FRC seeks to implement Sharman Panel’s recommendations on going concern
Further to the Sharman Panel’s recommendations issued in June 2012, the FRC has issued proposals to change fundamentally the basis for the statement under the Listing Rules as to whether an entity is judged to be a going concern or not: no change is proposed to the threshold for using the going concern basis of accounting. The FRC is also proposing to extend narrative reporting on going concern and change the threshold for including material uncertainty disclosures.
The Financial Reporting Council (FRC) has published its proposals to implement the recommendations of the Sharman Report on going concern (see the May/June/July 2012 Update). The report recommended that:
- listed companies make extensive, company-specific ‘front end’ disclosures of their going concern assessment;
- the going concern disclosures should include a longer-term assessment of risks to the business model and solvency; and
- the existing financial statements regime for the basis of accounting, accounts disclosure and auditor’s emphasis of matter should be retained.
The FRC’s proposals would not change the threshold for using the going concern basis of accounting. As now, the financial statements would be prepared on a going concern basis unless, considering the look-forward period required by accounting standards, the directors intended to, or had no realistic alternative to, liquidate the company or cease trading. However, the revised guidance would change the basis for the statement required by the Listing Rules, as to whether the company is judged to be a going concern or not; it would also extend the narrative reporting on going concern and change the threshold for including material uncertainty disclosures.
Currently the concept of going concern for the purpose of the Listing Rules statement follows that applied in respect of the going concern basis of accounting. However, under this guidance that would change fundamentally.
For the purpose of the Listing Rules, for an entity to be a going concern the directors would need to conclude that, “For the foreseeable future there is a high level of confidence that it will have the necessary liquid resources to meet its liabilities as they fall due and will be able to sustain its business model, strategy and operations and remain solvent, including in the face of reasonably predictable internally or externally generated shocks”. This new ‘foreseeable future’ test goes beyond the current look-forward period of at least twelve months from the date of signing the accounts. This is because the FRC explains that, when considering solvency, this look-forward period will depend upon on the nature of the company’s business, its business cycles and the general economic cycle. Part of the assessment would include the identification of solvency risks that will threaten the survival of the company over the general economic cycle and its specific business cycles.
Commenting on the FRC’s consultation draft of guidance on going concern reporting, Tony Cates, Head of Audit at KPMG in the UK commented: “My concern is that it will be difficult for many companies to meet what appears to be such a tough test.”
A key recommendation of the Sharman Report was for more depth of substantive narrative reporting about the assessment behind the Listing Rules statement. To address this, the FRC’s proposals include disclosure of the board’s conclusion as to whether the company is a going concern (as defined in the revised guidance) and confirmation (with specific illustrations) that a robust assessment was undertaken. The proposed narrative reporting would also cover what the board interpreted as the ‘foreseeable future’, the significant solvency and liquidity risks and how they are managed.
When the financial statements are prepared on a going concern basis, the guidance retains the current obligation on the directors to report any material uncertainties. However, the proposals would bring about a major shift in the threshold on which this is to be assessed. A material uncertainty would be disclosed in the accounts if there is more than an evens chance that over, potentially, the economic cycle the company will experience severe economic or financial distress.
While the proposals do implement the Sharman Panel' reporting recommendations for narrative reporting in respect of going concern, they would appear to set a high hurdle for a company to give, within that narrative, an unqualified, binary conclusion that the company is a going concern and set another high hurdle for a company not to disclose a material uncertainty in its financial statements. Will only a minority of companies be able to clear these hurdles?
The FRC invites comments on its proposals by 28 April 2013. It intends to issue final guidance by 30 June 2013, to apply to financial years commencing on or after 1 October 2012.