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FRC guidance on ‘going concern’ focuses on directors’ roles

Given the current economic climate, the
Financial
Reporting Council
wants to ensure its guidance on how directors
report on the ‘going concern’ principle is still robust enough to satisfy
regulators and investors. As a result, it has published a consultation paper
setting out proposals for its revision.

Currently, the Listing Rules of the
Financial Services
Authority
require the annual reports of listed companies to include a
statement by the directors on the going concern status of the company. But the
regulator believes the guidance ­ published in 1994 ­ needs updating to keep in
line with corporate reporting requirements and best practice.

Directors at present can reach three conclusions on a going concern:

  • Directors have a reasonable expectation that the company will continue in
    operational existence for the foreseeable future and have, therefore, used the
    going concern basis in preparing the financial statements;
  • Directors have a reasonable expectation that the company will continue in
    operational existence for the foreseeable future and have, therefore, used the
    going concern basis in preparing the financial statements;
  • Directors have identified factors which cast doubt on the ability of the
    company to continue in operational existence for the foreseeable future, but
    they consider that it is appropriate to use the going concern basis in preparing
    the financial statements; and
  • Directors consider that the company is unlikely to continue in operational
    existence for the foreseeable future and, therefore, the going concern basis is
    not an appropriate one on which to draw up the financial statements.

But the FRC has proposed adding a fourth, which states that “directors have
identified material uncertainties that may cast significant doubt about the
ability of the company to continue as a going concern and so need to make
additional disclosures.”

However, there are fears that more extensive disclosures could unsettle
investors. John Pierce, chief executive of business lobby group the
Quoted
Companies Alliance
, says, “We’re wary about rushing on such a key
area. We are studying it to determine whether it means a change in substance or
in form. If substance, then it could have all sorts of unintended consequences
and perhaps precipitate the demise of a business that, without veiled warnings,
could pull through.”

Updating the rules
The FRC has said it does not consider the changes to be a new departure and says
they largely represent updates to accounting rules made since the guidance was
first drawn up almost 15 years ago.

But some experts have questioned the need for a fourth category in the
updated guidance. Steve Priddy, director of technical policy and research at the
Association of Chartered Certified Accountants, says it is not clear why the FRC
has developed a fourth option when “it could just use the new tougher language
and replace the middle one.”

The FRC intends to publish a summary of key comments received and its plan
for revision during December 2008 to help boards understand how the Guidance for
Directors may be amended. The consultation period ends on 24 November.

More changes
But the additional conclusion on going concern is not the only substantial
change in the consultation paper. Other changes relate to greater disclosure,
prompted by the apparent failure of many organisations ­ particularly those in
the financial services sector ­ to alert investors or regulators about the state
of their organisations’ finances.

The FRC’s consultation paper says that:

  • Directors should make an explicit written statement in their annual report
    that they are satisfied that the going concern assumption remains appropriate;
  • Directors should say if the period they have reviewed in making their going
    concern assessment isn’t at least 12 months beyond the date they approved the
    financial statements;
  • Auditors should assign a qualified report if they are unable to obtain all
    the information and explanations which they consider necessary for the purpose
    of their audit, especially if the period is less than 12 months;
  • Any potential deficits, arrears or breaches should be discussed with the
    company’s bankers to determine whether any action is needed. The onus is on the
    directors to be satisfied that there are likely to be appropriate and committed
    financing arrangements in place. The FRC points out that IFRS 7 Financial
    Instruments: Disclosures requires disclosure to be made of defaults on
    borrowings and certain breaches of covenants. It also requires directors to
    disclose what financial risks they face and their objectives, policies and
    processes for managing these risks; and
  • The going concern statements should be included in the Business Review
    section of the directors’ report, which lets members of the company assess how
    the directors have performed their duty to promote the company’s success.

While the guidance is primarily intended for directors of listed companies,
the directors of AIM companies, PLUS-quoted companies, large private companies
and public interest entities may wish to adopt appropriate procedures to comply
with best practice.

Gerard Cranley, a partner at law firm
Howard
Kennedy
, says the FRC is not trying to impose any further duties on
directors. “The regulator just wants more disclosure on the actions that
directors are already taking.

The credit crunch has highlighted investor concerns over the level and
timeliness of directors’ disclosures about the financial risks and exposure that
their companies are facing, particularly as banks are now less likely to lend
funds,” Cranley says. “The FRC is trying to tackle these issues, but businesses
do have some concerns about whether these changes are being made too quickly or
unnecessarily.”

Useful links
The
Consultation
Paper
can be downloaded from the FRC’s website

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