Directors must be confident their enterprise can continue operating into the foreseeable future when preparing to sign off financial statements.
Assessing going concern for financial reports
Australian accounting standards require an entity’s board to assess whether the company can continue operating for the foreseeable future, and at least the next 12 months, before they prepare their accounts on a going concern basis. Where uncertainty exists, directors may be able to deal with the going concern assessment by making a going concern statement with a material uncertainty around COVID-19 related issues, which will require detailed disclosure of what those uncertainties are.
The Australian Accounting Standards Board and Auditing and Assurance Board have jointly published a guidance on assessing going concern and solvency declarations — The Impact of COVID-19 on Going Concern and Related Assessments. This is a list of indicators management should consider when trying to assess going concern, such as unavailability of resources or breaching loan covenants. It sets out mitigating strategies that directors and managers might consider when issues are raised in relation to going concern, including government stimulus or support, sale of liquid assets and capital raising.
On specific disclosure around going concern, the guidance talks about different categories of disclosure and matters boards should consider disclosing. This includes circumstances where no issues are identified, where issues are identified but resolved, where there is a material uncertainty and where the entity is assessed as no longer a going concern.
Much of the guidance covers the auditor’s responsibilities in reviewing the going concern assessment and disclosures in financial reports. This should form the basis for discussions between directors and auditors over the auditor’s role and the professional scepticism they are asked to bring.
Declaration of solvency
Annual financial reports (and half-yearly reports for listed companies) must contain a director’s declaration that the entity is solvent; whether, in the directors’ opinion, there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable.
The federal government decision to temporarily suspend the duty to prevent insolvent trading means that, in certain limited circumstances, an insolvent company may remain a going concern. Where directors are unsure of an entity’s solvency given market uncertainties, they may make a qualified declaration as to solvency and disclose their material uncertainty. The ASIC website has a handy FAQ on COVID-19 and solvency declarations. If in doubt as to an entity’s solvency, directors should immediately consult an independent and suitably qualified adviser.
Refresher: solvency basics
- Current liquidity ratio Compares current assets to current liabilities — usually defined as assets that are cash or will be turned into cash in a year or less, and liabilities that will be paid in a year or less.
- Acid test — quick liquidity ratio A measure of very short-term liquidity — for example, cash, accounts receivable and short-term investments, excluding inventory — to current liabilities. The formula used in the AICD Company Directors Course is: current assets less inventories, divided by current liabilities less bank overdrafts.
- Debt covenants Examine debt covenants and stress test them to determine risk of likely breaches.
- Days payable Indicates the average time in days it takes to pay bills and invoices to suppliers, vendors or other trade creditors. It shows how well the company’s cash outflows are being managed.
- Ability to meet GST/superannuation contribution provisions Under the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2019 directors are personally liable for a company’s unpaid GST, luxury car tax and wine equalisation tax in some circumstances.
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