U.K. FRC to Implement Sharman Commission Proposals on Going Concern

In a partial implementation of the Sharman Commission recommendations, the U.K. Financial Reporting Council would require outside auditors of financial statements to consider whether reporting is fair, balanced and understandable, and to consider and report if they are aware of any material matter in connection with the disclosure of principal risks that should be disclosed. The FRC also proposes to remove the current Corporate Governance Code provision requiring listed companies to make a going concern statement. The FRC concluded that the best way to address these issues is to integrate its current guidance on going concern and risk management and internal control, and to make some associated revisions to the Corporate Governance Code. A going concern statement is focused on the narrow meaning of assessing the going concern basis of accounting, reasoned the FRC, and so detracts from the broader integrated assessment and description of solvency and liquidity risks envisaged by Lord Sharman.

The draft sets out the duty of directors to set the company’s risk appetite, ensuring there is an appropriate risk culture throughout the organization, and assessing and managing the principal risks facing the company, including risks to its solvency and liquidity. The board should summarize the process applied in reviewing the effectiveness of the system of risk management and internal control and explain what actions have been taken to remedy any significant failings or weaknesses identified from that review.

In its seminal report on auditors and going concern, the Sharman Commission recommended a process to produce a going concern opinion that envisions a key role for company directors, audit committees and auditors. The panel would also require the going concern assessment process to focus on solvency risks and liquidity risks, as well as identifying risks to the company’s business model or capital adequacy that could threaten its survival. The Sharman Commission wants to move away from a model where the company only highlights going concern risks when there are significant doubts about its survival, to one which integrates the going concern reporting with the directors’ discussion of strategy and principal risks.

A meeting earlier this year of the PCAOB’s Standing Advisory Group revealed a growing consensus in the SAG that going concern must focus beyond the traditional liquidity risk to other risks. This dovetails with the Sharman Panel, which urged the UK oversight authority to ensure that the going concern guidance for directors reflects the right focus on solvency risks, not only on liquidity risks, including identifying risks to the company’s business model or capital adequacy. Similar to the Sharman Panel, SAG members are also concerned about the current binary nature of the going concern report.

The Sharman report was initiated by the Financial Reporting Council, the UK counterpart to the PCAOB. Lord Sharman, Chairman of the Commission, said that, while the work of the panel emanates from the financial crisis, companies in all sectors can do more to improve their management and disclosure of risks relating to going concern, liquidity and solvency. There should also be early identification and attention to economic and financial distress, he noted. Lord Sharman was the Liberal Democrat Spokesperson for Trade and Industry/Business and Regulatory Reform from 2001 to 2010.