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Financial Reporting and the Financial Crisis
Jinal Shah, Of Counsel, Orrick, Herrington & Sutcliffe, London, UKThe financial crisis is causing companies to look more carefully at their disclosures in financial reports and publications. In May 2008 the Financial Reporting Council ('FRC') commissioned a study of going concern and liquidity risk disclosures made by thirty companies listed on the Official List or AIM, who reported in December 2007 and March 2008.
The concept of 'going concern' underpins the preparation of annual reports and accounts of UK companies. Under both International Financial Reporting Standards ('IFRS') and UK Generally Accepted Accounting Principles, directors are required to satisfy themselves that it is reasonable for the financial statements to be prepared on a 'going concern basis'. The going concern basis assesses the value of a company as an operating business, as opposed to the value of its assets on liquidation. It would be reasonable to prepare the financial statements on a going concern basis unless the directors think that the company may not be able to continue to trade.
The FRC study concluded that there are significant opportunities for improvement by way of better rather than more disclosures in relation to going concern and liquidity risks. Liquidity risk is the risk that the cash resources of the company are insufficient to meet its cash needs within a specified timeframe. In particular, the FRC noted that there was often a lack of clarity about how liquidity risk is managed in practice and that much of the relevant information was distributed amongst different parts of annual reports, making it difficult for users to appreciate the full picture.
This article looks at the recommendations by the FRC and also considers certain recent statutory provisions which impose further potential liabilities on directors in connection with their financial reports.
Disclosures in financial reports
On 27 November 2008, the FRC published an update for directors of listed companies on going concern and liquidity risk. The update does not establish any new requirements, but it summarises the requirements on directors to comment on going concern and liquidity risk in annual reports and accounts, in the light of current economic conditions. The key requirements are set out below:
(a) Listing Rules
The Listing Rules published by the United Kingdom Listing Authority require that the annual reports of listed companies include a statement by the directors as to whether the business is a going concern, together with supporting assumptions or qualifications as necessary.
The directors’ statement is prepared in accordance with the FRC’s Guidance for Directors issued in 1994 (the ‘Guidance’). The Guidance outlines procedures that directors may wish to adopt in making their assessment. Major areas where procedures are likely to be appropriate include forecasts and budgets, borrowing requirements, liability management, contingent liabilities, financial risk management, products and markets, and financial adaptability.
The list of factors to consider is not exhaustive and the significance of each will of course vary from company to company. What is clear, however, is that in the current economic climate many of these factors will have greater importance requiring directors to consider them with ‘more rigour and formality’.
Doubts about going concern do not necessarily mean that the company is, or is likely to become, insolvent. Where the directors are unable to state that the going concern basis is appropriate, they should consider taking professional advice. If doubts exist as to the appropriateness of the going concern presumption, the annual accounts must set out in detail any relevant factors to show a true and fair view, the directors should explain the circumstances so as to identify the factors outside their control which may affect the outcome and explain how they intend to resolve the problem.
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