With the many recent corporate collapses and scandals such as Thomas Cook, BHS, Carillion, Patisserie Valerie, Conviviality, Rolls-Royce, BT, Mitie Group, Sports Direct, Ted Baker, Quindell, to name just a few of the high profile ones, it is little wonder that political pressure is beginning to come to bear on UK Business and the UK Accounting Profession.
This has, as a result, seen the finger being pointed at two parties; The Directors of Companies and The Auditors that audit those companies and are meant to provide assurance to shareholders, investors and the banks.
Whilst we would very much hope that the glare of the public eye is unlikely to shine upon your business, we believe it is still important that:
You remain aware of your responsibilities over your company’s financial sustainability as a director
You understand why there is a gap between what the auditor does and what they are perceived to do
You are aware that the regulator is closing that gap and what that means for you during the audit process
Directors’ responsibilities
In accordance with UK Generally Accepted Accounting Principles (“UK GAAP”), namely Accounts Regulations for small, medium and large-sized companies (SI 2008 No. 409 and 410) there is a presumption that UK accounts will be prepared on a going concern basis.
Under this assumption, an ‘entity’ is viewed as continuing in business for the foreseeable future and therefore it accounts for its assets and liabilities on the basis that it will be able to realise and discharge them in the normal course of business. Financial statements are prepared on a ‘going concern’ basis unless the management or directors either intend to liquidate the entity or cease operations, or have no realistic alternative but to do so.
The assessment of whether the presumption that a company remains a ‘going concern’ is the responsibility of the directors and as such, they need to satisfy themselves of this basis of preparation. As a minimum this assessment should include:
The preparation of a budget,
Trading estimates and cash flow forecasts (albeit smaller entities may not prepare such a detailed analysis)
An analysis of the company’s borrowing requirements and facilities
In addition, larger companies, or those with more complex business models, may need substantially more procedures as part of the going concern assessment, such as annual reviews of medium and long-term plans, analysis of the major aspects of the economic environment in which they operate (market size, market share, competitors etc.) and financial and operational risk management.
Having conducted their ‘going concern assessment’, the directors will have to evaluate which of three potential conclusions is appropriate to the circumstances of the company. In particular they may conclude:
There are no material uncertainties that may cast significant doubt about the company’s ability to continue as a going concern
There are material uncertainties related to events or conditions that may cast significant doubt about the company’s ability to continue as a going concern but the going concern basis remains appropriate
The use of the going concern is not appropriate
The expectation gap
Our analysis clearly highlights the important role directors play in making their going concern assessment, but that does not down play the responsibility of the auditor.
In fact, the auditors’ responsibility in the going concern question is actually ‘can they obtain sufficient appropriate audit evidence to support the assessment made by management?’
This difference is referred to as ‘the expectation gap’, industry jargon indicating that potentially the public’s expectations of auditors are too high; jargon assessed by the Government Select Committee looking into the current role of auditors as “an attempt to paint the crisis in audit as a perception problem arising from an ‘expectation gap’, when in actual fact the delivery gap is far wider than the expectation gap and that is what must be fixed as soon as possible”
So what now?
In addition to directors taking on more responsibility for their assessment, the regulator has identified that the auditing standards need to do more to bridge this gap and increase auditor accountability, and issued a new ISA, ISA 570.
The key elements of the new standard focus on:
The auditor more robustly challenging management’s assessment of going concern, including obtaining supporting evidence and evaluating the risk of bias; and
An improved transparency over reporting on the positive conclusion on whether management assessment is appropriate
What does it actually mean for your business? Well, as a result of the new standard you should therefore expect to see:
Auditors asking for your assessment of why your business remains a going concern
Auditors seeking more evidence to support each assumption within your assessment
Auditors working with management to determine sensitivities that may demonstrate a more neutral position than traditional forecasts, and work on those sensitivities to determine if they present a more realistic future position
A need for greater disclosure in your financial statements over why your business remains a going concern
Greater narrative within the auditors report
Conclusion
In the current economic environment, as we move from one corporate collapse to another, the issue of going concern and financial sustainability is not going away.
The responsibility for this remains that of company directors and we recommend that all our clients revisit their obligations and how they fulfil them.
To assist the directors, the UK regulator has revised its auditing standard on how auditors complete their work over management’s assessment. This will mean you see an increase in auditors’ work to meet this new requirement and hopefully a reduction in the expectation gap.
