A timely reminder. Just as company directors and those involved in the financial reporting chain are beginning to prepare the 2008 annual reports, the Financial Reporting Council (FRC) last week issued: An Update for Directors of Listed Companies: Going Concern and Liquidity Risk (the "Update"). Directors should consider this note in light of the requirements of the UK Listing Rules, IFRS and GAAP to disclose in a company's financial statements if a company's going concern status is uncertain. Although aimed at directors of listed companies, directors of unlisted companies may also benefit from the content of the FRC's update.
CURRENT ECONOMIC CONDITIONS
The current economic conditions have led the FRC to publish the Update ahead of the results of its consultation on changes to the "Going concern and financial reporting: Guidance for directors of listed companies registered in the UK" first published in 1994 ("1994 Guidance").
The FRC cites the current global liquidity squeeze and its impact on the wider economy as increasing the challenges to directors in preparing 2008 annual reports. In particular, the Update brings together in one document the requirements of IFRS, UK GAAP, the Listing Rules, the 1994 Guidance and the Companies Act 2006 requirements for a business review to be included in annual reports for December 2008 year ends. The Update does not introduce any new requirements.
GOING CONCERN STATUS AND LIQUIDITY RISK
The Update highlights the responsibilities of directors, auditors, investors and lenders in preparing and reviewing disclosures. The use of the going concern basis of accounting is fundamental to the preparation of all UK companies' annual report and accounts.
The Update includes specific advice to directors and auditors when assessing and disclosing a company's ability to continue as a going concern. The requirement to assess going concern can be summarised as:
- Directors are required when preparing financial statements to assess the company's ability to continue as a going concern. The period considered should be at least 12 months from the end of the reporting period, however if less, a relevant disclosure should be made.
- If directors are aware of "material uncertainties related to events or conditions that may cast significant doubt upon the [company]'s ability to continue as a going concern, the [company] shall disclose these uncertainties" (IAS 1.25). Doubts about the ability of a company to remain a going concern does not necessarily mean the company is, or is likely to become, insolvent.
The FRC comments that the general economic situation does not itself necessarily means that material uncertainty exists about a company's ability to continue as a going concern. However, it is important that annual accounts contain appropriate disclosures of liquidity risk and uncertainties in order to give a true and fair view.
The FRC also notes that if a company's bank is refusing to give confirmation of the company's financial arrangements, this does not necessarily itself cast significant doubt upon the ability of the company to continue as a going concern, nor necessarily require auditors to refer to going concern in their report. With regard to bank finance, directors will have to consider carefully the position in light of the information available to them and the assumptions as to the future availability of finance. In a letter to the Financial Times, 5 December 2008 from Mr Michael Izza (Chief Executive, Institute of Chartered Accountants in England and Wales) and others, it was suggested that "limited access to borrowing facilities….where they affect a company's going concern status, need to be disclosed in an open and transparent way."
The Listing Rules require a company's annual report to contain a statement by the directors as to the ability of the company to continue as a going concern (with assumptions and qualifications as necessary). This statement must be prepared in accordance with the 1994 Guidance. In recent years, the specific accounting standards of IFRS and UK GAAP relating to disclosures of material uncertainties have been changed and these are set out in the Update. IFRS requires a specific disclosure if there is liquidity risk, that is a risk that the company will encounter difficulty in meeting its obligations associated with its financial liabilities (IAS 7). The FRC notes that this disclosure is likely to be relevant to many more companies this year.
The Companies Act 2006 requires a business review to be included in the directors' report section of the annual report for December 2008 year ends. The FRC notes that the directors will need to explain in the business review "the principal risks and uncertainties facing the company arising from the current economic conditions". The FRC suggests such risks and uncertainties may include:
- uncertainties about current financing arrangements and potential changes to such arrangements;
- risks to current credit arrangements (including insurance) with either customers or suppliers;
- a dependency on key suppliers and customers; and
- uncertainties posed by the potential impact of the economic outlook on business activities.
CONSULTATION PAPER AND STUDY INTO DISCLOSURES
In September 2008, 14 years on, the FRC launched a review of the 1994 Guidance and is in consultation with interested parties as to any changes that may be required. The FRC is seeking responses by mid-December 2008. It will then announce a draft of the changes by the end of the first quarter of 2009 and publish the revised guidance later on in 2009.
The FRC conducted a study of the disclosure of going concern status and liquidity risk in 30 annual reports for companies applying IFRS 7 (Financial Instruments: Disclosures) in December 2007 and March 2008. It has concluded that better disclosure is needed and the study recommends that disclosures are contained in one single section of the company's annual report rather than spread throughout the report and accounts. The single section would cover:
- the cash and borrowing positions and how liquidity risk is managed in practice;
- whether confirmation of the renewal of banking and other facilities has been sought and if so whether those confirmations have been obtained; and
- explain that going concern was appropriate and explain the basis of the condition.
The FRC papers referred to above can be found at www.frc.org.uk/press/pub1781.html.