015: How to prepare financial statements when going concern does not apply?
IFRS Question 015: IFRS financial statements under basis different than going concern
I am now preparing the financial accounts of a company which is forced to cease its business, and it is apparent that the going concern basis is no longer appropriate.
I am not familiar with the presentation of the accounts using the basis other than the going concern basis.
Please could you provide a little guidance on how to prepare the financial statements under IFRS when going concern assumption does not apply?
IFRS Answer 015
This is another great question – well I think that all my readers ask great questions!
What is going concern?
It is one of the basic assumptions described in IAS 1 Presentation of financial statements.
It says that all entities have to prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so.
The problem is that IAS 1 does not tell us how to prepare the financial statements when going concern does not apply.
There is no description of what you should do, how you should apply IFRS in this case and what policies to adopt when you are not going concern.
It means that we have to apply IFRS standards to the best of our knowledge and you have to consider carefully your individual circumstances to arrive at appropriate basis of accounting.
Alternative: Break-up basis of accounting
You can for example use so-called “break-up” basis of accounting. It is not defined in IFRS, that’s true, but it is defined in the legislation of some jurisdictions.
So if you apply the break-up basis, then the objective of financial statements is not to assess the financial performance of an entity as under going concern.
Here, you need to asses:
- Whether the company has sufficient assets to cover its liabilities, and
- If after all liabilities are settled, there will be some surplus or something left to distribute to shareholders.
However, your financial statements – the statement of financial position and the statement of total comprehensive income – will still look almost the same way, there’s no special format or anything.
It is more about the way of looking at individual assets and liabilities, about valuing them and presenting them.
Here, I’d like to outline a few issues to be aware of:
#1 Comply with IFRS
First of all, you still need to comply with the requirements of all other IFRS standards, even if you are not going concern.
So, not applying going concern does NOT make an excuse to depart from IFRS – that’s simply not true.
#2 Current vs. non-current distinction
Many people believe that they automatically must present all assets and liabilities as current if they are not going concern.
So, if you classified your assets as non-current under IAS 1, then they are non-current.
They can become current if they meet the criteria in IFRS 5 Non-current assets held for sale and discontinued operations.
So if you plan to sell your PPE and you actively started to offer it at the market, then yes, they are held for sale, they meet the criteria in IFRS 5.
And, this can be true only about some portion of your PPE.
For example, you stopped production and trading, and now you started to offer your big machines for sale – OK, then classify them as current as they meet IFRS 5 criteria.
But, if you did not do the same with other assets, like cars, computers, etc. – then you have to keep them as long-term assets.
#3 Perform impairment testing
Liquidation, cessation of trade or production and after all – not going concern are all indicators of impairment.
Because, you are not going to use your assets to generate future economic benefits anymore and as a result, the recoverable amount can sharply fall down below their carrying amount.
IAS 36 requires performing the impairment test on tangible assets when there’s an indication of impairment, so there you go.
Sure, it does not necessarily mean that there will be the impairment, because the fair value of your assets can still be higher than the carrying amount, but you are at risk and you must test it.
#4 Valuation of inventories
As you might remember from IAS 2, you have to carry your inventories at lower of cost and net realizable value.
When you decide to close the business, then the net realizable value of stock might sharply go down as you are probably going to sell off everything you have in the warehouse.
#5 Onerous contracts
It can happen that some contracts can become onerous as a result of your decision to cease trading or close the business.
For example, you might need to pay high penalties for early termination of your lease contracts.
Therefore, maybe you need to make a provision in line with IAS 37.
#6 Government grants
Government grants can become repayable if you are not going concern.
#7 Clearly indicate
Finally, you have to show very clearly that the financial statements are not prepared under going concern assumption.
Questions or comments to this topic? Please share them below. Thank you!
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