Going concern considerations for charities

Performing a going concern assessment has been increasingly difficult against the backdrop of a challenging economic environment over the past eighteen months, and charities are no exception to this.

Is a going concern basis appropriate for your charity?

Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. Where management either intend to liquidate the entity or cease operations or has no realistic alternative but to do so, the going concern basis of accounting would not be appropriate and an alternative basis of preparation would be required.

Trustee responsibilities

Management is required to carry out an assessment to ascertain whether the entity is a going concern when preparing the financial statements. Within a charity, trustees would be considered management or for charitable companies, their directors would be the management making this assessment.

In making its assessment, management must consider all available information about the future, which is at least, but not limited to, twelve months from the date the financial statements are authorised for issue.

The approach to this assessment will depend upon the size and complexity of the charity as well as how the charity might be affected by changes in the social, political and/or economic environment.

Going concern assessment requirements

The assessment of going concern should be accompanied by appropriate supporting documentation, such as cash flow forecasts and consideration of alternative scenarios and sensitivities. The extent of the sensitivity analysis and scenarios considered will depend on the challenges around the charity’s going concern position – the more challenging the financial situation a charity is in, the more likely it is that detailed analysis will be required to give trustees sufficient comfort and basis to form their overall going concern assessment.

Some of the scenarios which charities may find useful to consider, and sensitivities they could apply, include:

• Loss of income streams – for example, no legacy income or loss of specific grants,
• Removing income streams which are speculative or unconfirmed from forecasts,
• Considering the extent to which investments could be liquidated to support cash flow if required,
• Delaying receipts of income by a period of time, and
• Increasing costs by a set percentage/reducing income by a set percentage.

The impact and likelihood of each possible scenario would need to be considered. Where a scenario would have a high impact and high likelihood, further work may be required to determine whether the charity is a going concern or whether a material uncertainty related to going concern exists.

Charities may also need to consider the headroom available in unrestricted reserves. While a charity might be holding healthy cash reserves, if a large proportion of the cash is held for restricted purposes, then the charity may not be able to fund its general expenditure. Accurate allocation of income and costs in the forecasts between unrestricted and restricted funds then becomes even more critical in forming the assessment.

What challenges are charities facing?

There are a number of areas where charities are encountering challenges in the current economic environment. Investment performance and overall valuations have decreased in light of the conflicts in Ukraine and more recently the Middle East, together with volatile markets. Costs have risen for many charities with double digit inflation, and these are generally not being offset by additional income. On the contrary, with the cost-of-living crisis, charitable giving has reduced in many areas and corporate discretionary spend on sponsorship and general charitable donations are also in decline as a result.

While that does all sound rather negative, it’s worth noting that many charities have been resourceful in generating additional income, reducing overhead spend and encouraging further charitable giving. Nonetheless, this has required a great deal of effort.

What should trustees and management look out for?

Planning ahead is important so that trustees and management have visibility of future performance and can take the necessary steps to safeguard the charity’s future and ability to continue as a going concern.

Red flags worth watching out for include:

• Deterioration in cash flow – this can happen even with a surplus,
• Loss of income streams such as end of corporate sponsorship deals or withdrawal of grant funding,
• Legacy income dwindling,
• Finance expiring,
• Net current liabilities – ie where your current liabilities exceed current assets, and
• Complaints from regulators – reputational impact/legal claims.

What are the implications of not being a going concern?

If the charity is not deemed to be a going concern, the first consideration trustees and management should consider is whether it’s appropriate to continue in operation. For charitable companies, directors must not trade under Company Law where they are insolvent; this would constitute “wrongful trading” if the directors continue to trade when they know, or should have known, that there was no reasonable prospect that the company would avoid insolvent liquidation or insolvent administration. While this is a matter of judgement, it’s important to seek professional advice where the trustees suspect there is a risk of trading insolvently. In this case, early intervention can often enable the charity’s operations to be saved and insolvency avoided.

Although this is clearly an extreme scenario, planning ahead to spot the warning signs is important. Further guidance on this area is available from the Charity Commission.

If there is uncertainty around going concern, this may give rise to a “material uncertainty related to going concern”. Appropriate disclosure about the material uncertainty related to going concern would be required in the financial statements and a separate “Material uncertainty related to going concern” section will be added to the auditor’s report.

Auditor requirements

If your charity is subject to audit, your auditors will be required to obtain sufficient appropriate audit evidence to conclude on whether a material uncertainty related to going concern exists and the appropriateness of management’s use of the going concern basis in the preparation of the financial statements.

The auditors will want to see the charity’s going concern assessment, the supporting forecasts and also confirmation from the trustees that they agree with this assessment.

In addition to the supporting forecasts, the auditors may want to see some form of sensitivity analysis and consideration of different scenarios. The extent of what is required here will depend on how tight the going concern position is.

If you’d like any further information and specific guidance on the areas discussed, please get in touch with Gareth Norris.