Page last updated at 08:25 GMT, Monday, 9 February 2009

The importance of a 'going concern'

Money Talk
By Michael Izza
Chief executive of The Institute of Chartered Accountants in England and Wales

Auditors must make clear what the numbers actually mean

The credit crunch is putting a lot of pressure on many companies.

As a result, they may have to make disclosures in their accounts about their ability to stay in business.

Auditors will modify their audit reports to draw attention to these disclosures.

Investors need to understand what all this means.

Full disclosure

Each year, when they prepare their accounts, company directors must consider whether there are any material uncertainties that cast significant doubt on the company's ability to continue as a going concern.

If there are, they must disclose them in the accounts.

To be a going concern, a company must be capable of continuing in business for the foreseeable future without the likelihood of liquidation, ceasing to trade or seeking protection from those to whom it is in debt.

To decide whether there are material uncertainties that require disclosure, directors look at existing budgets and financial forecasts.

They also take into consideration the company's borrowing requirements and other relevant, available information.

This year, given the economic uncertainty which is making it harder for companies to access the finance they need to trade, this task may not be that easy, either for the directors of companies or for their auditors who have to give an opinion on the accounts and the disclosures they contain.

The auditor's role

Where the accounts are audited, the auditor - an independent accountant or firm of accountants - forms a judgement as to whether they comply with all relevant requirements and, in particular, whether they give a true and fair view.

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If the accounts disclose material uncertainties that cast significant doubt on the company's ability to continue as a going concern, the auditors will draw attention to this in their report by modifying their opinion to include an 'emphasis of matter', which is a paragraph highlighting those disclosures.

Does it mean the company will fail?

The fact that accounts disclose material uncertainties that cast significant doubt on the company's ability to continue as a going concern does not mean that the company will necessarily go bust.

It is also true to say that where the directors conclude there are no material uncertainties, it does not mean that the company is guaranteed to continue in business until the date of the next accounts.

So why is this so important?

In the current economic climate many more annual accounts than before are likely to contain disclosures relating to going concern.

It is important that investors and others in the business world do not jump to the wrong conclusions about these disclosures.

If they do, this could undermine wider business confidence even further and make the overall economic situation worse.

The damaging effects could include:

  • A bank refusing to lend a company the money it needs to run its business and pay staff wages
  • A modified audit opinion being interpreted as a business having broken the terms of its loan agreement with the bank
  • Suppliers deciding to withdraw credit facilities (time to pay) to a business, disrupting its trading activities
  • Landlords enforcing break clauses on rented business premises

What can be done to stop these things happening?

Everyone in the business world needs to understand the true significance of going concern disclosures in the current business environment and to avoid making hasty judgements without considering the full disclosures in the accounts.

All of us have a duty to respond to such disclosures in a measured and considered way - there is helpful guidance on the Financial Reporting Council's website.

If we don't the consequences could be significant - not just to the businesses concerned but also to the return of confidence in the economy more broadly.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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