FINANCIAL REPORTING AND IR

Securities regulators and accounting standard setters around the world have viewed going concern disclosures as a hot topic for some time, and have been seeking to improve clarity of reporting in circumstances where a company’s ability to continue as a going concern may be in substantial doubt. Better clarity has arrived for Canadian companies that report under either IFRS or U.S. GAAP, and a new U.S. accounting standard was issued in August 2014.

The new accounting standard will change how companies that apply U.S. GAAP assess and disclose their ability to meet their financial obligations. Previously under U.S. GAAP, the onus to alert the marketplace that a company may be in for a bumpy ride was the responsibility of the company’s auditors. This new standard now moves the responsibility to management to take the first step in warning investors.

The going concern reporting standard sets out the financial statement disclosure requirements when a company may be unable to meet its financial obligations within the next year. This new standard applies to all financial statements for years ending after December 15, 2016.

IFRS already contain guidance regarding the assessment of going concern and the required disclosures. Reflecting similar concern over the adequacy of such disclosures in practice, a call for better and more comprehensive disclosures has also recently been made by the IFRS standard setters’ interpretive body. Depending on the circumstances, this may warrant a change in practice for some companies.

Fundamentals of the U.S. GAAP new standard

The new standard amended U.S. GAAP’s definition of ‘substantial doubt’ in the context of assessing going concern uncertainties, and now requires management to first make this assessment, rather than its auditors. Substantial doubt about a company’s ability to continue as a going concern exists if it is probable that the company will be unable to meet its obligations as they become due within one year after the annual or interim financial statements are issued. Management needs to consider known (and reasonably knowable) events and conditions at the assessment date. Examples of such conditions may be negative cash flows from operations, loan defaults or the loss of a key license to operate.

One of the key differences in the new rule is the date of the look-forward period. Under the new rule, the look-forward period to be used by management is 12 months from the financial statement issuance date, as opposed to what is currently required to be used by auditors, which is 12 months from the balance sheet date. Clearly this may result in different conclusions about the company’s ability to continue as a going concern.

Considering management’s plans when substantial doubt is raised

While management may initially have to conclude that it is probable that the company will be unable to meet its obligations within the look-forward period, in many cases it will have developed a plan to address that risk. In such situations, the mitigating effect of management’s plans can overcome a substantial doubt conclusion only if it is probable the plans can be effectively implemented. Examples of management plans include plans to dispose of assets, plans to restructure debt, and plans to reduce expenses.

If management first concludes that it is probable such plans can be effectively implemented, it must then also assess whether it is probable that those plans will mitigate the conditions or events that raise substantial doubt.

If it is not probable that management’s plans can be effectively implemented, and that they will effectively mitigate the conditions or events that raise substantial doubt, those plans cannot be used to overcome substantial doubt about the company’s ability to continue as a going concern.

New information to be disclosed in U.S. GAAP financial statements

Three categories of disclosures may be required:

1. Substantial doubt is raised, but management’s plans overcome that doubt: the company must disclose the principal conditions or events that gave rise to the substantial doubt and management’s evaluation of the significance of those conditions or events, as well as management’s plans to address.
2. Substantial doubt is not overcome after consideration of management’s plans: the company must explicitly state in the financial statement notes that there is substantial doubt about its ability to continue as a going concern within one year from the assessment date. Disclosure must similarly include the principal conditions or events that gave rise to the substantial doubt and management’s evaluation of the significance of those conditions or events, as well as management’s plans to address (i.e. even where substantial doubt is not overcome).
3. Subsequent disclosures: if conditions or events continue to raise substantial doubt in subsequent reporting periods, the company should continue to disclose the relevant information described above and should increase the extent of the disclosures as additional information about the relevant conditions or events and management’s plans becomes available. If substantial doubt no longer exists in a later period, the company must disclose how the relevant conditions or events were resolved.

IFRS Developments

Unlike U.S. GAAP, IFRS already contain disclosure requirements relating to the assessment of going concern. Similar to the new U.S. GAAP requirements, IFRS requires material uncertainties related to events or conditions that may cast significant doubt on a company’s ability to continue as a going concern to be disclosed in the financial statements. While some constituents requested clarification of these disclosure requirements, the IFRS accounting standard setters decided not to amend the existing literature. Rather, the IFRS Interpretations Committee (IFRS IC) issued some observations based on its discussions of the issue in July 2014.

The IFRS IC observed that if, after considering all relevant information, management’s conclusion that no material uncertainty exists involved significant judgment (i.e. a ‘close call’) then management must disclose these judgments in the financial statements.

The overall impact of these going concern changes is to bring consistent ‘early warning’ reporting of going concern matters to the marketplace by reducing diversity in the nature, timing and extent of going concern disclosures.

If your company does have going concern matters to be disclosed in the financial statements, the investor relations department must, of course, become intimately involved in understanding the conditions and events giving rise to these concerns, management’s plans to address, and be prepared to fully answer questions and provide relevant information to investors.

Katie McGarry, CPA, CA is a Senior Manager, and Rob Brouwer, FCA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.