Improvements to Going Concern Reporting, Liquidity Risks Pushed
Going concern and liquidity risks reports should be designed “to encourage appropriate behaviours such as good risk decision-making, informing stakeholders about those risks and early identification and attention to economic and financial distress,” according to the Sharman Panel of Inquiry, established at the invitation of the Financial Reporting Council.
The Sharman Panel published its preliminary report and recommendations on Going Concern and Liquidity Risks: Lessons for companies and auditors.
The Panel’s key recommendations, on which it will now consult, urge the FRC to establish protocols with BIS and other regulatory authorities that will enable it to take a more systematic approach to learning lessons relevant to the scope of its functions when significant companies fail, through assessing the underlying circumstances.
According to the Sharman report, the FRC should harmonize and clarify the common purpose of the going concern assessment and disclosure process in the accounting standards and Code.
The going concern assessment process has been pushed to focus on solvency risks as well as liquidity risks, whatever the business, 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.
The report added that it should also include stress tests of liquidity and solvency.
The FRC is further urged to move away from a model where the company only highlights going concern risks when there are significant doubts about the entity’s survival, to one which integrates the directors’ going concern reporting with the directors’ discussion of strategy and principal risks.
Finally, the Sharman report recommends moving away from the three category model for auditor reporting on going concern to an explicit statement in the auditor’s report that the auditor is 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.
Lord Sharman, Chairman of the Panel, said: “The recommendations we are publishing today aim to capture key lessons from the recent past. Although this work emanates from the financial crisis, I hope there will be wide acceptance that companies in all sectors can do more to improve their management and disclosure of risks relating to going concern, liquidity and solvency.
“Our report includes recommendations that involve companies, auditors, regulators and government and we look forward to engaging with the widest possible range of stakeholders to build a broad consensus on how to take forward these proposals.”
Stephen Haddrill, Chief Executive of the Financial Reporting Council, said: “The management and disclosure of key risks is an essential part of the role of an effective company board. Lord Sharman’s inquiry has revealed the vital role directors and auditors must play in bringing short term liquidity risks and longer term, but no less important, solvency risks, to the attention of investors and other stakeholders.
“There is a clear connection between Lord Sharman’s work and proposals from UK Government and the FRC. I hope the consultation period will provide a useful opportunity to assess how they fit together to improve both the quality of corporate reporting and the dialogue between investors and company boards.”