As one of the many facets of the UK's response to the financial crisis, the Financial Reporting Council ("FRC") launched an inquiry earlier this year into the ways in which companies assess and report going concern and liquidity risks. The inquiry, which is being led by Lord Sharman, published a call for evidence last month.

Background

Under the UK and international financial reporting framework, directors are required to take a view as to whether it is appropriate to prepare the company's accounts on a going concern basis. Disclosures must also be made about issues which may affect the company's prospects of being able to continue as a going concern, and about liquidity risks (that is, risks concerning the company's ability to meet its obligations in relation to its financial liabilities).

The Sharman Inquiry stems from recommendations in the FRC's January 2011 discussion paper on effective company stewardship that:

  • directors should provide a more detailed account of the means by which they ensure that their management of the company is based on reliable information
  • audit committees should provide a more detailed account of the measures which they have taken in relation to ensuring the integrity of the annual report.

The FRC also envisages that the results of the inquiry will feed into the government's efforts to reform the narrative reporting regime, and one of the questions on which the inquiry is seeking views is whether the FRC's 2009 guidance for directors on going concern and liquidity risk should be amended.

The call for evidence

The scope of the inquiry is quite wide. It will address the role not only of directors (including audit committees), but also of auditors, and will look both at companies' internal assessment of risks and at the ways in which risks are reported. It is important to remember in this context that going concern assessments are relevant to companies of all sizes, and not just to listed companies.

The call for evidence is a short document, running to just three pages and comprising thirteen questions or sets of questions. Whilst some of the questions are designed to elicit information about how directors go about assessing going concern and liquidity risk issues, others ask for suggestions as to how the regime might be improved. Some of the questions go to the very heart of the current framework.

The list of questions includes the following:

  • what information do investors need in order to evaluate the going concern and liquidity risks facing the company?
  • do companies face any barriers to making full disclosure of going concern and liquidity risks?
  • how do directors go about assessing whether their company is a going concern?
  • is the current model of disclosure, which divides companies into three categories, suitable? (The three categories are: (i) going concern basis of accounting is appropriate, and there are no material uncertainties; (ii) going concern basis of accounting is appropriate, but there are material uncertainties; (iii) going concern basis of accounting is not appropriate.)
  • do auditors report to audit committees on their work in relation to going concern and liquidity risk?
  • could the FRC's 2009 guidance for directors on going concern and liquidity risk be improved?

Is it worth responding?

It is easy to take the view that there is no point in responding to inquiries such as this one, on the assumption that plenty of other companies will respond and that their feedback will be broadly sensible. The practical impact of regulators' efforts to learn the lessons from the financial crisis may well be considerable, however, and it is in companies' interests to do all they can to shape the debate. One way to do that is to contribute, where possible, to relevant consultations.

Responses to the Sharman Inquiry's call for evidence are invited until 30 June 2011, and the inquiry is expected to publish its recommendations by the end of 2011.