Going concern and liquidity risk - guidance for directors of UK companies
The Financial Reporting Council (FRC) published updated guidance, on 15 October 2009, for directors of UK companies to assist them when making their assessment of going concern. The guidance applies to accounting periods ending on or after 31 December 2009. The guidance is applicable to all sizes of company and annual and interim financial statements intended to give a true and fair view. Although drafted in the context of companies the guidance may also be useful to the management of other entities that produce financial statements that are intended to give a true and fair view.
The press notice and guidance from the FRC relating to this can be found on FRC’s website.
Directors need to evaluate which one of three potential conclusions regarding going concern is appropriate to the specific circumstances of the company. The directors may conclude:
There are no material uncertainties that may cast significant doubt about the company’s ability to continue as a going concern; or
There are material uncertainties related to events or conditions that may cast significant doubt about the company’s ability to continue as a going concern but the going concern basis remains appropriate; or
The use of the going concern basis is not appropriate i.e. the company has no realistic alternative but to cease trading or go into liquidation or the directors intend to cease trading or place the company into liquidation.
Paragraph 24 in the guidance sets out for each of the conclusions above the ‘resulting disclosures’ and ‘consequence(s) for the auditor’s report’.
UK GAAP provides that disclosure should be made where the review period considered by the directors as part of the assessment of going concern is less than twelve months from the date of approval of the annual financial statements. If the review period is less than twelve months from the date of approval of the annual financial statements they should also explain why.
The FRSSE, UK GAAP and IFRS require explicit disclosure of the material uncertainties that directors are aware of arising from their assessment of going concern that may cast significant doubt on the company’s ability to continue as a going concern.
Disclosure will also need to be made about liquidity risk, other uncertainties and key assumptions concerning going concern necessary to give a true and fair view. In addition, disclosure of principal risks and uncertainties will be needed in the directors’ report (except for small companies).
The guidance states three principles in assessing going concern as follows:
Assessing going concern
Directors should make and document a rigorous assessment of whether the company is a going concern when preparing annual and half-yearly financial statements. The process carried out by the directors should be proportionate in nature and depth depending upon the size, level of financial risk and complexity of the company and its operations.
The review period
Directors should consider all available information about the future when concluding whether the company is a going concern at the date they approve the financial statements. Their review should usually cover a period of at least twelve months from the date of approval of annual and half-yearly financial statements.
Directors should make balanced, proportionate and clear disclosures about going concern for the financial statements to give a true and fair view. Directors should disclose if the period that they have reviewed is less than twelve months from the date of approval of annual and half-yearly financial statements and explain their justification for limiting their review period.
The guidance produced by the FRC explains what is considered to be ‘balanced, proportionate and clear disclosures’ and gives examples illustrating such disclosures for both small companies and other companies.