Going concern reporting during covid-19 period

Reference extracted from ACCA guideline

The principle of Going Concern Reporting During Covid-19 Period has always been very important; its importance is accelerated in a Covid-19 period. Most of the businesses are suffering as a consequence of the pandemic and this might have a substantial impact on the going concern basis. Auditors carrying out audits of financial statements must have regard to ISA (UK) 570 (Revised June 2016) or (Revised September 2019).

The September 2019 edition of ISA (UK) 570 is effective for audits of financial statements for periods commencing on or after 15 December 2019.

FRS 102 paragraph 3.8 states: ‘When preparing financial statements, the management of an entity using this FRS shall make an assessment of the entity’s ability to continue as a going concern. An entity is a going concern unless management either intends to cease the operation and want to liquidate, or has no other alternatives.

For the assessment of going concern assumption whether it is appropriate, management should take into account all relevant and available information about the future, which is at least, but is not limited to, twelve months from the date when the financial statements are authorized for issue.’

In other words, it only refers to the situation of liquidation or cessation of trade in deciphering whether the going concern basis of accounting remains appropriate. Although when a company is encountering notable cash flow hurdles, the default presumption is to prepare the financial statements on the basis of going concern (if management do not intend cease trading, liquidating or have no realistic alternative but to do so).

Management must be smart to disclose the material uncertainties related to going concern in the financial statements.

Under the current situation of Covid-19, there may be material uncertainties that may cast significant doubt on the entity’s ability to continue a going Concern reporting during covid-19 period disclosure of such material uncertainties must be required in order to make it clear to the users that the going concern basis is subject to material uncertainties.

The natures of the virus and its impact on businesses is unpredictable and have an inimical impact on that assumption and this issue must be considered wisely by auditors and accountants who may conclude that non-disclosure may not be appropriate in the circumstances for each of entity.

Going concern reporting in Small entities Accounts preparation

Small entities choosing to apply the presentation and disclosure requirements of FRS 102, Section 1A Small Entities under FRS 102 paragraph 1AE.1(c) encouraged to disclose all the relevant material uncertainties relating to going concern. Where there are material uncertainties relating to the small entity’s ability to continue as a going concern, it is ACCA’s view that if such disclosures are not made, it would be extremely difficult to justify that the financial statements give a true and fair view and hence are misleading.

For ACCA member firms, this creates an ethical threat as member firms cannot have their names associated with financial statements that are misleading. Directors of small entities must therefore advised to disclose material uncertainties relating to going concern where there are such material uncertainties. In particular, section 393 of the Companies Act 2006 prohibits directors from approving financial statements which they know do not give a true and fair view.

Note in the accounts where Going concern basis is not appropriate

As mentioned earlier, certainly there are going to be some cases when an entity won’t be able to survive the impact of the current scenario and the going concern basis of accounting will not be fitting. FRS 102 paragraph 3.9 says: ‘When management is aware, in making its assessment, of material uncertainties related to events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. An entity if does

not draw up financial statements as per going concern basis, it must disclose the appropriate reason for not being regarded as going concern , together with the basis on which it prepared the financial statements. Going Concern Reporting During Covid-19 Period.

FRS 102 and FRS 105 do not specify the basis on which the financial statements should be prepared in the event that the going concern basis is not appropriate. Many accountants are familiar with the ‘break-up’ basis of accounting in which, assets are restated to recoverable amount and long-term liabilities are restated as current, with provisions being made for unavoidable costs under onerous contracts and the costs of winding the business down. Hence, the accruals concept becomes secondary because under the break-up basis, the financial statements throw back a forecast of future realization.

There is no exemption from applying the recognition and principles of UK GAAP (including disclosure requirements as well) if entity states that the going concern basis of accounting is not suitable. So, the normal recognition and measurement bases of accounting principles should be applied and must only be deviated from where it can be well justified.

An example:

A notable decline in profitability and cash flow experienced by ABC Ltd. since the pandemic can state that going concern basis of accounting is not really helping or not suitable . The company has prepared its financial statements for the year ended 30 June 2020 but on 16 July 2020, the directors decided to stop trade as renew of the company’s loan was not done by the bank. The financial statements for the year ended 30 June 2020 include the following note relating to the basis of preparation of the entity’s financial statements:

Note A: Basis of preparation of the financial statements

As explained in Note B to the financial statements, the company will cease trading on 16 July 2020 and the financial statements have not been prepared on the going concern basis. The basis used includes, where applicable, writing the company’s assets down to net realisable value. Provisions have also been made in respect of contracts that have become inconvenient at the balance sheet date. Provision has not been made for the future costs of terminating the business unless such costs were committed to at the reporting date.

Note B: Notes to financial statements: Going concern

Going Concern Reporting

Since the financial statements have been made on the basis other than the going concern, the directors have concluded that the company is not a going concern which can be clearly noted from the financial statements above. The company was not able to have additional borrowing, which resulted in inadequate working capital to run its day to day operation smoothly. As per the directors’ the company will stop to operate on 16 July 2020 due to loss of customer’s contract and the pandemic which has been very strenuous. Going Concern Reporting During Covid-19 Period.

Reference taken from Deloitte recent guideline

Directors have responsibilities to both solvency and going concern. The entity’s ability to pay its debts as and when they become due and payable is Solvency whereas, going concern contemplates whether a business will be able to operate for the upcoming 12 months. This paper focuses on going concern however to aid directors there is inclusion of a refresher on solvency.

Solvency

Within the Corporations Act 2001 for entities, directors are required at least annually (and half- yearly where required) to make a declaration of solvency. Declaration states that in the directors’ opinion “there are reasonable grounds to believe that the entity will be able to pay its debts as and when they become due and payable”. Directors must consider the capacity of the entity to pay debts that it has incurred at the time of the declaration, while making above mentioned declaration. At the time of the declaration of solvency, the directors have an obligation to assess solvency throughout the year. Depending on the outcome of the assessment by the directors,

In respect of solvency directors’ declaration may be that:

• reasonable grounds to believe that the entity will be able to pay its debts as and when they become due and payable (positive declaration),
• stating of a material uncertainty as to the entity’s ability to pay its debts as and when they become due and payable – for instance, the ability to renegotiate loans due for repayment is not certain at the date of the declaration and the entity will not be able to pay its debts as and when they become due and payable without this being achieved, or
• May have reasonable grounds to not to believe that the entity will be able to pay its debts as and when they become due and payable (negative declaration)

Going concern

Management and directors have an obligation in relation to going concern that arises under Section 296 of the Corporations Act 2001, which requires companies to comply with accounting standards in addition to their responsibilities in respect of solvency. As per the accounting standards, management must make an assessment of an entity’s potentiality to continue as a going concern and preparation of financial statements as per going concern , unless management either intends to liquidate the entity, to cease trading or has no realistic alternative but to do so.

It is must for management and directors to gain a view regarding going concern by taking into account all information available concerning the future for a period which is at least 12 months from the end of the reporting period but not just limited to it. Going Concern Reporting During Covid-19 Period.

It seems very challenging for all entity to reach a view on minimum 12 month horizon due to heightened risk that entities could fail over the short and medium term as the current situation is very much unpredictable.

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