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 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. 12 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
© Copyright 2024