In January 2013, the Financial Reporting Council (FRC) consulted on how to implement the recommendations on the assessment of going concern which were set out in Lord Sharman's report: "Going Concern and Liquidity Risks" (Report). For further background on the Report and the FRC consultation, click here to read our article in the February corporate newsletter.
General support of principles but still lessons to be learnt
On 6 June 2013, the FRC announced that the majority of respondents supported the principles behind the recommendations of the Report. In support of the principles, the FRC will draw lessons from the responses to the consultation and develop its guidance by:
issuing separate and simplified guidance for small and medium-sized enterprises (SMEs),
clarifying the meaning of 'going concern'. The FRC had received feedback that the distinction between the purpose of going concern reporting to describe the specific assessment required when preparing the financial statements and the broader assessment of the risks affecting a company's viability caused confusion. The FRC will consult on whether changes to the UK Corporate Governance Code (Code) are required to make this distinction clearer and any required changes will take effect in October 2014, and
making a clearer link between the assessment of business viability risks in relation to the going concern assessment and the broader risk assessment that should form a part of a company's standard risk management and reporting processes.
The FRC expects to issue further consultation documents in the autumn which will cover SMEs and the proposed changes to the Code including guidance on integrated going concern and risk management.
Back to the drawing board?
The recommendations of the Report support the overarching principles of better transparency and reporting of companies, which have been broadly accepted by respondents. The FRC's proposed implementation of those recommendations, however, has triggered some criticism. In particular, the FRC has been forced to re-think its proposals on how SMEs approach their assessment of going concern, having provided in its consultation that the assessment is important to all companies but failing to specify exactly how the draft guidance should apply to SMEs. Certain respondents have highlighted that it would be disproportionate for the proposed new requirements to be applicable to SMEs, particularly those companies which are not subject to the Code. Consequently, we expect that stakeholders will welcome the FRC's new proposals to issue simplified guidance specifically for SMEs.
The dual purpose of the new going concern assessment has caused further controversy. In particular, there is confusion about the interaction between the two new limbs of assessment, being the broader "stewardship purpose", which is to provide information on the company's financial viability, and the narrower "financial reporting purpose", which is to establish the information about going concern needed for the financial statements to give a true and fair view. Certain respondents have argued that, under the new approach, it is possible for a company to conclude that it is not a going concern for stewardship purposes but it is a going concern for the purposes of financial reporting, which may be misleading to investors. Additionally, in an uncertain economic climate, it may be difficult for companies to conclude that they are a going concern under the "stewardship" test, unless the statement is mitigated with standard boilerplate disclosures, which is unlikely to be the intended outcome of the proposals. It will be interesting to see whether the FRC is able to address these concerns in the autumn, whilst meeting the key objectives of the Report.