In
a seminal report on auditors and going concern, the UK Sharman Panel
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 entity’s business model or capital
adequacy that could threaten its survival. The
Sharman Panel 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 directorial discussion of strategy and principal risks.
Lord Sharman said that the aim of the directors’
assessment and reporting of going concern risks is not primarily to inform
outsiders of distress. Rather, it is to ensure that the company is managed to
avoid such distress, while still taking well-judged risks. That judgment must
rest with the directors, emphasized Lord Sharman, and regulators and policy
makers must encourage them to discharge their duties in that regard with skill
and in good faith. Therefore, in reaching its recommendations, the Panel’s
primary purpose has been to reinforce responsible behavior in the management of
going concern risks for companies.
Essentially the Sharman
Panel recommends a model for auditor reporting on going concern in which there
is an explicit statement in the auditor’s report that the auditors are satisfied
that, having considered the assessment process, they have nothing to add to the
disclosures made by the directors about the robustness of the process and its
outcome. The Panel’s final recommendation
in relation to the auditor’s role is therefore an enhanced one in which, in
addition to addressing the basis of accounting and material uncertainty disclosures,
the auditor also considers the directors’ going concern assessment process and narrative
disclosures about the going concern status of the entity and includes a
statement in the auditor’s report as to whether the auditor has anything to add
to or emphasize in relation to the disclosures made by the directors about the
robustness of the process and its outcome.
The
Panel found strong support for regular and more nuanced disclosure in narrative
reporting, compared to the current more binary approach to reporting on going concern
in the financial statements. The moment when a company moves from being a going
concern to a gone concern is dependent on a variety of interrelated factors,
noted the Panel, and it is therefore important to articulate the assumptions,
caveats and sensitivities associated with the going concern status of the
entity well before significant doubts about its ability to continue as a going
concern emerge.
The
report recommended that the Financial Reporting Council consider moving UK auditing
standards towards inclusion of an explicit statement in the auditor’s report as
to whether the auditor has anything to add to the disclosures made by the
directors about the robustness of the process and its outcome, having
considered the directors’ going concern assessment process. The Sharman group
also urged the FRC to encourage the IAASB to accommodate this approach to the international
auditing standards.
Similarly,
the Panel recommended that the FRC engage with the IASB and the IAASB to agree on
a common international understanding of the purposes of the going concern
assessment and financial statement disclosures about going concern, and of the
related thresholds and descriptions of a going concern.
The Panel also recommended
that the audit committee report
illustrate the effectiveness of the process undertaken by the directors to
evaluate going concern by confirming that a robust risk assessment has been
made, providing an explanation of the material risks to going
concern considered and how they have been addressed.
The
report noted that the success of audit committees in tightening up corporate
governance in the past means that they are seen as the most appropriate type of
body to implement these improvements. The Sharman panel noted that reporting by
audit committees and auditors on the directors’ assessment of going concern
should engender greater confidence in the process that is undertaken.
The Panel recommends that
the going concern assessment reflect the right focus on solvency risks, not
only on liquidity risks, including identifying risks to the entity’s business model or
capital adequacy that could threaten its survival, over a period that has
regard to the likely evolution of those risks given the current position in the
economic cycle and the dynamics of its own business cycles. Also, the going
concern assessment should be more qualitative and longer term in outlook in
relation to solvency risk than in relation to liquidity risk; and include
stress tests both in relation to solvency and liquidity risks that are
undertaken with an appropriately prudent mindset. Special consideration should
be given to the impact of risks that could cause significant damage to the
community and environment.
In
its preliminary report, the Panel posited that an expectation gap exists
between what stakeholders expect and what directors and auditors actually
deliver. This expectation gap may result from an expectation that the absence
of disclosure by directors, and the absence of a modified audit opinion in
respect of the going concern status of the company, can be taken as a guarantee
that the company will not collapse or fail. The Panel concluded from the
comments received that there is a risk that there is not a sufficiently common
understanding, in relation to going concern assessments, about the going
concern threshold or the
degree of conviction with which a going concern statement is required to be
made or about the purpose for which the assessment is made.
The Sharman report was
initiated by the Financial Reporting Council, the UK counterpart to the PCAOB. Lord
Sharman, Chairman of the Panel, 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. Before that, he held numerous senior UK and international positions with
KPMG. The other two members of the Panel are Roger Marshall, Interim Chair of
the FRC’s Accounting Standards Board, and David Pitt-Watson, Chair of Hermes
Focus Funds, and former Finance Director of the Labor Party.