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FRC reaches compromise rather than consensus over going concern

AFTER two years, three consultations and countless disagreements between investors, directors, accountants and regulators, the FRC’s much anticipated guidance on going concern owes more to compromise than consensus.

Given the vested interest in its outcome, the reporting watchdog’s final position on going concern – the original recommendations of which were published by Lord Sharman in 2012 – was always going to lend itself to reconciling the views of investors and directors. And, though the final document is far from perfect in the eyes of some, the FRC has settled on a position that most can accept.

Under the rules, directors must give shareholders a more detailed account of the potential risks facing their companies over a longer timescale, with greater emphasis placed on the steps taken to mitigate those risks.

For instance, boards will be required to include a ‘viability statement’ in the strategic report to investors that will provide a broader assessment of long-term solvency and liquidity over the next year, although It is expected that this statement will look forward significantly longer than 12 months.

“Recognising the different circumstances for business, companies are allowed to choose the period over which they look forward but we are clear this should be more than a year and reflect the nature of the business,” says Stephen Haddrill, CEO of the FRC.

Substantial disagreement

The inclusion of the viability statement alongside a separate statement relating to the accounting basis assessment of going concern – and the timescale the statements will cover – proved a thorny issue. By the FRC’s own admission this section “provoked the most comments and disagreement between respondents”.

“Some respondents wished to continue to have a single statement about viability, but there was a substantial disagreement about what this statement should cover,” the FRC said in its feedback statement.

The disagreement – largely between investors and corporates – centres on the need for companies to publish a ‘viability statement’ in the strategic report which will look ahead “significantly longer than 12 months”. Investors feel this doesn’t go far enough while directors argue that they are being forced to guesstimate how long their businesses will be able to continue as a going concern beyond the generally agreed accounting principle of 12 months.

“The future is inherently uncertain and companies do not have crystal balls. Although investors would like companies to provide them with certainty about their future prospects, this is often not realistic,” says an Institute of Directors (IoD) corporate governance adviser Oliver Parry.

Investors such as Iain Richards, head of governance and responsible investment at Threadneedle and an outspoken critic of the FRC’s earlier guidance, are not wholly satisfied. Although Richards agrees the guidance represents “an improved version of assessment for going concern” arguably the substance of investors’ concerns and feedback has effectively not been taken on board or recognised.

Indeed, a group of top investors including Royal London Asset Management (RLAM), Legal & General Investment Management (LGIM) and the Local Authority Pension Fund Forum (LAPFF), accused the regulator of “perversely” proposing changes to the longer-term viability statement that “run contrary” to the aims of the Sharman Review.

“Ensuring that directors of a company make a positive assertion to those providing capital about the business’s solvency is surely the least one might expect. However, the FRC’s proposal to amend the going concern statement has stirred up heated debate, with directors and audit firms arguing that it is not reasonable to expect them to offer a commitment on the future solvency of the business,” they said in a letter published in the Financial Times during the third consultation.

“We disagree with the FRC proposal. The directors’ obligations – and ultimately their accountability – to shareholders, revolve around just this commitment.”

Challenge for boards

But what does this mean for directors in practice? For one, companies can choose where to put the risk and viability disclosures. If placed in the Strategic Report, directors will be covered by the “safe harbour” provisions in the Companies Act 2006.

Richards says he likes the concept of safe harbour – a legal provision to reduce or eliminate liability as long as good faith is demonstrated – but adds that directors must make sure what they have to say is “robust”.

Companies will also need to monitor their risk management and internal control systems and, at least annually, carry out a review of their effectiveness, and report on that review in the annual report.

Implementing the new guidance could present “really big challenges for boards” according to ICAEW, such as “working out what they need to change in their risk management and reporting to satisfy the new guidance,” says Robert Hodgkinson, executive director at the institute.

Just as importantly, will it be helpful? The certainty that many investors are looking for may still elude them, even under these revisions. It will be hard for many to avoid the lure of looking over at competitors to see what predictions they are making.

“The concern is to what extent they will allow this to influence their own forecasts. Will boards feel that they need to somehow match or better the estimates of others on the basis of the influence that it could have on the investment community? Or will investors question the legitimacy of lengthy projections, and dismiss those extended beyond a particular time period as mere conjecture?” explains Roger Barker, director of corporate governance and professional standards at the IoD.

The greatest likelihood is the majority will hold sway and hopefully good judgment will carry the day. There is too much volatility in world markets for predictions more than 12 months hence to be anything other than guesswork, experts suggest.

The notes that accompany the going concern will be of interest, and investors will no doubt want to read details of a company’s long-term plans to raise capital, its investment strategy and future plans.

All in all, however, Barker believes this attempt to look beyond the horizon is simply going to stretch credibility too far. “We can only hope that common sense will prevail,” he says.

Going concern, risk management and internal control
> Companies should state whether they consider it appropriate to adopt the going concern basis of accounting and identify any material uncertainties to their ability to continue to do so;
> Companies should robustly assess their principal risks and explain how they are being managed or mitigated;
> Companies should state whether they believe they will be able to continue in operation and meet their liabilities taking account of their current position and principal risks, and specify the period covered by this statement and why they consider it appropriate. It is expected that the period assessed will be significantly longer than 12 months; and
> Companies should monitor their risk management and internal control systems and, at least annually, carry out a review of their effectiveness, and report on that review in the annual report.
> Companies can choose where to put the risk and viability disclosures. If placed in the Strategic Report, directors will be covered by the “safe harbour” provisions in the Companies Act 2006.

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