In the current COVID-19 reality, numerous entities have been forced to either shut down their operations, or to operate at a reduced capacity. Consequentially, users of financial statements will be looking at the going concern disclosure with particular interest.
Auditors need to keep this in mind and apply careful judgement when signing reports. However, it is management’s responsibility to assess the entity’s ability to continue as a going concern.
By default, financial statements are prepared on a going concern basis. However, if management intends to liquidate the entity, intends to cease trading, or has no realistic alternative but to do so, the financial statements should be prepared on an alternative basis – a basis which is not specified by IAS 1 ‘Presentation of Financial Statements’. Entities impacted negatively, and critically, by COVID-19, might need to prepare their financial statements on a different basis because COVID-19 has given no realistic alternative but to liquidate or cease trading.
Possible new factors that could affect entities during the pandemic include the effects of shutdowns of entity activities, government restrictions that might be imposed by governments in the future, the availability of government support during the pandemic as well as long-term changes in consumer behaviour that could persist even after the pandemic. For instance, consumers have shifted to online shopping by necessity, but might not revert back to highway shopping. Also, companies may have switched to teleworking by necessity, but might opt not to switch back to leasing their previous offices – or opt to switch back on a very limited basis. These types of changes in behaviour mean losses in sales for retail outlets that operate exclusively offline, and lessors of offices.
IAS 1 requires management to look ahead to up to 12 months after the reporting date, when assessing going concern. However, nowhere is it prohibited to look beyond that. Given the uncertainty surrounding COVID-19, it might be appropriate to look ahead as far as 12 months from the authorisation date. Furthermore, IAS 10 ‘Events After The Reporting Period’ needs to be considered for situations that have deteriorated between the reporting date and the signing date. In case of such deterioration, the going concern basis may not be appropriate. This could be relevant, for instance, for situations where financial year-ends dated 31 December 2019 are being signed during 2021.
Ultimately, all situations can be classified in four categories:
- The company is a going concern, with no significant doubts.
- There are significant doubts about going concern, but there is no material uncertainty.
- There are significant doubts about going concern, and a material uncertainty exists.
- The company is not a going concern.
The first three categories all result in the going concern basis of preparation being appropriate, but require different degrees of disclosure.
- Category 1 requires no disclosure other than the going concern basis.
- Category 2 relates to an adverse situation with some evidence of a situation being successfully turned around. The entity needs to disclose its judgements made in order to conclude that no material uncertainties exist. It is also necessary to disclose key sources of estimation uncertainty.
- Category 3 relates to an adverse situation with no sign of success in turning things around. The disclosures relate to both the material uncertainties relating to the entity’s ability to continue as a going concern, as well as the judgements made in order to conclude that the going concern assumption is suitable.
- Category 4 – which is not a going concern – requires disclosures of the fact that the entity is not a going concern, the basis used, as well as the judgements made in order to decide that the entity is not a going concern.