A chilling phrase is about to make its first appearance for a long time in many company accounts: “significant doubt”. Those two words are particularly worrying when they are linked to another pair: “going concern”.
Annual reports from companies with calendar year-ends are due to appear in the coming weeks. Auditors are currently in intense discussion with clients finalising the reports and questions around “going concern” are the biggest issue they face.
“Going concern” is the basic but crucial judgment made when accounts are prepared, and means directors and auditors believe a company is viable for at least 12 months from the date the accounts are signed off.
Most companies will receive a full, clean bill of health from auditors. But a growing number will run into difficulties or struggle to provide the kind of detailed information on funding plans to satisfy the auditors.
Auditors can qualify their report, meaning they do not believe the accounts are true and fair, or that key disclosures by directors have not been made. These are extremely rare and expected to remain so.
Far more likely are “emphasis of matter” paragraphs in the auditor’s report. These are designed to draw attention to key disclosures made by directors
“An added emphasis is not a qualified disagreement, it’s a directional statement to say ‘this is important’,” says Richard Sexton, head of assurance at PwC. “It is saying: ‘We believe the accounts present a true and fair view, but it is really important investors read this part’.”
The parts investors are likely to need to scrutinise centre on funding plans. Auditors are asking clients whether loan facilities and bank credit are really guaranteed, and want the letters to prove it. This can be complicated, since a company with loan facilities due for renewal in the middle of the year cannot guarantee right now that this will be possible, meaning auditors and directors have to use their own judgement.
Last week, the Financial Services Authority, the City watchdog, met the biggest audit firms to continue discussions on how it could assist in providing information to the banking sector to help avoid their receiving “emphasis of matter” paragraphs. This particularly relates to the government funding some of the biggest banks are receiving.
Auditors are also combing through managers’ forecasts for the next year and questioning assumptions about the economic outlook.
“If you’ve got a company close to breaching covenants if markets deteriorate further, I’d want that to be set out very clearly,” said Andrew Buchanan, technical partner at BDO Stoy Hayward. “If a sensitivity analysis on forecasts shows that you’re in danger of breaching [loan] covenants, auditors are more likely to consider adding an emphasis paragraph to their report.”
Tough discussions between auditors and directors could delay publication of results, often a tell-tale sign of problems at a company. But auditors said a delay could also have a more straightforward cause in the current environment.
“There are going to be a lot of conversations in the coming weeks between auditors and their clients as issues are brought to a conclusion, but that shouldn’t be read as disagreements, it is more that things are moving so quickly,” said Mr Sexton.
The good news is that there has been so much discussion around the issue of going concern that few will be surprised when the “added matter” paragraphs start appearing.
But this too can have its downside if it removes the seriousness with which they are taken. Auditors do not want to terrify investors, but they do not want to see their warnings go unheeded, either.
“Too many emphasis paragraphs would devalue the effect. Any competent reader of accounts should know to look for the disclosures and the auditors should only be adding emphasis where there are material uncertainties over going concern,” said Mr Buchanan.