Where 'going concern' raises concern
It is vital at this time to understand the issue of “going concern” – not just for a firm’s standing but for the economy as a whole, says Keith Proudfoot.
MANY companies in the North East are feeling the strain of the credit crunch, which is inevitably putting a lot of pressure on their business.
As directors struggle to weather the storm and navigate their way through the economic downturn, it is vital to have a proper understanding of the issue of “going concern”.
To be a going concern, a company must be capable of continuing in business for the foreseeable future without the likelihood of liquidation, ceasing to trade or seeking protection from its creditors.
Misinterpretation of this principle can have serious consequences, both for individual businesses and the wider economy.
The damaging effects could include:
A bank refusing to lend a company the money it needs to run its business and pay staff wages;
A modified audit opinion being interpreted as a business having broken the terms of its loan agreement with the bank;
Suppliers deciding to withdraw credit facilities to a business, disrupting its trading activities;
Landlords enforcing break clauses on rented business premises.
When preparing their year-end accounts, company directors must consider whether there are any material uncertainties which cast significant doubt on the company’s ability to stay in business – in other words, continue as a going concern. If so, these must be disclosed in the accounts.
Auditors will modify their audit reports to draw attention to these disclosures and it is important that investors and others understand what this means.
To decide whether there are material uncertainties requiring disclosure, directors look at existing budgets and financial forecasts.
They also take into consideration the firm’s borrowing requirements and other relevant, available information. Given the economic uncertainty which is making it harder for companies to access the finance they need to trade, this task may not be that easy, either for the directors of companies or for their auditors, who have to give an opinion on the accounts and the disclosures they contain.
Where the accounts are audited, the auditor – an independent accountant or firm of accountants – forms a judgment as to whether they comply with all relevant requirements and, in particular, whether they give a true and fair view.
If the accounts disclose material uncertainties that cast significant doubt on the company’s ability to continue as a going concern, the auditors will draw attention to this in their report by modifying their opinion to include an “emphasis of matter”, which is a paragraph highlighting those disclosures.
The danger is that the modified audit opinion could be misinterpreted to the company’s detriment. It is important to remember that while the accounts disclose material uncertainties casting significant doubt on the company’s ability to continue as a going concern, this does not mean that the company will necessarily go bust.
Equally, where the directors conclude there are no material uncertainties, it does not mean the company is guaranteed to continue in business until the date of the next accounts.
In the economic climate we now have, many more annual accounts than before are likely to contain disclosures relating to going concern.
It is important that investors and others in the business world do not jump to the wrong conclusions about these disclosures.
By doing so, they could undermine wider business confidence even further and make the overall economic situation worse.
To avoid this happening, everyone in the business world needs to understand the true significance of “going concern” disclosures in the current economic environment, and to avoid making hasty judgments without considering the full disclosures in the accounts.
We all have a duty to respond to such disclosures in a measured and considered way. Helpful guidance is available on the Financial Reporting Council’s website - www.frc.org.uk.
If we don’t, consequences could be significant – not just for the businesses concerned, but also for the return of much needed confidence in the economy as a whole.
Keith Proudfoot is regional director of the Institute of Chartered Accountants in England and Wales
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