COVID-19 Financial reporting: Going concern COVID-19 Financial reporting: Going concern COVID-19 Financial reporting: Going concern

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FINANCIAL RESILIENCE

Most organisations are being impacted by the coronavirus (COVID-19) pandemic, either directly or indirectly, and the increased economic uncertainty and risk may have significant financial reporting implications.

The coronavirus (COVID-19) outbreak has caused significant deterioration in economic conditions for some organisations and an increase in economic uncertainty for others. Management needs to assess whether these events or conditions, either individually or collectively, cast significant doubt on the organisation’s ability to continue as a going concern and, in severe cases, whether the going concern assumption is still appropriate as a basis for the preparation of the financial statements.

When assessing an organisation's ability to continue as a going concern, management will need to consider the expected impact of the current economic uncertainty and market volatility caused by COVID-19.

When assessing an organisation’s ability to continue as a going concern, management may need to do the following:

• Update forecasts and sensitivities, as considered appropriate, taking into account the risk factors identified and the different possible outcomes. It is important to consider downside scenarios, e.g. taking into account the impacts of lockdown restrictions potentially being tightened again, where relevant.
• Review projected covenant compliance in different scenarios.
• Assess its plans to mitigate events or conditions that may cast significant doubt on the organisation’s ability to continue as a going concern. In particular, management would be expected to reassess the availability of finance. The organisation needs to assess whether its plans are achievable and realistic.

• Does management have to assess the organisation’s ability to continue as a going concern?
• Under what circumstances might an entity need to prepare a detailed analysis to support the going concern assumption?
• What information should management include in their assessment of going concern?
  
• What is the impact on the going concern assumption if significant deterioration has occurred since reporting date?
  
• When does an organisation include information about the assumptions supporting the going concern basis?
  
• Where significant judgements were involved in concluding that the going concern assumption is appropriate, what are examples of information that may be included in the going concern disclosure?
  

Yes, under Australian Accounting Standards, management are required to assess an organisation’s ability to continue as a going concern. Most organisations probably have never performed this analysis previously as this assumption was readily met based on historical, current and forecasted performance.

Given the uncertainty caused by the pandemic, it is likely that some organisations, in particular those in vulnerable industries, will have to model different scenarios before being able to conclude that the going assumption is appropriate. An organisation or entity is no longer a going concern if management either intends to liquidate the entity or cease trading, or have no realistic alternative but to do so.

Management may need to prepare an analysis of whether it will have sufficient liquidity to continue to meet its obligations as they fall due to support its going concern assessment if, for example, a number of the following indicators are present:

a. Revenue or profitability indicators

• It operates in a highly exposed sector and has experienced significant decrease in sales.
• It has experienced or is expected to experience significant supply chain disruptions which would impact its ability to continue with its operations.

b. Funding and liquidity indicators

• Major suppliers are exerting pressure for payments.
• Profitability has fallen and EBITDA may be insufficient to fund operating expenses and financing obligations.
• It has breached or is likely to breach its loan covenants and it is unlikely that they will be waived.
• Unsuccessful refinancing.
• Asset disposals are being contemplated to free up cash or eliminate losses.
• It has a net liability or net current liability position.
• It is relying on the Government stimulus packages to continue trading.

All relevant information available up to the date the financial statements are issued must be considered when assessing whether an organisation is a going concern. An entity should take into account all available information about the future, which generally is at least, but is not limited to, twelve months from the date the financial statements are issued.

Management assesses how the current events and conditions impact its operations, in particular, its revenue, expenses, funding and liquidity, with the key focus being whether it will have sufficient liquidity to continue to meet its obligations as they fall due.

Where events occurring after the reporting date cause a significant deterioration in economic conditions such that for some entities the going concern basis of preparation is no longer considered appropriate, the financial statements would need to be prepared on a non-going concern basis.

When significant judgments were involved in concluding that the going concern assumption is appropriate and that there are no material uncertainties then a company should at a minimum, disclose:

• details of events or conditions that may cast significant doubt on the company’s ability to continue as a going concern and management’s evaluation of their significance in relation to the going concern assessment
• management’s plans to mitigate the effects of these events or conditions; and
• significant judgments made by management in their going concern assessment, including their determination that there are no material uncertainties.

When the entity is aware of material uncertainties related to events or conditions that may cast significant doubt upon its ability to continue as a going concern, additional information on the details of those uncertainties must be included in the financial report.

In our view, an explicit statement that there is a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern, and therefore that it may be unable to realise its assets and discharge its liabilities in the normal course of business should also be made.

In our experience, a company usually provides such disclosure as part of the basis of preparation note in the financial statements.

An example of a possible going concern disclosure (in italics), including associated considerations (in [brackets]) is provided below.

COVID-19 and related measures to slow the spread of the virus have had a significant impact on the Australian and global economy, supply chains and financial markets, and resulted in increased levels of volatility and uncertainties. The effects of this health crisis are continuing to unfold and the ultimate extent of the economic impacts worldwide are unknown.

For the year ended [30 June 2021], COVID-19 has impacted the Group, specifically as follows: [Consider providing details of the following:

• Consequences on the operations of the Group, for example, if any parts of the business have shut down or been restructured.
• Impacts on the financial position of the Group, for example, if there is a negative working capital or net liability position, any breaches of debt covenants with associated consequences on timing of debt repayments, and outstanding capital commitments.
• Implications on the current period financial performance and cash flows (particularly operating cash flows).
• Details of financing facilities sought and now available at balance date, potentially to cover any working capital deficiency, including expiry periods and any significant requirements under the facility agreements i.e. debt covenants.
• Details of financial support received from parent entity and/or governments in Australia or overseas].

This information should be followed by a discussion of how the directors have concluded that the Group is a going concern. This could include information of their assumptions and inputs used in their modelling of cash flow forecasts and actions the organisation will be embarking to support the going concern assumption.

Illustrative example wording is provided below:

As of [insert date] 2021, the Group had net working capital [deficiency] of [$xxx], and undrawn capacity under its debt facilities of [$xxx] maturing in [insert details]. As of [balance date], the Group had capital commitments of [insert details].

The directors have prepared projected cash flow information for the [twelve months/longer] from the date of approval of these financial statements taking into consideration the estimation of the continued business impacts of COVID-19. In response to the uncertainty arising from this, the Directors have considered severe but plausible downside forecast scenarios.

These forecasts indicate that, taking account of reasonably possible downsides, the Group is expected to continue to operate, with headroom, within available cash levels and the terms of its debt facilities [or include details of expected risks of breaching terms]. Key to the forecasts are relevant assumptions regarding the business, business model, any legal or regulatory restrictions, financing and shareholder support, in particular: [insert details of scenarios and key assumptions made, the uncertainties attached to their execution, including any severe but plausible downside scenarios, such as:

• Description of the different scenarios modelled including length of government-imposed lockdowns and recovery periods, risks, conditions or dependencies for these to occur.
• Key assumptions related to customer actions and associated sales volumes, closure of operations in specific locations, key implications on supply chain and expected impacts of restructuring programs.
• Whether forecasts assume debt facilities remain available throughout the forecast period, and what actions are required to achieve this, e.g. renegotiation, waivers.
• Details of the results of the key scenario modelling on the entity’s ability to meet its obligations over the forecast period.
• Mitigating actions undertaken or planned by directors and group to manage and respond to cash flow uncertainties or potential risks of shortfall in financing and the implementation status and uncertainties that arise from them].

The directors remain focused on the Group’s liquidity, and expect to manage business operations in the forecast period whilst maintaining adequate liquidity through the execution of:
[insert details of management's plans to ensure going concern remains appropriate along with the uncertainties to their execution, for example:

• Anticipated refinancing of debt arrangements or sourcing new financing options, which require X actions/approvals/events to occur.
• Expectations associated with capital raisings, which require X actions/approvals/events to occur.
• Plans to divest significant assets or businesses, which require X actions/approvals/events to occur.
• Deferral or suspension of non-critical or discretionary operating and capital expenditure.
• Deferral or suspension of dividends.
• Possible diversification or repurposing of operations for alternate income sources, which require X actions/approvals/events to occur].

Based on these forecasts, the directors believe that it remains appropriate to prepare the financial statements on a going concern basis and have a reasonable expectation that the Group’s [details of key covenants i.e. debt to equity ratio, interest cover ratio] will comply with the requirements of the debt facilities during the next twelve months.