Financial statements are a structured representation of an entity’s financial position and performance. The main objective of preparing financial statements is to provide information about the financial position, performance and cash flows of an entity. This information is useful to a wide range of users, in making economic decisions regarding the allocation of resources. It is therefore of importance that financial statements be prepared correctly to aid accurate decision making.

International Accounting Standards (IAS 1)

International Accounting Standards (IAS 1): Presentation of Financial Statements sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content. It requires an entity to present a complete set of financial statements at least annually, with comparative amounts for the preceding year (including comparative amounts in the notes).

The standard further requires financial statements to be identified clearly and distinguished from any other information in the same document. In addition, the financial statements should display the name of the reporting entity, whether the financial statements cover the individual entity or a group of entities; the date of the end of the reporting period and the period covered by the financial Statements; presentation currency; and the level of rounding of, if any, used in presenting amounts in the financial statements.

Notes to the financial statements

The notes to the financial statements should explicitly disclose the domicile and legal form of the entity, a description of the nature of the entity’s operations and its principal activities among others. An entity whose financial statements comply with IFRS Standards must make an explicit and unreserved statement of such compliance in the notes. It is wrong for an entity to describe its financial statements as complying with IFRS Standards if they do not.

The Going Concern AssumptionHowever, despite the above provisions of the standard, a number of preparers of financial statements are faced with serious application hurdles and hence the financial statements prepared therefrom fall short of the application and disclosure requirements as required by the standards. One of the underlying assumptions that is pivotal to the preparation of financial statements and upon which accuracy of the financial statements hinges is the going concern assumption. Financial statements are prepared with the assumption that an entity will continue to operate in the foreseeable future (usually 12 months) without the need or intention on the part of management to liquidate the entity or to significantly curtail its operational activities. Therefore, it is assumed that the entity will realize its assets and settle its obligations in the normal course of the business.

The standards emphasize that management is responsible for evaluating and disclosing uncertainties about an entity’s ability to continue as a going concern. If the going concern assumption is considered by the management to be invalid, the financial statements of the entity would need to be prepared on a breakup basis. This means that assets will be recognized at an amount which is expected to be realized from its sale (net of selling costs) rather than from its continuing use in the ordinary course of the business. Assets are valued for their individual worth rather than their value as a combined unit. Liabilities shall be recognized at amounts that are likely to be settled when an entity does not prepare its financial statements on a going concern basis.

IFRS requires that the entity discloses the basis of preparation used. IFRS does not however, provide guidance on the liquidation basis of accounting. Although IFRS require disclosures, in the financial statements, of any material uncertainties relating to events or conditions that may cast doubt as to an entity’s ability to continue operations in the foreseeable future, the constant changes in economic conditions render this quite difficult. The dilemma with application of the going concern assumption is a double edged concern and very susceptible to improper judgement. From the preparer’s point of view, there is need to consider proper application of the assumption while from the auditor’s point of view, assessment of prudence in the use of the assumption is paramount.

An auditor may need to consider the following to ensure prudence in the application of the going concern principle;

• Has the board conducted a rigorous process to assess the validity of going concern assumption and related risks and uncertainties?
• Have borrowing facilities and covenants been considered and likelihood of facilities being maintained and renewed assessed?
• Are cash flow forecasts based on relevant information and reasonable and supportable assumptions consistent with business plans?
• Are cash flows extended for a period sufficient to enable all major issues to be evaluated and cover a period of at least 12 months from the date the accounts are approved? Have they also been stress tested against a combination of pessimistic but plausible assumptions?
• Have guarantees, indemnities and commitments been taken into account and risks of the company being called on to honor them assessed?
• Do the annual report and accounts explain the basis for adopting going concern assumption and risks, uncertainties been described?

For Small and Medium- sized Entities (SMEs), the challenge of the going concern assumption is even more pronounced. Section 3 of the IFRS for SMEs[1] which deals with fair presentation of financial statements and what comprises a complete set of financial statements also requires application of the assumption.

However, given the nature and expertise of management among SMEs, little appreciation is accorded to application of the assumption. A number of times this is purely left for auditors to decide and where management attempts to apply the assumption, little effort is made to give a relatively clearer picture of the state of affairs. This partly explains why a number of SMEs will not shy away from shutting down operations a few months following the publication of financial statements prepared under the going concern assumption.

The key lesson here is that whether one is a preparer of financial statements or an auditor, it is always important to ensure adequate appreciation of the application of the assumption of going concern. More care needs to be taken to ensure that a proper assessment of the assumption is done.