- concern for going-concern accounting

The going-concern assumption is a fundamental principle underlying the preparation and presentation of financial statements. Under the going-concern assumption, a business entity is ordinarily viewed as continuing in business for the foreseeable future with nei­ther the intention nor the necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to laws or regulations. However, the unexpected speed, severity and consequences of the current global financial crisis posed many issues, challenges and concerns to preparers of financial statements affected by the impact of financial reporting based on the going-concern accounting principle.

Factors affecting the going-concern assumption under the current economic climate
Examples of events or conditions that may cast significant doubt on the going-concern assumption under the current economic climate include:

• loss of a major market, franchise, license or princi­pal supplier
• excess and /or obsolete inventories
• fixed-term borrowings approaching maturity with­out realistic prospects of renewal or repayment
• excessive reliance on short-term borrowings to finance long-term assets
• inability to comply with the terms of loan agreements
• recoverable amounts of assets, substantially below their carrying amounts
• requiring impairment charges

The market expects almost all industries to be affected. If the 2008 financial results of companies listed on Bursa Malaysia so far as reported in the media is an indication of what to expect, financial results for 2009 will be even more volatile. Entities with property, plant and equipment, investment properties, investment in subsidiaries and other non-current investments would need to perform impairment tests on these assets which may result in impairment amounts to be expensed to the income statements.

Availability of credit
One major effect of the credit crisis and economic down­turn is the lack of available credit to business entities. Turmoil in the global banking sector has led to a general contraction in credit lending, which may have a pervasive effect on an entity’s ability to continue as a going concern. As an entity’s financial health worsens, contractual terms in loans and other obligations, including debt covenants and guarantees, and an entity’s compliance with such terms, are likely to be under greater scrutiny from lenders. Fortunately, Malaysian banks remain well-capitalised with adequate liquidity which will enable them to continue lending. This is due largely to years of reforms, especially in corporate governance and risk management standards and practices, by Bank Negara following lessons learned from the Asian financial crisis in the late 90s.

Unfair to fair value
When markets become inactive, price information becomes unavailable and estimates need to be made on the basis of other information, often using models, some of which incorporate inputs that are subject to management bias. The degree of estimation uncertainty increases and affects risks of material misstatement. Routine valuation methods and techniques used in an environment of actively traded markets may now become a source of significant risks. This has resulted in concerns about accounting measurement using fair value. Some critics suggested that fair value accounting should be suspended and be replaced by historical cost accounting, which they argue, are more reliable. The problem is that if fair value were suspended or replaced with some method based on historical cost, investors would be left to their own devices to determine the current value of the assets and liabilities, which would be less reliable.

Fair value accounting does not bring about increased volatility or markets illiquidity. Banks, not fair value accounting, caused the financial crisis due to their poor lending policies. Accounting rules are designed to reveal the full extent of the losses and future risks so that regulators and governments can put matters right, by identifying the specific causes of the crisis. The impacts of such measurements, whether positive or negative, on a given company are the results of market forces, not accounting methodologies. Price swings and fluctuations are a reality of financial markets and fair value still represents the most effective method to reflect the economic realities of market conditions.

Continuing assessment
The assessment of an entity’s ability to continue as a going concern is the responsibility of the entity’s management / directors. The appropriateness of management’s use of the going-concern assumption is a matter for the auditor to con­sider. It’s not an easy time for company directors. They have to develop and implement business strategies to ride through this crisis and also need to consider the impact of applying accounting principles and rules on their reported financial statements.

Early detection of problems and discussions with company auditors about plans to address going concern issues may help minimize the risk of last minute surprises. It may be helpful for a draft of the relevant disclosures about going concern and liquidity risk to be prepared and discussed with the auditors before the end of the financial year.

With hindsight, perhaps a delay in adopting International Financial Reporting Standards has its advantages. A case in point is the adoption of FRS 139- Financial Instruments: Recognition and Measurement which should have taken effect 1 January, 2006 but is delayed to 1 January 2010. If FRS 139 were adopted in 2006 with fair value accounting applied in full, its impact on the reporting of financial assets and liabilities will be even more profoundly volatile.