The FRC has updated its 2016 guidance on disclosure of going concern. It aims to help companies increase investor and stakeholder confidence, through clearer demonstration of their assessments.
The revised, non-mandatory guidance – issued in February – reflects changes in accounting and auditing standards, as well as market and economic developments. It clarifies overarching disclosure requirements. Its scope also now includes companies which apply the UK Corporate Governance Code.
The concept of going concern is a core accounting and financial reporting principle. It’s significant for capital market entities with its direct implications for investor confidence, regulatory expectations, and disclosure of financial information.
For capital markets, that investor confidence and regulatory compliance are key. Likewise, management’s duty to provide clarity to users as to how they reached their conclusions is crucially important.
What is management’s role in going concern assessment?
Management is responsible for evaluating the going concern status of an entity. This means reviewing:
- Future cash flows
- Debt obligations and maturities
- Availability of capital
- Market and operating conditions
They must document their assessment and include explicit disclosures in the financial statements, especially where there are material uncertainties.
What should they be careful to avoid?
Some of the common pitfalls of going concern disclosures are:
- Boilerplate or generic disclosures
- Insufficient disclosure of material uncertainties
- Disregarding events more than 12 months beyond the minimum
- Overly-optimistic or weakly-supported assumptions
- Lack of transparency in relation to Group support
- Deficient disclosure of judgements
- Inadequate scenario analysis
- Misstated growth rates and mathematical errors used in underlying model.
What makes a robust going concern model?
For the going concern model of a UK-listed company to work well, it should align with the latest FRC guidance and detail the following:
1. Clear governance and responsibility
- Board responsibility
- Systematic process
- Risk management integration
2. Forward-looking financial analysis
- Cash flow forecasting
- Liquidity analysis
- Solvency review
3. Stress testing and scenario planning
- Review of plausible worst-case scenarios
- Evaluation of management’s mitigating measures in each instance
4. Clear documentation and evidence
- Clear documentation of assumptions underlying forecasts, judgements by management and external evidence
5. Clear disclosures
- Allow users to understand the risks and how the directors are managing the company’s financial position.
6. Compliance with regulatory expectations
- Ensure compliance with latest regulatory guidance
What should companies disclose for going concern?
The FRC’s updated guidance consolidates and harmonises the various legal, accounting, listing, auditing and governance requirements.
1. Basis of preparation
All financial statements must declare whether they have been prepared on a going concern basis or, if not, show the alternative basis used. Any material uncertainty which gives rise to doubt regarding this assumption requires disclosure.
The level of disclosure must be proportionate to the level of uncertainty, as well as to the financial robustness of the company. Where higher uncertainty exists or limited headroom is available, greater disclosure is expected.
2. Material uncertainties
Where there are material uncertainties these should be disclosed, together with an outline of the key events or conditions that created them and how management are managing the situation. There has been an increase in material uncertainties, driven by a combination of factors:
- Economic uncertainty
- Supply chain disruptions
- Geopolitical risks
- Environmental risks
- Dependence on key contracts or customers
- Timing for ongoing negotiations of funding facilities
Declaring material uncertainties provides transparency to users and a clear insight into management’s actions. A material uncertainty note doesn’t mean the company is, or will become, insolvent. It shows that certain key events need to occur for it to remain liquid. For example, the refinance of a loan facility or capital raise.
Unless those are unsuccessful, the uncertainty may not occur. By identifying and disclosing uncertainties, organisations can better prepare for them. It also alerts stakeholders that the organisation is actively addressing its risks and preparing for differing outcomes.
3. Significant judgements, assumptions and other sources of estimation uncertainty
Major judgement disclosures regarding going concern assessment must be company-specific. They should also clarify the major considerations and how these influenced directors’ judgements.
Examples of judgemental situations include:
- Potential restructuring or refinancing
- Breach of a covenant
- Planned business restructurings
Disclosure of assumptions made should also be tailored to the company and be sufficiently detailed to allow the users to grasp the rationale behind the directors’ conclusions.
What is best practice for disclosing geopolitical risk?
Geopolitical risk has, sadly, become more prevalent in recent times. This means there is increased focus on those risks and their impacts and how they are disclosed. Key considerations are:
- Identification of geopolitical risks
- Linking risks to financial forecasts
- Assessing material uncertainties
- Presenting reports consistently
- Disclosing company-specific circumstances
- Engaging the board and audit committee, and disclosing the process
- Transparency
What are the potential challenges for management?
The revision of ISA 570 has increased auditor responsibility in relation to going concern. Among the key questions for management to answer are:
- Reasoning behind their belief that going concern is appropriate
- Whether all material events beyond the minimum 12-month time frame have been considered
- Current cash runway and susceptibility to variability in revenue or costs
- Contingency arrangements
- Arrangements and likelihood for securing further funding
- Near-term debt maturities or covenant tests likely to impact liquidity
- Formal commitments received from lenders, investors or parent entities
- Material uncertainties identified
- Potential triggers that could cause uncertainties to crystallise
- Judgements reached and how assumptions used compare with others used elsewhere in the financial statements eg impairment
- Whether any scenario analysis or stress testing has been carried out, and outcomes
Preparers should incorporate all these considerations when they make their going concern disclosures and design the supporting models. They must produce a thorough explanation and documentation of every major assumption, important judgement and probable risk factor, in accordance with relevant financial reporting frameworks and supervisory standards.
Comprehensive and concise going concern disclosures are important to the integrity and reliability of financial reporting. They provide stakeholders with valuable information on the financial situation of a business, its exposure to risk, and its management’s forward-looking judgements.
In periods of heightened economic uncertainty or operating stress, tailored and clearly worded disclosures enable users to make well-informed decisions and boost confidence in the company’s stewardship.
If you would like further advice on the issues raised in this article, please contact Joseph Archer or Elorm Numadz
