In the current economic environment there is an increased focus on ‘going concern’. The Charities SORP committee has recently issued Implications of Covid 19 control measures and charity financial reporting which provides guidance on the impact of Covid 19, including going concern considerations.
The requirement to consider going concern in the preparation of the financial statements and the trustees’ report is not new, but rarely before has it been so inherently difficult to predict what the future cash flows of a charity will be, thus increasing the likelihood that enhanced disclosures regarding going concern and any uncertainties will be required in a charity’s financial statements.
What does going concern mean?
Going concern is a fundamental principle when preparing accounts, as it underpins the measurement basis for all the balances and transactions. As defined in FRS 102, an entity is a going concern unless trustees either intend to liquidate the charity or to cease operating, or have no realistic alternative but to do so in the foreseeable period (at least 12 months) from the date of approving the financial statements.
Trustees are required to confirm the basis of preparation of the financial statements within accounting policies. When the charity is considered to be a going concern but there is a material uncertainty that could cast doubt over this, disclosure of that uncertainty is required in both the body of the financial statements and in the trustees’ report.
When the entity is not a going concern, this must be disclosed and the alternate basis of preparation of the financial statements is applied. The alternate basis of preparation may result in a different carrying value for assets and liabilities, as the expected realisation of those assets and liabilities up to the date of cessation need to be taken into account. Liabilities resulting from any decision to wind the charity up should also be considered.
It is the legal responsibility of the trustees, being those charged with governance, to assess whether the going concern basis of preparation of the financial statements is appropriate. It is the auditor’s responsibility to evaluate this assessment by the trustees and form their own opinion as to whether the financial statements give a true and fair view.
You do not need to wait until the end of the audit to discuss going concern. In anticipation of the current increased risk in this area and therefore the extra focus being placed on this by all businesses, as well as their auditors, it is advisable to prepare your going concern assessment and engage with your auditors as soon as you can, whilst recognising that the environment is changing daily.
Cash flow forecast
To demonstrate that a charity is a going concern, the trustees will need to forecast cash flow for the foreseeable period, which is at least 12 months from the expected date of approving the financial statements.
It is likely that most charities will already have a budget or forecast in place prepared by management and this may often be a good starting point for the cash flow forecast model. In discharging their responsibilities to manage the charity’s resources responsibly, the trustees will have been engaged in the assumptions under-pinning the forecast. There are several things that should be considered to make sure the model is fit for purpose:
- The model will need to be updated to reflect the impact of the Coronavirus pandemic on income and operating costs. It is advisable for the forecast to look beyond 12 months after the expected approval of the financial statements to allow for any unexpected delays in the process of approval of the financial statements.
- It should split out unrestricted and restricted income and expenditure to make it clear what funds the charity has available at its disposal to cover general operating costs.
- It must reflect cash rather than accounting surplus/deficit. If necessary, eliminate non-cash items such as depreciation. Reconcile it back to the latest management information to ensure the forecast is reliable and up-to-date.
- Account for other cash items that might not be reflected in the budget surplus, such as capital expenditure, movements in working capital and movements in borrowings.
- It should be stress tested for variations in key assumptions (an income reduction of 40% instead of 20% for example). If the outcome is different, how would this be addressed? Include contingencies and consider whether a downturn would have further cash impacts, such as breaches of bank covenants that may trigger early repayments.
- Scenarios should be presented to reflect possible variations in circumstances, for example problems in key supply chains to charity shops.
- Factor in the costs of any proposed restructuring, such as redundancy costs where employee headcount is being reduced.
- Having taken all the above into account, what is the available headroom in terms of cash? Is this sufficient to ensure that the charity can meet all its liabilities as they fall due? What are the other options available to bolster headroom?
- Finally, there should be evidence that the forecast has been approved by the board of trustees.
With a reliable forecasting model and a clear understanding of where the risk and uncertainties might lie, it should be possible to get an early understanding of any going concern risk within the business and involve auditors early in discussions around the evidence they will need to see in forming their audit opinion at the time of the financial statements being signed off.