Sharman’s going concern dream team

LORD SHARMAN and his team have tabled their inquiry on going concern, saying it should be re-nosed to give stakeholders better overview of risk management.

Going concern exploded into the headlines during the financial crisis, when auditors were attacked for signing off companies as going concerns shortly before they fell over.

Some stakeholders took the going concern label as a stamp of quality, or guarantee of future stability. They assumed, at least, that the company would not hit insurmountable financial problems so fast.

Directors were nervous of qualifying their going concern opinion for fear of sparking alarm that would mushroom into a self-fulfilling prophecy.

This meant only the most stricken companies acknowledged going concern issues, in turn reinforcing the panic.

Into the fray marched the Financial Reporting Council (FRC), emergency guidelines in hand, to successfully calm directors’ anxieties about the purpose and process of going concern and soothe investor fears.

Skip forward a couple of years and former KPMG chief Lord Sharman and his panel of trusty inquirers have been drafted in to develop recommendations for the future of going concern.

Behavioural change

Sharman’s focus is on behavioural change, encouraging directors to be more frank about the risks they face and take. No more should a going concern qualification signal certain doom, he argued.

Instead, the binary yes-no model for going concern should be swapped for a report that details how directors arrive at their going concern conclusion, giving investors better insight of risk management.

This should be complemented by an audit committee report on company threats and risk management procedures and the whole package should be wrapped up in an explicit auditor opinion confirming they are satisfied with the disclosures and have nothing more to add.

Sharman said: “The aim of these disclosures is to provide information to stakeholders and they should be designed to encourage appropriate behaviours such as good risk decision making, informing stakeholders about those risks and early identification and attention to economic and financial distress.”

Liability questions

The recommendations sound logical, but they throw up questions about the liability of risk reporting and whether participants will be happy with their new-found responsibilities.

A recent ICAEW missive warned that risk reporting “creates as many problems as it solves”. Directors are reluctant to disclose their risk assessments for fear of handing competitive advantage to peers, the institute said, claiming investors share these concerns.

For this reason, directors affected by his proposals are also likely to be nervous when it comes to laying bare business strategies.

This is on top of their fear of spooking stakeholders with too many gory details, which limited disclosure in the first place.

A recent Audit Quality Forum event raised the spectre of transparency-focused disclosure requirements actually rendering company decision making more opaque.

Participants warned directors might be less frank in their discussions or avoid putting risks on paper for fear of confidential issues later being public knowledge.

Sharman dismissed the problem, saying: “This isn’t the case in my experience.” But other stakeholders disagree.

One FTSE-100 audit committee chief told the ICAEW: “If dialogue between the auditor and the audit committee was published it would naturally reduce the openness and honesty of that conversation.”

It is not too much of a stretch to anticipate a similar effect if directors had to publish all their thinking on going concern.

Audit oversight

The second stratum of Sharman’s model – audit committees producing a report on the effectiveness of directors’ going concern evaluation – might also meet with resistance.

Audit committee chairs questioned by the ICAEW insisted their responsibilities must be clearly delineated – board oversight, not risk management – and said their job is increasingly onerous as their duties expand. Would they accept shouldering yet another risk reporting burden?

Auditors are Sharman’s last line of defence. They would have to give “an explicit opinion” confirming they are satisfied with the directors’ going concern assessments and have no qualms about “the robustness of the process and its outcome”.

Here, we might see the expectation gap rear its ugly head. Auditors could insist it is not their responsibility to make such portentous judgements, claiming the purpose of going concern must be redefined if regulators want to hang that yoke around their neck.

Expectation gap

The expectation gap debate affects audit as a whole, with firms arguing it is their responsibility merely to give assurance on accounts, not to say whether qualitative issues are leading companies down the path to certain ruin.

Sharman admitted that he “couldn’t say” whether auditors will be happy with his recommendations, adding: “That is why we are having a consultation – to find out what stakeholders think.”

Many auditors agree the current going concern model needs improving, as evidenced by responses to the inquiry’s call for evidence.

However, a vague “something should be done” is very far from assuming overall responsibility for a ‘correct’ going concern opinion and firms might have something to say when the burden is laid at their feet.

Sharman and Co are angling for behavioural change. This is admirable, but will inevitably take time. If their recommendations are incorporated into the FRC’s Effective Company Stewardship Code, as hoped, stakeholders must take them on board – but only on a comply-or-explain basis.

Behavioural change is challenging when the default position is minimal risk disclosure, but the panel have taken the first step on a very long path.

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