THE ACCOUNTING watchdog’s Sharman inquiry into going concern and liquidity risks has recommended enhancing the role of the auditor in assessing a company’s viability.
Under proposals laid out in Lord Sharman’s final report, Going Concern and Liquidity Risks: Lessons for Companies and Auditors, auditors will be handed an enhanced role by providing a specific statement in the auditor’s report on the directors’ going concern assessment process and its outcome.
In addition to addressing the basis of accounting and material uncertainty disclosures, auditors will be required to also consider directors’ going concern assessment process and narrative disclosures about the going concern status of the entity, the report said.
The Sharman inquiry, set up by the FRC in 2011 to investigate auditors’ shortcomings in the wake of the financial crisis, also found that the differing definition of going concern in accounting, auditing and governance requirements are “at worst inconsistent and at best open to different interpretations, and are in fact interpreted differently, by different people”.
The report has recommended that the FRC should engage with the international standard setters the IASB and the IAASB, to agree a common international understanding of the purposes of the going concern assessment and financial statement disclosures about going concern.
It was also recommended that the FRC review its guidance for directors so that the going concern assessment is integrated with business planning and risk management, focuses on both solvency and liquidity risks that could threaten the entity’s survival through the cycle, and includes stress tests of liquidity and solvency.
In addition, the inquiry panel also recommended that the FRC integrate going concern reporting with its Effective Company Stewardship proposals.
“The aim of the directors’ assessment and reporting of going concern is not primarily to inform outsiders of distress. Rather, it is to ensure that the company is managed to avoid such distress while still taking well-judged risks. That judgment must rest with the directors and our aim should be to encourage them to discharge their duties in that regard with skill and in good faith,” said Lord Sharman.
The inquiry was launched largely in response to the circumstances where banks failed shortly after their financial statements received unqualified audit opinions. However, the panel found that it should not be necessary to have a separate going concern disclosure regime for banks and that there is no need for separate industry-specific reporting standards for banks.
It also found that a bank could view itself as a going concern in the event that it was backed by state funds.
“Liquidity support from central banks may be a normal funding source for a bank and that reliance on such support, if reasonably assured and based on an assessment of the bank’s ability to meet and continue to meet the conditions for its availability, does not mean that the bank is not a going concern,” the report said.
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