Accounting: Still going?

Thousands of companies are going to go bust in 2009. Sorry to be so gloomy.
But sectors from housebuilding and airlines, to retailing, leisure and media
will witness failures on a scale not seen since the early 1990s. And that means
over the next 12 months, finance directors all over the country will have no
choice but to throw in the towel and make that unforgettable, unpleasant,
fateful call to the receivers.

Many FDs will know that the writing is already on the wall, legible at least
to them if not to others in the organisation. Company advisers, in particular
bankers and auditors, will also already be in on the soon-to-emerge secret.
Before many of those companies sadly fail, they will be preparing audited
year-end accounts.

While the results in this reporting round may appear satisfactory-to-all
right, most eyes are going to be on the next 12 months. So as we enter a
recession, ‘going concern’ is the key financial reporting issue dominating
discussions between financial directors and auditors in the upcoming audit
season.

Auditors, fearing the consequence in terms of litigation for not setting out
going concern fears, will be keen for the warning to be placed into the accounts
(usually in the directors’ report with the audit report drawing attention to the
words) while the company itself will be careful not to create a trigger event
which could be the start of the confidence- and morale-sapping process ­ almost
inevitably turning into a self-fulfilling prophecy of corporate failure.

Talk to finance directors and auditors about this issue and, as one FD says:
“Last year this would have been a side issue. Now it is potentially a
show-stopper.” Already the auditor/FD conversations have started and the
tensions are brewing. An FD for a private-equity backed group with a March
year-end described how his audit process was going well until, as he put it,
“the auditors started dragging their feet”. In fact, the feet-dragging went on
so long that deadlines were put in danger.

Auditors may reject the feet-dragging idea, but there is no doubt they are
going to be extremely vigilant this year and will expect the directors to show
the same attention reflecting the fact that, compared with the last few annual
audits, this one will be conducted against a radically different business and
economic climate.

Auditors will be focused on ensuring they understand the company’s bank
facilities, the renewal terms and how close the business is to breaching the
facilities. They will be expecting finance directors to show a strong grip over
the financial management of the company and for this to be most evident in the
planning and forecasting.

FDs can expect drawn-out discussions over cashflow and working capital
forecasts in particular, as well (to a lesser extent) on the forecast profit and
loss account, writedowns and impairments. But this will not be one set of black
and white numbers: companies should be looking at stress-testing their numbers,
looking how the cash increases, or more likely decreases, under various ‘what
ifs’.

But while it is tempting to think this is the time for FDs to concentrate on
the numbers they should try and retain their holistic view of the business.
While they cannot control a general economic downturn, they can ensure their
company is in the best place possible to withstand the shocks. And this means in
the stress-testing and scenario-planning that FDs should be looking beyond the
corporate boundaries and into the physical and financial supply chain. What is
the strength of the customer base? Is that overleveraged, or in any other way
vulnerable? And what about suppliers: how would your business cope if normal
service broke down?

While these scenarios are played out, it should be borne in mind that going
concern is an expression of the accounting basis on which the directors prepare
the accounts, which assumes that the business will carry on for the foreseeable
future. The audit should not be turned into a solvency review nor valuing assets
and liabilities at fire-sale prices.

Instead, the audit is there to check the directors’ assessment is reasonable.
And that assessment should be helped by the work of the audit committee. The
role of the audit committee is one interesting corporate governance twist to the
going concern issue that has not been in play in previous recessions.

How audit committees will work with FDs and auditors remains to be seen. FDs
will be hoping they support and maybe even defend the figures they present.
Auditors, on the other hand, will be looking to the audit committee to fight
with them for transparency in the disclosures on going concern and material
uncertainties in the annual statement.

What no one can forecast is the sort of twists and turns and cataclysmic
events that we’ve seen in the finance sector. If there is a complete loss of
confidence in a sector after the accounts have been signed off then in hindsight
both FD and auditor could look foolish. As one FD said: “It’s going to be a
tough season.” FDs and their financial management competency are set to be
tested to breaking point.