The Sharman Inquiry on “Going Concern and Liquidity Risk: Lessons for companies and auditors” published its final report and recommendations on 13 June 2012. The final report is here and the Financial Reporting Council’s accompanying press release is here.
The Inquiry was established by the FRC in March 2011, as we reported here, to “identify lessons for companies and auditors addressing going concern and liquidity risk” arising from the financial crisis. Amongst the Inquiry’s terms of reference were:
• “How companies ensure the adequacy, timeliness and reliability of the internal information used to monitor going concern and liquidity risk; and
• Whether the going concern and liquidity risk disclosures required by IFRS, the UK Corporate Governance Code and the Listing Rules provide timely and relevant information for all stakeholders.”
The Inquiry issued its interim report in November 201 (see our summary here).
Purpose of a company’s going concern assessment
The final report identifies two purposes for a going concern assessment:
“The first purpose is to establish and disclose information about the going concern status of the entity that is needed for the financial statements to give a true and fair view.”
“The second purpose is to provide information to stakeholders about the economic and financial viability of the company and to help demonstrate the directors’ stewardship and governance of the company in that respect. The Panel believes that this information element should include the directors’ conclusion about the going concern status of the company (as required by the Code and the Listing rules) together with relevant information about the company’s business model, strategy and principal risks (as required by the Code and Companies Act) to contextualise and explain that conclusion, in addition to the information about the appropriateness of the going concern basis of accounting and material uncertainty disclosures required by the accounting framework, with appropriate links and explanations. The audit committee report should also illustrate the robustness of the going concern assessment process and any limitations it may have had.”
Within that context, the Sharman Inquiry’s final recommendations (as summarised by the FRC – the full version is contained at page 10 and 11 of the final report) are that:
• “The primary purpose of the going concern assessment and reporting should be to reinforce responsible behaviour in the management of going concern risks; and
• The going concern considerations made by directors and reviewed by auditors should cover both solvency and of liquidity and that these should be considered over the cycle, taking an appropriately prudent view of future prospects.
and that the FRC should:
• Seek to clarify and harmonise the differing definitions of going concern and related risks in accounting, auditing and governance requirements, working with the international bodies.
• Review its Guidance for Directors to ensure that the going concern assessment is integrated with business planning and risk management; focusses as appropriate on both solvency and liquidity risks (including risks to the entity’s business model or capital adequacy) that could threaten the entity’s survival through the cycle; and includes stress tests of liquidity and solvency.
• Integrate going concern reporting with its Effective Company Stewardship proposals, to present a fuller picture of the principal risks the entity is taking and facing in pursuit of its business model and strategy rather than only highlighting going concern risks when there are significant doubts about the entity’s survival.
• Enhance the role of the auditor by seeking an explicit statement in the auditor’s report about whether the auditor has anything to add to or emphasise in relation to the narrative disclosures made by the directors about the robustness of the process of assessing going concern and its outcome.
The Inquiry also recommended that the FRC should take a more systematic approach to learning lessons when significant companies fail or suffer significant financial or economic distress but nonetheless survive.
Is a special “going concern” disclosure regime for banks required?
The Inquiry decided that, as a general matter, the fact that a bank has – in stressed circumstances – accessed liquidity support from a central bank should not necessarily mean that a bank is not a going concern or that material uncertainty disclosures or an auditor’s emphasis of matter paragraph are required.
The final report has an good discussion of the:
• disclosure requirements which banks have to navigate in those circumstances, including under the Listing Rules and the Disclosure Rules, at paragraphs 161 to 168, and
• how the Bank of England make available liquidity support to banks, at paragraphs 177 to 186.
The FRC will now consider how to take the Sharman recommendations forward “so as to improve the quality of corporate reporting and dialogue between investors and company boards and to reinforce the effective management of going concern risks for companies”.