What’s the issue?
External events – e.g. a natural disaster, geopolitical affairs or pandemic – may cause economic conditions to deteriorate significantly and create economic uncertainty for many companies. Management needs to assess whether these events or conditions, either individually or collectively, may cast significant doubt on the company’s ability to continue as a going concern or, in severe cases, whether the going concern assumption is still appropriate as a basis for the preparation of the company’s financial statements.
Although some sectors and jurisdictions are more affected than others, all companies need to consider the potential implications for the going concern assessment.
When companies prepare their year-end financial statements1 under IFRS® Standards, disclosures around going concern are especially important to achieve transparency and provide users with relevant information.
External events that create economic uncertainty may have a significant impact on a company’s ability to continue as a going concern and might require robust assessment and entity-specific disclosures.
Getting into more detail
Management is required to assess a company’s ability to continue as a going concern. A company is no longer a going concern if management either intends to liquidate the company or cease trading, or has no realistic alternative but to do so. [IAS 1.25]
In assessing whether the going concern assumption is appropriate, management assesses all available information about the future, considering the possible outcomes of events and changes in conditions and the realistically possible responses that are available to such events and conditions.
In times of rapidly changing economic and business conditions, the period for which management takes into account all available information about the future may need to be extended beyond the minimum specified in IAS 1 Presentation of Financial Statements (which is at least, but not limited to, 12 months from the reporting date). This will depend on the company’s specific facts and circumstances. [IAS 1.26]
It is important that management’s assessment considers different scenarios, including at least one severe but plausible downside scenario. The assumptions used in the going concern assessment should be consistent with those used in other areas of the company’s financial statements.
Revising budgets and forecasts
Previously prepared budgets may be of limited relevance when economic and business conditions are changing rapidly. They may require significant revision – e.g. for forecast sales, gross margins and changes in working capital – to be able to support management’s assessment in the unpredictable environment. After updating the forecasts, management will need to assess whether it expects to remain in compliance with financial covenants.
In times of economic uncertainty, it will be critical for management to assess what impacts the events and conditions have on a company’s operations and forecast cash flows, with the key issue being whether a company will have sufficient liquidity to continue to meet its obligations as they fall due.
For example, a company may need to consider whether:
- it has sufficient cash and unused credit lines/borrowing facilities to meet short-term needs;
- further actions are needed by management to enable the company to generate sufficient cash flows to meet its obligations when they fall due;
- it needs to negotiate with lenders to restructure and/or increase borrowing facilities;
- to restructure operations to reduce operating costs;
- to defer capital expenditure; or
- to seek financial support from shareholders and/or government programmes designed to support businesses.
Management should reassess the availability of financing because it may not be easily replaced and the costs may be higher in the current circumstances.
- Borrowers with weaker credit ratings may find it more difficult to access bond markets, and may find banks and other lenders less willing to renew or increase borrowing facilities.
- Lenders may demand new terms, such as significantly higher yields or improved collateral, particularly for companies in highly exposed sectors.
- Lenders themselves may be experiencing liquidity issues and may need central bank assistance to be able to continue to provide, or increase, financing.
- Borrowers with foreign currency-denominated debt may find that debt servicing costs increase significantly due to the depreciation of their local currency.
- Covenants in loan agreements may provide lenders with an opportunity to withdraw financing.
It is important for companies to consider not only traditional sources of financing but also other sources – e.g. supply chain financing and/or reverse factoring.
If, after the reporting date, management concludes that the consequences of an external event have led to a further deterioration in operating results and financial position that is so severe that the going concern assumption is no longer appropriate, then the financial statements would need to be adjusted – i.e. a change in the going concern assumption is considered an adjusting event. [IAS 10.14–16]
In times of economic uncertainty, going concern disclosures are more likely to be considered necessary.
It is important that disclosures on going concern are clear and robust to meet users’ and regulators’ expectations. The level of detail of disclosures will depend on the company’s specific facts and circumstances, including the nature and extent of impacts on the company.
Material uncertainty scenario
While assessing the appropriateness of the going concern assumption, if management is 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, then the company should disclose those uncertainties. In our view, if there are such material uncertainties then a company should, at a minimum, disclose the following information:
- 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;
- significant judgements made by management in their going concern assessment, including their determination of whether there are material uncertainties; and
- 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. [IAS 1.25, IU 07-10]
In our experience, if there are such material uncertainties then a company usually provides disclosure as part of the basis of preparation note in the financial statements.
In some cases, management may conclude 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. However, reaching that conclusion involved significant judgement. In these cases, the judgements made in concluding that there are no such material uncertainties are disclosed (a ‘close-call’ scenario). To meet these disclosure requirements, in our view similar information to that in respect of material uncertainties (as outlined in the first three bullet points above) may be relevant to the users’ understanding of the entity’s financial statements. [IAS 1.122, IU 07-14]
Liquidity risk disclosures
IFRS 7 Financial Instruments: Disclosures requires disclosure of quantitative data about liquidity risk arising from financial instruments. A company also needs to explain how it is managing this risk, including any changes from the previous period and any concentrations of liquidity risk. Disclosures addressing these requirements may need to be expanded, with added focus on the company’s response to the impact of external events. [IFRS 7.33]
Examples of specific disclosures required include:
- an explanation of how a company manages liquidity risk; and
- disclosures of defaults and breaches relating to the borrowings recognised during and at the end of the reporting period. [IFRS 7.18–19, 39(c)].
See our Guide to annual financial statements – COVID-19 supplement, which illustrates possible examples of going concern and liquidity risk disclosures.
Actions for management
- Update forecasts and sensitivities, as considered appropriate, taking into account the risk factors identified and the different possible outcomes. It is important to consider at least one severe but plausible downside scenario.
- Review projected covenant compliance in different scenarios.
- Assess its plans to mitigate events or conditions that may cast significant doubt on the company’s ability to continue as a going concern. In particular, management would be expected to reassess the availability of financing. The company needs to assess whether its plans are achievable and realistic.
- Provide clear and robust disclosures, including disclosures about uncertainties identified in the going concern assessment where relevant.
- Consider relevant regulatory guidance.
1 The considerations included in this article will also apply to interim financial statements. For more information see our article What is the impact of external events on interim financial statements?
References to ‘Insights’ mean our publication Insights into IFRS®
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