Financial Reporting
Preparing Financial statements when the going concern assumption does not apply
BY
Colm Divilly
Preparing Financial statements
when the going concern
assumption does not apply
Colm Divilly, B.Comm., F.C.A. gives an overview of the guidance to practitioners
when preparing financial statements that are not on a going concern basis
The aim of this article is to provide guidance
to practitioners when financial statements
must be prepared on a basis other than
on a going concern basis. This article is
based on Irish company law and Irish GAAP
but many of the principles outlined apply
equally to financial statements prepared
in accordance with International Financial
Reporting Standards.
Company law
Section 5 of the Companies (Amendment)
Act 1986 sets down as an accounting
principle that when drafting financial
statements the company is presumed to be
carrying on business as a going concern and
if not, the particulars of the departure from
the principle, the reasons for it and its effect
on the balance sheet and profit and loss
account of the company must be stated in
a note to the accounts. It is interesting to
note that the law must not specify what
basis is to be used if you depart from the
going concern basis.
Irish GAAP
Under Irish GAAP there is no specific
accounting standard dealing with going
concern but rather the going concern
principle and its application is addressed in
a number of accounting standards.
Financial Reporting Standard No. 21
This standard addresses the issue by stating
that “an entity shall not prepare its financial
statements on a going concern basis if
management determines after the balance
sheet date either that it intends to liquidate
the entity or to cease trading, or that it has
no realistic alternative but to do so”.
ACCOUNTANCY PLUS. ISSUE 04. DECEMBER 2012
Colm Divilly is the
Managing Director of
Professional Education
Seminars Limited, a
provider of training
and compliance
support services to the
accounting profession.
Financial Reporting Standard No. 18
This standard states that an entity should
prepare its financial statements on a
going concern basis, unless the entity is
being liquidated or has ceased trading,
or the directors either intend to liquidate
the entity or to cease trading, or have no
realistic alternative but to do so, in which
circumstances the entity should prepare its
financial statements on a basis other than
that of a going concern.
The standard requires that when preparing
financial statements, directors should
assess whether there are significant
doubts about an entity’s ability to continue
as a going concern. If the directors, when
making the assessment are aware of
material uncertainties related to events
or conditions that may cast significant
doubt upon the entity’s ability to continue
as a going concern, these matters must
be disclosed in the financial statements.
Where the financial statements are not
prepared on a going concern basis, that
fact, together with the basis on which the
financial statements are prepared and the
reason why the entity is not regarded as a
going concern must be disclosed. Irish GAAP
requires explicit disclosure if the period
of the review for going concern has not
extended to twelve months from the date
of approval of the financial statements.
Preparing Financial Statements on a
break up basis.
As you will have noted, the term “break up
basis” is not defined in company law or Irish
GAAP. Both company law and Irish GAAP
refer to financial statements being prepared
on a basis other than going concern. If the
accounts are prepared on a basis other
than going concern, all the normal rules of
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Continued on Page 12
11
FINANCIAL REPORTING
Preparing Financial statements when the
going concern assumption does not apply
BY
Colm Divilly
accounting still apply, other than that of
going concern. It is likely that the following
factors will require consideration when
drafting financial statements on a basis
other than going concern.
Fixed Assets
Fixed assets will need to be assessed
for impairment, and written down to the
recoverable amounts.
Stock
Stock must be carried in the financial
statements at the lower of cost and net
realisable value at the balance sheet date.
In many cases where a decision is made
to close a business, a significant loss will
be incurred in selling the stock. In arriving
at the net realisable value of the stock,
appendix 1 to SSAP 9 states that “events
occurring between the balance sheet date
and the date of completion of the financial
statements need to be considered in
arriving at the net realisable value at the
balance sheet date (e.g., a subsequent
reduction in selling prices).”
Liabilities
In deciding what liabilities to recognise, FRS
12 provides the rules to be followed. FRS 12
requires a provision to be recognised when
an entity has a present obligation (legal or
constructive) as a result of a past event, it is
probable that a transfer of economic benefits
will be required to settle the obligation, and a
reliable estimate can be made of the amount
of the obligation. Unless these conditions
are met, no provision should be recognised.
The decision to close an entity is likely
to create obligations where one may not
have existed when the entity was a going
concern. The accountant needs to exercise
care when deciding what liabilities should
be recognised in the financial statements.
Appendix III to FRS 12 provides excellent and
practical guidance on the application of FRS
12 and deals with the recognition of costs
associated with the closure of a division
(example 5A and 5B) and the recognition of
costs associated with an onerous contract
(example 8). The issue of reclassification of
long term liabilities to short term liabilities
also needs to be considered.
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Other matters that may require consideration
Basis of preparation
Government grants
The basis of preparation applied and the
reason for the adoption of this basis need
to be disclosed in the accounting policy
notes.
If the company has received government
grants in the past, you will need to consider
if these grants have become repayable as a
result of the decision to cease to trade.
Intangibles assets, goodwill and
capitalised development expenditure
The value of these assets is commonly
linked to the ability of the entity to continue
as a going concern and so the realisable
value of these assets requires careful
consideration.
Leases and hire purchase contracts
Directors’ report
The director’s report should outline the
decision reached by the directors in relation
to the future of the company and the
implication of these decisions for the basis
of preparation of the financial statements.
Profit and loss account
The following narrative may be required at
the foot of the profit and loss account.
Early settlement of these contracts may
result in the entity incurring penalties. In
addition, operating leases may give rise
to onerous contracts. FRS 12, Appendix
III provides examples of accounting for
onerous contracts.
“All of the activities of the company are classed
as discontinuing as the directors have the intent
to wind up the company within 12 months from
the signing of the financial statements.”
Disclosures required where the financial
statements are not prepared on a going
concern basis.
It is important that the audit report makes
clear that the financial statements are
prepared on a basis other than going
concern. In deciding on the appropriate audit
report to be issued in the specific client
circumstances it is recommended that you
use the decision chart on page 72 of Audit
Practice Board Bulletin 2006/1 to assist in
making the judgment on the audit opinion.
Irish company law and Irish GAAP require
detailed and specific disclosures where
financial statements are prepared on a
basis other than going concern. These
disclosures will be unique to the entity but
should address the following matters:
Auditor’s report
ACCOUNTANCY PLUS. ISSUE 04. DECEMBER 2012