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UK report on going concern considers efficacy of IFRSs

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03 Nov 2011

The Sharman Panel of Inquiry, established at the invitation of the United Kingdom Financial Reporting Council (UK FRC) to consider going concern and liquidity risks, has published its preliminary report and recommendations.

The aim of the Inquiry was to identify lessons for companies and auditors addressing going concern and liquidity risks and to recommend measures, if any, which are necessary to improve the existing reporting regime and related guidance for companies and auditors. The Panel recommends that for all businesses the going concern assessment should focus not only on short term liquidity risks but also on solvency risks that could threaten the company's survival over the business cycle or that could cause significant damage to the community and environment.

The terms of reference for the inquiry included consideration of whether the going concern and liquidity risk disclosures required by IFRS provided timely and relevant information for all stakeholders. The Panel's preliminary report makes a number of observations on IFRS related matters, including:

  • The Panel agrees and believes that the indicative minimum review periods set out in IFRS and UK GAAP are more relevant to considering the period over which detailed budgets and forecasts should be prepared than to the period over which other aspects of a going concern review should extend (particularly that 'stress tests' should be applied considering relevant economic outlook and business cycles)
  • Investors and quite a lot of others have raised questions about the suitability of IFRS accounts as a basis for assessing solvency - noting views such as in the finance sector the regulatory capital assessment rather than the IFRS accounts is the better starting point, that an IFRS balance sheet isn't that useful for assessing capital adequacy because it lacks prudence, or that the use of IFRS accounts requires adjustments for prudence to ensure that the measure of capital held is robust and able to withstand a reasonable range of stresses
  • Capital management is important to investors — they want to understand how this is done, through the eyes of management. The IAS 1 disclosures are not generally providing what they want, though they could in principle be used to do so
  • The going concern assessment is a forward looking process - whilst it builds on past data, it also includes looking at possible outcomes not yet experienced. This "does not sit well with the IFRS accounts which are essentially backwards looking"
  • The incurred loss model is widely accepted to have been inappropriate and is being addressed. A number of respondents and commentators suggested that "there was a sense that IFRS engendered a compliance mentality and that a more principles based approach was appropriate"
  • One area of concern to regulators is the inconsistency they observed in valuations of the same financial instruments using different models and there are "inherent issues with point estimates".

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