“Going Concern Concept” during Pandemic times

[CASeetharaman KC]

"Going Concern" is a concept where the continuity of a business organisation is assessed. Up until now, we were least bothered by this concept as this was taken for granted. With the present Covid19 crisis, the basic fundamentals of business existence itself has changed and standards relating to going concern are becoming suddenly relevant and important.

The going concern assumption is a fundamental principle in the preparation of financial statements. Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to laws or regulations. Accordingly, the assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business.

The assessment of going concern is the responsibility of the management
International Accounting Standard (IAS) 1, “Presentation of Financial Statements,” paragraphs 23 and 24 state: “When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. Financial statements shall be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, those uncertainties shall be disclosed. When financial statements are not prepared on a going concern basis, that fact shall be disclosed, together with the basis on which the financial statements are prepared and the reasons why the entity is not regarded as a going concern.

In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date. The degree of consideration depends on the facts in each case. When an entity has a history of profitable operations and ready access to financial resources, a conclusion that the going concern basis of accounting is appropriate may be reached without detailed analysis. In other cases, management may need to consider a wide range of factors relating to current and expected profitability debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate.

The present situation is a classic one where the above standard (IAS- 1) can be applied in toto but then the accounting standard states that when there is a significant doubt on the entity’s ability to continue as a going concern then those uncertainties should be disclosed. If we try to analyze this statement in the present scenario then the following questions emerge 

1.    If a unit is dependent on imported raw materials what would be the time line when the supplies would return to normal? And even if the supplies return to normal temporarily what is the guarantee that it would stay so? If there is a return of the pandemic in the raw material producing country then what happens?

2.    Furthermore if the pandemic gets severe in the  buying country then stocks and liabilities could pile up. Further the debtors to whom goods were sold would also end up not selling the goods thus money getting stuck everywhere. How would the management make reasonable projections in such a scenario?

3.    The Management is further expected to project the profitability of its business is such a fluid situation and redraw its debt repayment schedules and also look for alternative financing methods before it can say that the concern is actually a “Going Concern”

4.    Management’s assessment of the going concern assumption involves making a judgment, at a particular point in time, about the future outcome of events or conditions which are inherently uncertain like the present situation where nobody knows when this pandemic would be overpowered or defeated . The following factors are relevant:

• The degree of uncertainty associated with the outcome of an event or condition increases significantly as we go further into the future for making a judgment  about the outcome of an event or condition.The present situation being an unique one, fixing of timelines, looking at possibilities and coming to reasonable judgements become impossible as the uncertainties outnumber the certainties.
• Any judgment about the future is based on information available at the time at which the judgment is made. Subsequent events can contradict a judgment which was reasonable at the time it was made. As it is said “People normally become wiser after the event”
• The following areas may become most concerning and need to be emphasized: 

i.    Size and Nature of business of the entity, 
ii.   Extent of its borrowings and resultant interest and repayment burdens.
iii.  Nature of Sales whether cash or credit and resultant Debtors 
iv.  Creditors and the time they would be willing to wait for without litigation 
v.   Extent to which the entity would be affected by external factors
vi.  Loss of faithful and committed employees who cannot be retained
vii. Labour shortages created by migration of labour to their home states
viii. Loss of markets and major Suppliers 
ix.   Risk of Non compliance of legal and statutory requirements 
x.    Risk of being prone to Litigation by Creditors, Ex employees and Government agencies

• To elaborate , a Mask manufacturing business may make the highest profits of its lifetime whereas a 200 room hotel property with huge loan burdens would start creaking under its overhead and interest burdens and eventually end up in disaster

The Management is being asked to make a reasonable judgement on whether the entity could be classified as a “Going Concern “ after doing a thorough study of all the above factors and  assessing whether the entity will be able to meet its future commitments.

Further the Auditor is required to evaluate the assumptions which the management has made to arrive at the conclusion of “Going Concern”. He is expected to do Risk Assessment after evaluating and understanding the business of the auditee thoroughly and then come to his own conclusion as to whether the judgements made by the management are reasonably correct.

Under the present conditions when apparently everyone is in a quandary as to when normalcy would return and as to how long this hiccups would continue reporting and validating the management’s assessment of “Going Concern “ is a tough ask, especially due to the fact that as of now no one in this planet knows how the course of things would be one month from now let alone periods of one year or two years. Invariably the Auditor and the Management would never agree as the Auditor would try to be conservative in his approach whereas the Management would try to be optimistic. 

The Auditor would not risk making a commitment that the entity is a “Going Concern “ except where it is crystal clear and is backed by enough financial backup to cover liabilities for over two years from the Balance Sheet date.

The reason is that lot of external agencies and other entities rely on the Auditor’s report to reassure themselves that everything concerning the Entity or the Unit to whom they have loaned public money or supplied goods is fine and that the obligations will be met successfully by the entity in the future. 

The Auditor has no alternative but to be extra cautious in this scenario as he would otherwise be pulled up for professional negligence and inefficiency.

In such a scenario to avoid such adverse reports  some expert guidance would be required from the Regulatory Authorities and the Government’s of all developed and developing countries as to how these risks can be evaluated and reported