; and
  • access to government grants or ability to defer payments.

Factors to consider related to financing and investing might include: 

  • access to additional funding if required;
  • ability to roll over any loans;
  • stability of the group structure of which an entity is a part;
  • likelihood of any loan covenant breaches; and
  • any unavoidable capital expenditure commitments

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 appropriate 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).

When an entity ceases to be viable, directors must 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.

FRS 105 does not specify an alternative basis on which the accounts should be prepared when the entity is not a going concern. Preparers will need to determine an appropriate basis that provides relevant information that faithfully represents the non-going concern circumstances of the entity.

Depending on the circumstances of the entity, those applying FRS 105 may wish to consider:

  • writing down assets to their recoverable amounts;
  • recognising provisions for contractual commitments (including staff employment contracts) that have become onerous at the balance sheet date as a result of the entity no longer being a going concern;
  • reclassifying ‘creditors falling due after one year’ as ‘creditors falling due within one year’ where the entity no longer has an unconditional right to defer settlement for at least twelve months after the period end.

Recognising provisions for future losses or anticipating gains on disposals of assets would not be appropriate where the entity is not a going concern and the financial statements are still being prepared under FRS 105.

What disclosures might be appropriate?

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.

Nevertheless, in 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 make disclosures which are as specific to the business as possible.

Disclosures may therefore be considered appropriate 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 may be 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 consider it appropriate 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.

If the entity does choose to include additional information, over and above that required by FRS 105 and the law, it must have regard to any requirement of Section 1A Small Entities of FRS 102 that relates to that information (FRS 105.1.3).

Section 1A of FRS 102 encourages, but does not directly require, entities to disclose material uncertainties that might affect the entity’s ability to continue as a going concern (FRS 102 1AE.1).

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In this guide we summarise management’s responsibilities for assessing going concern and the associated practical implications for financial reporting under FRS 105

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