Going Concern - Annual Update
Background
The concept of going concern, the assumption that a business will continue its operations into the foreseeable future, is a fundamental principle of financial reporting. However, the COVID-19 pandemic brought renewed focus and scrutiny to this concept from 2020 onwards. Increased attention from regulators and the public has made going concern assessments a critical area for businesses and their accountants.
The Role of Accountants
According to FRS 102 Section 3.8, the responsibility for assessing whether an entity is a going concern rests with the directors and management of the entity. Accountants, however, play a supportive role by guiding clients through the assessment process when needed. This guidance is particularly valuable for clients unfamiliar with making such assessments or uncertain where to begin.
Accountants can offer insights and advice, but ultimately, the directors must decide if their business is a going concern, as they possess the most intimate knowledge of their operations. It’s also crucial to remind clients that their going concern assessment must cover a minimum period of 12 months from the date of approval of the financial statements. Significant events falling just outside this period, such as key contract renewals or loan repayments, should also be considered.
Key Considerations for Going Concern Assessments
When assisting clients with going concern assessments, accountants might start by discussing the following:
Have forecasts or budgets already been prepared?
What are the future plans for the business, including any significant contracts or acquisitions?
Are there any known issues that may arise post-year end, such as financial difficulties, significant one-off expenditures, key contract renewals, or loan repayments?
What is the financial position at year-end and post-year end, including cash balances and profitability?
Is the business overly reliant on certain customers, suppliers, or staff members?
Are there wider industry, local, national, or global factors that could impact the business?
Forecasts
While preparing forecasts or budgets is not a mandatory requirement, they can significantly aid management in making their going concern assessment. When forecasts are prepared, it is crucial that the assumptions and methods used are reasonable and appropriate. For example, projecting a 10% increase in revenue may look promising on paper, but management should consider if this is achievable, how it will be accomplished, and what actions have already been taken to support this growth.
If forecasts indicate that the company is in a loss-making position, management must assess whether the situation is severe enough to suggest wrongful trading. Conversely, even if accounting losses are expected, a sufficiently strong cash position could still support a positive going concern assessment.
Auditors will also review and challenge forecasts during the audit process, making it essential for management to ensure that these forecasts are robust. In addition, management should critically evaluate their own assessments, using techniques such as reverse stress-testing to identify potential issues that may not have been previously considered. This proactive approach allows management to address potential problems before they become critical.
Past vs. Future Performance
While past performance can offer insights into future prospects, it should not be the sole basis for a going concern assessment. A company’s longevity does not guarantee its future success; notable examples of long-standing businesses that failed include Wilko, BHS, Thomas Cook, and Woolworths.
The best way to use past performance in going concern assessments is as a benchmark to validate future projections. If forecasts suggest increases, decreases, or stability in performance, management should critically evaluate the reasons behind these expectations and ensure they are realistic. Simply assuming that past performance will continue unchanged is not a safe approach, as external factors such as market conditions, industry trends, or broader economic shifts can significantly impact future results.
Disclosures
FRS 102 requires specific disclosures related to the going concern assumption. If the financial statements are not prepared on a going concern basis (for instance, if a break-up basis is used), this must be disclosed. Furthermore, if the going concern basis is applied but there are material uncertainties that cast significant doubt on the entity’s ability to continue as a going concern, these uncertainties must also be disclosed.