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Going concern considerations – a guide for FRS 102 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 under FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. This guide focuses on the requirements set out in FRS 102 and does not cover other reporting obligations, for example the disclosures required in the strategic or directors’ report.

Guidance for those preparing accounts under IFRS or FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime is available as follows:

When is an entity a going concern?

The accounting concept of going concern is based on the assumption that an entity 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 102.3.8).

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. 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 (i.e., 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.

Material uncertainties

As part of their assessment, management must consider whether there are any events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern. Resulting 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.

When assessing whether material uncertainties exist, management should consider both the uncertainty and the likely success of any response to mitigate the uncertainty. If significant uncertainty remains about the entity’s ability to continue as a going concern, even after mitigating action is taken, management is required to disclose this. The financial reporting implications of this are considered in more detail below.

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. The most severe but plausible downside scenario will need to be assessed when forecasting. 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. 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

Reverse stress testing, most commonly associated with certain financial institutions, might be useful to enhance the robustness of the going concern assessment. This involves identifying which scenarios would make a business model or financial structure unworkable, and assessing the likelihood of these scenarios occurring, as well as the extent to which management can assure the success of any mitigating actions. Common scenarios to explore include any that would cause asset values or earnings to fall to the extent that loan covenants are breached.

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 needed as support for associated disclosures, in particular any material uncertainty disclosures, and as evidence for the auditors.

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 whether or not management conclude that the entity is a going concern. There are also financial reporting implications when management have assessed the entity to be a going concern but identified material uncertainties that cast significant doubt on the entity’s ability to continue as a going concern.

In all cases, openness and transparency are paramount considerations. Providing clear, candid and well-explained disclosures on key judgements and assumptions applied during the assessment will be critical for users. 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: 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 (FRS 102.8.6).

Entities are encouraged to disclose accurately and concisely 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. This may be done, for example, by reference to the entity’s cash flows, liquidity position and borrowing facilities.

Financial reporting implications: the use of the going concern basis is appropriate but there is a material uncertainty about the going concern status of the entity

If management conclude that a material uncertainty exists, this must be disclosed in the financial statements (FRS 102.3.9). The disclosure must fully describe the events or conditions and clearly state that they indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern. 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.

For small entities applying Section 1A of FRS 102, FRS 102 itself encourages, but does not directly require, disclosure of material uncertainties (FRS 102.1AE.1). However, directors of small entities must make all disclosures necessary for the financial statements to give a true and fair view. In order to achieve this, it may be expected that material uncertainties will still need to be disclosed.

There may be rare circumstances in which delaying completion of the accounts may resolve uncertainties, for example if waiting on formal approval of a refinancing request. In these circumstances, management may wish to take advantage of filing extensions (when applicable) or changing the reporting date. The benefits of making full use of the time available should be high on the board’s agenda.

Financial reporting implications: the entity is not a going concern

If management conclude either during or after the reporting period (see post balance sheet events guidance) that the entity is not a going concern, the financial statements should not be prepared on a going concern basis. An entity (including a small entity) 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.

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 102 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. A careful review of the entity’s accounting policies will be needed to ensure that all of its material accounting policies are disclosed. Some accounting policies may become material as a consequence of preparing the financial statements on a basis other than going concern.

Preparers of financial statements that are not on a going concern basis should ensure there is clear presentation and disclosure of the accounting treatment. Depending on the circumstances of the entity, those applying FRS 102 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 102.

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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 102

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