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Key takeaways:
Almost all IFRS-compliant financial statements are prepared on the going concern basis. This assumes that the entity will continue in operation for the foreseeable future, which is usually at least one year from the date of the financial statements. The management should assess an entity’s ability to continue as a going concern when preparing financial statements.
Under IFRS Accounting Standards, “An entity shall 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. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties.”
It is important to note the “or” nature of the test in the requirements above. If the entity will cease trading or has no realistic alternative but to do so, it is no longer a going concern, even if the legal entity itself will remain in existence. There is no guidance on determining when an entity will “cease trading.” However, our view is that this would occur when an entity ceases to carry out its ordinary activities, typically those that generate revenue. An entity may cease trading and still have some activity, albeit at a reduced level, associated with the administration of the legal entity or the disposal of remaining assets.
Once an entity has determined that the going concern basis is no longer appropriate, it must then consider how to present its financial statements.
“When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.” (IAS 1.25)
IFRS Accounting Standards state that the going concern basis should not be used but do not provide detailed guidance on what an appropriate alternative basis is.
In this article, we will consider what alternative basis might be used and how it should be presented, using only the requirements of International Financial Reporting Standards Accounting Standards. Anyone preparing should also consider whether relevant laws, regulations, or applicable local guidance exist in their jurisdiction.
What other basis should be used?
There is no one defined term for financial statements prepared on a non-going concern basis. Commonly used terms for other bases of preparation include:
- Liquidation basis
- Break-up basis
- Winding-up basis
- Orderly termination of business basis
- Orderly realisation of assets basis
None of the above terms have any universally accepted IFRS definition or requirements, although the liquidation basis is a concept that exists in US GAAP. There is some nuance in the choice of description used. For example, an “orderly realisation” basis implies a planned and considered disposal of assets over a longer timeframe, whereas a “break-up” basis might imply more of a sudden “fire-sale” approach in which assets would be shown at a value below their fair value.
However, all the terms above are commonly used. The financial statements should reflect the facts and circumstances related to each specific entity. For example, suppose an entity is in the process of being liquidated. In that case, the financial statements should reflect that, whereas if the entity has ceased trading (and potentially rendered dormant), then the disclosures should make that clear.
Considerations when applying a non-going concern basis
- Whether the entity’s assets are sufficient to settle the entity’s liabilities.
- Determination of any amounts available to distribute to shareholders on winding-up.
- When and to what extent provisions for losses after the reporting period and for terminating the activities of the business should be recognised.
- Whether assets should be restated at their actual or estimated sales amount, even if that amount may be different from their fair value at the reporting date.
These considerations will have an impact on the application of accounting policies in the financial statements.
How should the financial statements be presented?
We have considered issues with recognition, measurement, and disclosure, which commonly arise when financial statements are presented on a non-going concern basis. In the absence of any authoritative IFRS Accounting Standards guidance, preparers must follow the requirements of IAS 8, which require them to choose an approach that results in relevant and reliable information. In making that determination, they should consider:
- The requirements of IFRS in respect of similar and related issues
- Pronouncements from other reporting frameworks. For example, the description of the liquidation basis in US GAAP may be relevant
- Available technical accounting literature and industry practice.
The table below sets out an approach which, in our view, meets the above requirements. In the absence of an authoritative pronouncement, none of the positions described below can be definitive, but they represent our view on the most frequently asked questions which arise:
| Assets | Writing down assets Preparers should consider whether there is a need to write down assets. If management intends to liquidate the entity or cease trading, this would usually indicate impairment. Each asset’s value in use will usually no longer be applicable since there is unlikely to be material future cash flows generated by assets other than through disposal. Therefore, it is necessary to write down assets to their fair value less costs of disposal. In some situations, such as where an entity is severely distressed or is being liquidated, it may be appropriate to write assets down to the net realisable value, where this is materially below their fair value. Writing up assets Generally, IFRS does not permit the write-up of assets held at cost if the fair value is greater than the carrying amount. The amount to be recognised is restricted to the lower of cost and net realisable value or fair value less cost to sell. It usually would not be appropriate to increase the carrying value of assets held at cost in these circumstances, even if their future disposal proceeds are likely to be greater than their carrying value. |
| Liabilities | Financial Liabilities Where an entity is being liquidated, particularly because of financial distress, it may appear likely that trade payables, contract liabilities, accruals, and other financial liabilities will not be paid in full. Regardless of the likelihood of this outcome, the contractual value of such liabilities should continue to be recognised in full until a binding agreement with creditors is reached to forgive or restructure any existing debts. This is consistent with IFRS 13 Fair Value Measurement, which requires the fair value of a financial liability with a demand feature to be not less than the amount payable on demand. Onerous contracts and provisions There may be contractual commitments which may become onerous contracts because of the decision to cease trading or liquidate a business. The entity should apply the requirements on onerous contracts in IAS 37 Provisions, Contingent Liabilities and Contingent Assets. In our view, there is no general dispensation from the measurement, recognition, and disclosure requirements of IFRS if the entity is not expected to continue as a going concern, and they should continue to be applied to the extent possible. Provisions for employee terminations and other restructuring should be recognised if the decision to cease trading had occurred by the reporting date, as that decision is likely to constitute an obligating event under IAS 37. However, if the decision to cease trading has not occurred by the reporting date but occurred before the financial statements are issued, then no such provision would be recognised, as the obligating event has not yet occurred. Similarly, provisions for future operating losses should not be recognised. Entities may also need to consider reclassifying financial instruments they have issued from equity to liabilities, where those instruments contain terms that require the entity to settle the obligation in cash or another financial asset only in the event of liquidation of the entity. Such terms are ignored under IAS 32.25(b), where an entity is a going concern. |
| Presentation and disclosure | Reclassification of assets and liabilities from non-current to current The classification of assets and liabilities as current or non-current is important to assess. The principles in IAS 1 should be applied to determine the correct classification. Generally, in a situation where an entity ceases trading, it would expect to realise most assets within 12 months and would therefore classify them as current. Assets that are expected to be held for over 12 months will still be classified as non-current. However, the existence of a significant amount of such assets would bring into question whether a non-going concern basis was appropriate, as it might imply that an entity is changing the nature of its operations rather than ceasing them altogether. Presentation of discontinued operations When an entity decides to cease trading, it may meet the definition of a discontinued operation in IFRS 5. However, in our view, presenting discontinued operations is not relevant or meaningful where a non-going concern basis is to be used. This is because the use of such a basis implies that the entire entity is a discontinued operation, and therefore, the distinction between continuing and discontinued operations no longer exists. Presentation of Comparative Results In 2021, the IFRIC considered the matter of how to treat comparative information within the financial statements when an entity is no longer a going concern. They concluded that it was not necessary or appropriate to restate the prior year comparatives, which would, therefore, still be prepared on a going concern basis. This means that entities will need to consider their accounting policy disclosures carefully, as the disclosures will need to describe both the policies adopted for the non-going concern basis in the current year and those adopted for the going concern basis in the prior year. Disclosure IAS 1 requires disclosure of the judgements made in applying the entity’s accounting policies that have the most significant effect on the amounts recognised in the financial statements. The basis of preparation should include appropriate disclosure where financial statements are prepared on a basis other than going concern. These disclosures may include:
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