COVID-19 shines spotlight on going concern statements

One of the many consequences of the continuing COVID-19 pandemic, is a growing spotlight on the fundamental accounting principle of going concern statements which is set to continue as 2021 unfolds. In this piece, the authors consider the impact of the pandemic on going concern statements, recent regulatory changes, as well as the steps being taken to ensure best practice and consistency in the role played by auditors.

COVID-19 impact

Investors and other stakeholders in capital markets rely on timely and accurate financial reporting. Companies and their auditors currently face unprecedented challenges in preparing and auditing financial information. Directors have a responsibility when preparing annual accounts to make an assessment of an entity's ability to continue as a going concern by taking into account all available information about the future, covering at least 12 months from the date on which the accounts are approved and signed-off by the directors.

In previous years this may have been a relatively straightforward exercise but the pandemic has resulted in challenging economic conditions for many businesses and an increase in uncertainty for companies and markets. Although some sectors and geographies are more impacted by this than others, all companies across all jurisdictions need to consider the potential implications this has for the going concern assessment.

The going concern is a fundamental accounting principle which assumes that any organisation will continue to operate its business for the foreseeable future, with every decision taken with the objective of continuing to run the business rather than liquidating it. Given the current environment, management needs to assess whether the operating conditions precipitated by COVID-19, create significant doubt around the company's ability to continue as a going concern. This has highlighted the importance of the going concern statement.

Current events and conditions may have a significant impact on a company's ability to continue as a going concern and therefore more than ever, robust and entity-specific disclosures will need to be provided.

Calls for consistency

With market conditions requiring a renewed focus on instilling best practice, it is important that management's assessment considers different scenarios, including at least one severe but possible downside scenario. It is crucial that the assumptions used in the going concern assessment are consistent with those used in other areas of the company's financial statements.

Audit best practice

Management are not the only ones with a role to play the new International Standard on Auditing (UK) 570 (ISA (UK) 570) requires auditors to challenge management's assessment of going concern more effectively and firms to be as transparent as possible amid uncertainty. ISA (UK) 570 sets out the auditor's responsibilities in ensuring fulsome and accurate going concern statement.

They are responsible for obtaining "sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management's use of the going concern basis of accounting in the preparation of the financial statements, and to conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity's ability to continue as a going concern."

In recent years, however, a number of high profile business failures, despite a clean bill of health on going concern statement from auditors, has raised questions over the role of the auditor, and variance in the processes and judgements applied to going concern statements, across the audit firm community.

In Q4 2020, the UK's Financial Reporting Council (FRC) conducted a review, finding that that audit firms have largely applied the recommended enhanced policies and procedures to support the accurate evaluation of companies' going concern assessments during the pandemic. The review follows updated guidance issued to companies and auditors by the FRC on related disclosures throughout the course of 2020.

The FRC review found that some firms had adopted more enhanced consultation of going concern statements prepared by company directors than others, such as technical panels. Economic scenarios had been tailored to the circumstances of the companies being audited and the use of reverse stress testing and consideration of other plausible but severe scenarios had helped the auditors' consideration of potential material uncertainties.

The review showed that in some cases, auditors needed to improve their consideration of the going concern assessment period, which was not always clear. According to the FRC's findings, auditors could also improve their approach to testing the integrity of the forecasting models.

One consideration that was of particular interest to the market is the finding that the length of the going concern assessment was not always clear in cases where it went beyond a year. The FRC therefore asked that auditors ensure their audit covers the same period as that used by management.

Closing thoughts

The impact of COVID-19 on the global economy is expected to continue to evolve, adding complexity to the production of going concern statements. In 2021 and beyond, companies and their auditors will need to commit to providing an assessment of going concerns and continue implementing good practice and identify areas for improvement in the years ahead.