Management’s assessment of going concern is in the spotlight because of COVID-19 and uncertainties involved.
From the IFRS Institute – December 4, 2020
The going concern presumption – i.e. that the company will be able to meet its obligations when they become due – is fundamental to financial reporting. With the timing of the economic recovery from COVID-19 yet unknown, this year many companies may need to approach their going concern assessment differently. There is typically heightened sensitivity around this assessment and required disclosures. Here we provide an overview of the going concern requirements of IFRS Standards, and summarize key differences between IAS 11 and ASC 205-402.
Going concern – the underlying basis of financial statements
Under IFRS Standards, financial statements are prepared on a going concern basis, unless management intends or has no realistic alternative other than to liquidate the company or stop trading. Unlike US GAAP, there is no liquidation basis of accounting under IFRS; when a company determines it is no longer a going concern, it does not prepare financial statements on a going concern basis. However, in our view, there is no general dispensation from the measurement, recognition and disclosure requirements of the Standards in this case, and these requirements are applied in a manner appropriate to the circumstances.
When management becomes aware of material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, those uncertainties must be disclosed in the financial statements. The terms ‘material uncertainties’ and ‘significant doubt’ are important – this standard phrasing is expected to be used in the basis of preparation note to the financial statements.
Further, even if management concludes that there are no material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, but reaching that conclusion involves significant judgement – i.e. a 'close-call’ scenario, disclosure of the judgements made is required3.
Similarly, US GAAP financial statements are prepared on a going concern basis unless liquidation is imminent. Disclosures are required if events and circumstances raise substantial doubt about the entity’s ability to continue as a going concern. Although the terminology varies slightly, both GAAPs share the same objective of informing users of the financial statements early about the company’s potential financial difficulties.
A robust framework under US GAAP vs limited guidance under IFRS Standards
While US GAAP has extensive guidance around going concern, IFRS Standards do not. The following table summarizes the five key areas of the going concern assessment that we believe are most important for management. We expand on each of these areas further below.
| Key area | IFRS Standards application | US GAAP comparison |
|---|---|---|
| 1. How to perform the assessment | IFRS Standards do not prescribe a method to perform the going concern assessment. | US GAAP includes a detailed two-step process that requires determining whether it is probable the company will be unable to meet its obligations over the ‘look-forward period’. |
2. Time period to assess (the look-forward period) | Assessment is performed for a period of at least, but not limited to, 12 months from the reporting date (i.e. the balance sheet date). The period may need to be expanded depending on the company’s specific facts and circumstances. | Assessment is performed for a period of 12 months from the date the financial statements are issued (or available to be issued). |
| 3. Events and conditions to consider in the assessment | Management assesses all available information about the future. This includes information that becomes available on or before the financial statements are authorized for issuance – i.e. events or conditions requiring disclosure may arise after the reporting period. | Under Step 1, management determines whether events and conditions raise substantial doubt about the company’s ability to continue as a going concern. US GAAP includes examples of such adverse events and conditions. This includes information known or reasonably knowable at the date the financial statements are issued (or available to be issued). |
| 4. Management’s plans | Management’s plans are typically factored into the overall assessment. IAS 1 is silent on which management plans can be considered in the assessment. | Management’s plans are ignored under Step 1, but considered under Step 2, to determine if they alleviate the substantial doubt raised in Step 1. US GAAP requires management’s plans to meet certain conditions to be considered in the assessment. |
| 5. Disclosure triggers and requirements | When management concludes that there are no material uncertainties that may cast significant doubt on a company’s ability to continue as a going concern, but reaching that conclusion involved significant judgment, disclosure of the judgments is required. | Disclosures are required as soon as substantial doubt is raised, even if alleviated by management’s plans. |
| When material uncertainties may cast significant doubt on a company’s ability to continue as a going concern, disclosure of those uncertainties is required. | When substantial doubt exists (i.e. is not alleviated by management’s plans), disclosures are more prescriptive. |
1. How to perform the assessment
IFRS Standards do not prescribe how management performs the going concern assessment. IAS 1 only states that when a company has a history of profitable operations and ready access to financial resources, management may reach a conclusion on the appropriateness of the going concern assessment without detailed analysis. It follows that when this is not the case, a detailed analysis will be necessary, which likely includes robust cash flow forecasts and a review of existing and forthcoming financial obligations. The assessment typically requires significant judgment.
COVID-19 impact on the assessment.
Management’s going concern assessment may be significantly affected by the current economic environment. For example, a company may have a profitable track record or prior success at refinancing. However, market conditions have changed as a result of COVID-19 – e.g. financing may be significantly more difficult and more costly to obtain now. Therefore, historical trends may not indicate present and future conditions. When building forecasts or looking at management’s plans and realistically possible responses, management may need to consider different forecasting scenarios and perform more robust sensitivity analyses than previously to determine whether there are material uncertainties about the company’s ability to continue as a going concern.
US GAAP comparison
US GAAP includes a two-step process that first determines whether substantial doubt about the company’s ability to continue as a going concern is raised. If substantial doubt is raised, management then assesses whether that substantial doubt is alleviated by management’s plans. Unlike IFRS Standards, if substantial doubt is raised in Step 1 about the company’s ability to continue as a going concern, the extent of disclosure depends on the outcome of Step 2 and whether that doubt is alleviated by management’s plans. See our US GAAP Handbook, Going concern.
2. Time period to assess (the look-forward period)
Management assesses all available information about the future for at least, but not limited to, 12 months from the reporting date. This means the 12-month period is a minimum and management needs to exercise judgment to determine the appropriate look-forward period under the circumstances. Factors to consider include when the financial statements are authorized for issuance and whether there is any known event occurring after the minimum period of 12 months from the reporting date relevant to the analysis.
For example, the look-forward period for a company with a December 31, 20X0 reporting date is at least the 12 months ended December 31, 20X1, but it may need to be extended depending on the facts and circumstances. For example, if the company expects to lose a major customer in 15 months from the reporting date, it may be necessary to extend the look-forward period up to at least March 31, 20X2.
COVID-19 impact on the assessment
Impacts from a fall and winter COVID-19 surge may bring further uncertainty to many companies. Management should continually evaluate the effects of COVID-19 on the company’s going concern assessment, including information obtained after the reporting date and up to the date the financial statements are authorized for issuance.
US GAAP comparison
Unlike IFRS Standards, the going concern assessment is performed for a finite period of 12 months from the date the financial statements are issued (or available to be issued for nonpublic entities). Known or knowable events beyond the look-forward period can be ignored in the going concern assessment, although disclosure of their potential effects may still be required by other standards.
For example, under US GAAP, the look-forward period for a company with a December 31, 20X0 balance sheet date and financial statements issued on March 31, 20X1 is the 12-month period ended March 31, 20X2.
3. Events and conditions to consider in the assessment
Under IFRS Standards, management assesses all available information about the future, considering the possible outcomes of events and changes in conditions, and the realistically possible responses to such events and conditions. Events or conditions arising after the reporting date but before the financial statements are authorized for issuance should be considered. IAS 1 states that management may need to consider a wide range of factors, including current and forecasted profitability, debt maturities and replacement financing options before satisfying its going concern assessment.
Further, under IFRS Standards, if the company ceases to be a going concern after the reporting date but before its financial statements are authorized for issuance, IAS 104 requires a change in the basis of accounting, as opposed to adjustments to the amounts recognized under the going concern basis of accounting.
COVID-19 impact on the assessment
The effects of COVID-19 are negatively affecting many companies’ financial performance and liquidity in some way. Management will need to monitor the expected impacts on operations, forecasted cash flows, and debt covenants, with the primary focus being on whether the company will have sufficient liquidity to meet its financial obligations as they fall due.
US GAAP comparison
Unlike IFRS Standards, US GAAP includes examples of events and conditions that may adversely affect a company’s ability to meet its financial obligations, and therefore raise substantial doubt about its ability to continue as a going concern. These examples include effects such as negative financial trends, negative cash flows from operating activities, default on loans, denial of usual trade credit from suppliers, work stoppages and external matters such as legal proceedings.5
Although US GAAP is more prescriptive than IFRS Standards, we do not expect significant differences in the types of events or conditions management would consider when assessing going concern under both GAAPs.
Further, under US GAAP, the liquidation basis of accounting6 applies only from the point that liquidation becomes imminent. If liquidation becomes imminent after the reporting date but before the financial statements are issued (or available to be issued), the financial statements would still be prepared under the going concern basis; the fact that liquidation is imminent would be disclosed.7
4. Management’s plans
Management typically develops plans to address going concern uncertainties – e.g. refinancing of debt, renegotiating breached covenants, and sale of assets to generate sufficient liquidity to continue to meet its obligations as they fall due. IFRS Standards do not prescribe how management should evaluate its plans to mitigate the effects of these events or conditions in the going concern assessment.
COVID-19 impact on the assessment
Management may have a history of successful refinancing or carrying out other plans. However, current economic and market conditions are likely very different from those of the past. Given the significant effects of COVID-19, management may need to reassess the company’s access to financing sources; they may not be easily replaced and the costs may be higher in the current circumstances. Further, other actions such as deferring capital expenditures or adjusting the workforce may be needed to generate enough cash flow to meet the company’s financial obligations.
US GAAP comparison
Under US GAAP, management’s plans are ignored under Step 1 of the going concern assessment. Their mitigating effect is considered under Step 2 to determine if they alleviate the substantial doubt raised in Step 1, but only if certain conditions are met. This means management needs to run two sets of forecasts, before and after management’s plans, whereas IFRS Standards are not prescriptive in this regard.
Under US GAAP, plans must be approved before the financial statements are issued (or available to be issued), and management needs to demonstrate that it is probable the plans will be timely and successfully implemented, mitigating the conditions and events that raised the substantial doubt.
Although US GAAP is more prescriptive than IFRS Standards, we would also expect under IFRS Standards that management plans are achievable and realistic, timely and sufficient to address the going concern uncertainties.
5. Disclosure triggers and requirements
Disclosure of material uncertainties related to events or conditions that may cast significant doubt on a company’s ability to continue as a going concern are required. In our view, if there are such material uncertainties, a company should disclose the following, at a minimum:
In our experience, if there are such material uncertainties, then the company usually provides disclosure as part of the basis of preparation note in the financial statements.
Even if management concludes that there are no material uncertainties related to events or conditions that may cast significant doubt on a company’s ability to continue as a going concern, however, reaching that conclusion involved significant judgment (i.e. a close-call scenario)3, disclosure of the judgments is required. To meet these disclosure requirements, in our view, similar information to that in respect of material uncertainties may be relevant to the users’ understanding of the company’s financial statements, as appropriate.
While IFRS Standards do not provide guidance on the placement of disclosure in a close-call scenario, in our experience such disclosure may be provided as part of the basis of preparation note or elsewhere in the financial statements. It may be provided in a single note or in multiple notes. However, we believe that the information disclosed in a close-call scenario should be appropriately cross-referenced to the note discussing significant judgements.8
The assumptions used in the going concern assessment should be consistent with those used in other areas of the company’s financial statements, for example impairment of assets, liquidity risk disclosures, etc.
COVID-19 impact on the assessment
Disclosures of material uncertainties that may cast doubt on a company’s ability to continue as a going concern as well as significant judgments involved in close-call scenarios may be more frequent as a result of COVID-19, given the continued economic uncertainty. Management should critically assess the disclosure requirements of IAS 1 and consider drafting required disclosure language early in the financial reporting process.
In addition to IAS 1, IFRS 79 requires disclosure of information about the significance of financial instruments to a company, and the nature and extent of risks arising from those financial instruments, both in qualitative and quantitative terms. Disclosures addressing these requirements may need to be expanded, with added focus on the company’s response to the effects of COVID-19.
US GAAP comparison There are two types of disclosures under ASC 205-40. | |
|---|---|
| Substantial doubt is raised but alleviated by management’s plans | Substantial doubt exists (i.e. it is not alleviated by management’s plans) |
| Disclose principal conditions or events that raise substantial doubt (before consideration of management’s plans) | Disclose principal conditions or events that raise substantial doubt |
| Disclose management’s evaluation of the significance of those conditions or events in relation to the company’s ability to meet its obligations | |
| Disclose management’s plans that alleviated substantial doubt | Disclose management’s plans intended to alleviate substantial doubt |
| No statement that substantial doubt was raised is required | Include an explicit statement in the notes that indicates there is substantial doubt |
The takeaway
The going concern assessment is inherently complex and judgmental and will be under heightened scrutiny for many companies this year due to COVID-19. Management should carefully consider the requirements of IFRS Standards and reevaluate their historical approach to the going concern analysis; it may no longer be sufficient given the current economic environment.
Because the US GAAP guidance is more developed in this area, it may provide certain useful reference points for IFRS Standards preparers – e.g. to identify adverse conditions and events or to assess the mitigating effects of management’s plans. However, dual reporters should be mindful of the differing frameworks, terminologies and potentially different outcomes in their going concern conclusions. The timing and extent of disclosures may also differ. Our IFRS Standards resources will help you to better understand the potential accounting and disclosure implications of COVID-19 for your company, and the actions management can take now.
Dual reporters may also wish to consider our US GAAP Handbook, Going concern.
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