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In historical terms the conceptual framework for accounting is a relatively recent phenomenon, only being developed in the latter part of the last century. One of the key accounting concepts is going concern i.e. that accounts are prepared on the basis that the organisation is a going concern – it will continue to trade for the foreseeable future. It means that a wide range of assets and liabilities and estimates are valued differently to the situation where there is no going concern, i.e. on break up or 'fire sale' values. This concept is essential to civil society. In our own day to day lives we constantly assume that we are a 'going concern'. We plan for holidays next year, we save for pensions, we pay a mortgage, we expect to be paid a salary every month. It is salutary to remember that there are peoples and cultures where this is not the case.

Under UK law, and in many jurisdictions, the limited liability company is assumed to be a legal person with rights and obligations. The International Accounting Standards Board have incorporated going concern into the International Financial Reporting Standards (IFRS) regime. And in many jurisdictions the company is assumed to be a going concern unless its Board of Directors explicitly state the matter to be otherwise. What does this mean in practice, and why has it suddenly become controversial in the current economic climate?

Recently the UK’s Financial Reporting Council (FRC) produced updated guidance for directors of listed companies on how they should acquit their responsibility with respect to the going concern principle. Although this useful guidance in no way adds to the burden on directors, the FRC saw fit to revisit the document because of the difficult economic circumstances we now find ourselves in. Additionally adherence to the going concern principle is important because it is a duty of the auditor to examine the status of the organisation and to report on any concerns they have as to its viability. And the failure of a major banking organisation such as Lehman Brothers, or the (unlisted) XL travel group seemed to have happened suddenly and without warning. This inevitably leads to questions along the lines of, 'where were the auditors?'

Actually the going concern principle is demanding even in the best of economic times. Practically the guidance defines 'foreseeable future' as 12 months into the future. 12 months from when? Here there is divergence between the UK’s FRC and the IASB. The latter suggest the 12 months runs from the most recent balance sheet date. The FRC continues to say that the period should run from the date of signing of the financial statements. These can be two very different durations. Under UK company law, a listed company’s financial statements can be legally signed off at any point up to 9 months after the balance sheet date. XL’s accounts, for example ran to a 31 October balance sheet date, but were actually signed off in May 2008. They entered administration in September, i.e. only 4 months later.

IFRS 7 applied for the first time to December 2007 year ends, although early adoption was permitted. It requires a significant increase in disclosures about how liquidity risk is managed when it becomes a material financial risk. The new IFRS disclosures require information seen 'through the eyes of management'. In particular, IFRS 7 requires disclosure of how material financial risks, such as liquidity risk, are managed in practice together with supporting numerical disclosures drawn from key summarised financial data used by key management personnel.

This increase in disclosure should not be an onerous requirement, since it should simply be setting down in the financial statements a summary of the procedures which are followed daily, weekly monthly and yearly to ensure the solvency of the organisation. All well run organisations will understand at any point in time their cash at bank, how this compares to a rolling forecast, what their treasury policy is for managing working and longer term capital, debtor and work in progress days and so on.

Yet disclosure continues to be uneven. Thus a recent survey of UK listed companies by the FRC found that information about going concern and liquidity risk was included in many different places in the reports reviewed – sometimes in the chairman’s statement, chief executive’s report, Directors Report as well as in the notes to the accounts. This is not helpful to users of financial statements.

A current example serves to illustrate the complexity of the judgement that needs to be made by directors and auditors. A straw poll of the general public today (28.11.08) as to whether Woolworths plc was in administration or not would probably lead to a 'yes' response. Yet a statement on their website states: '…the boards of Woolworths plc and Entertainment UK Ltd have concluded that there is no longer any prospect of those businesses being able to operate as a going concern. Accordingly, the boards of both companies last night resolved to file petitions for administration in the High Court.

'Woolworths Group plc is not in administration and remains in discussions with BBC Worldwide relating to the possible sale of its 40% interest in 2 Entertain Ltd.'

The financial statements of Woolworths Group also make interesting reading. The last annual statements cover the 52 weeks ended 2 February 2008. They were signed off by the Board of Directors and the Auditors on 2 April 2008. The audit report confirms that the accounts are true and fair and makes no reference to going concern in its opinion. It would be easy to stop there and to criticise the auditors. But closer inspection of the statements show that going concern was seriously addressed by their Board of Directors.

So, for example the 90 plus pages of the annual report and accounts – comparatively short by listed company standards – contains the following:-

• The Director’s Report – Business Review – Finance Director’s Report, 'The Directors confirm that, after making enquiries, they have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason they continue to adopt the going concern basis in preparing the accounts.'
• Notes to the Group Accounts – Liquidity Risk – 'The Group Treasury function is required to ensure the Group has sufficient committed debt facilities to cover its liquidity requirements for at least the next 12 months. During the year, the Group replaced its bank facilities with a £350 million asset based lending facility and £35 million 2nd lien loan. These are in addition to a £20 million invoice discounting facility available to Bertrams. At the year end £234 million remained undrawn. Management monitors rolling forecasts of the Group’s liquidity reserve on the basis of expected cash flow.'
• Notes to the Group Accounts – Borrowings – 'The Group has collateralised borrowing facilities up to £370 million (2007: £40 million) which enable the Company to receive funds in respect of available assets. This comprises of a £350 million asset based lending facility, established in January 2008 and a £20 million invoice discounting facility available to Bertrams. The £350 million facility matures in January 2012, with an option to extend for a further year.'

These extracts show how seriously the directors of a major quoted corporation have discharged their duty with regard to going concern. They also demonstrate the weight and the complexity of that judgement in the current difficult trading environment. The UK’s FRC are to be congratulated in updating going concern guidance at this time. It should be remembered too, that the annual financial statement is only one source of information for the investor community. The financial press, analysts, corporate communications departments and others, as well as the interim results all provide useful information as to the ongoing viability of the listed company.

Going concern can never be jettisoned – it simply becomes harder to evaluate when times are hard.

What's your opinion?

Is it reasonable to expect the Board of Directors to explicitly state that their company will continue trading for the foreseeable future? How long should 'the foreseeable future' be? Might it vary by industrial sector? Where should the statement on going concern be shown? What sort of evidence can reasonably be expected to be disclosed? What other communications to investors might be helpful in this regard? Should the going concern review be limited to listed companies?

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