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The CICA’s IFRS Discussion Group recently discussed going concern assessments for development stage entities, in particular what criteria these entities should use to determine whether going concern uncertainty disclosure is required. For illustration, they focused on a common case – a mining company in the exploration stage that, if it encounters difficulty in raising financing, can either “slow its rate of exploration activity and associated spending to a level that can be sustained for a significant period of time based on its existing financial resources; or defer exploration spending to the level necessary to keep its exploration property and permit rights, and reduce its operational spending to a level that enables it to ‘keep the lights on’ for a significant period of time.”
Some members of the group “supported the view that going concern uncertainty disclosure is necessary because the entity does not have sufficient funds and faces significant uncertainty about its ability to raise funds.” Others thought though this isn’t necessary, for a mixture of reasons: “only contractually required payments should be considered; the entity can scale back and modify its business plan to “keep the lights on” until additional financing is available; and disclosures that are required by other IFRSs, such as IFRS 7 Financial Instruments: Disclosures, are sufficient to inform users of the risks that the entity faces.” Overall: “group members agreed that while it may not be necessary to provide going concern disclosure, disclosure of some sort is required for the fact pattern discussed. Group members noted that to be useful those disclosures should be specific to the entity and avoid being boilerplate. Group members agreed that sufficient disclosure is necessary for a user to have a proper understanding of the nature of the business and the stage of the business cycle. However, Group members expressed different views on the form and content of the disclosures.”
IFRIC has also been considering this issue, and has recommended that the IASB issue an exposure draft to provide more guidance on the area, so we'll see where that goes. In the meantime, I’d certainly agree with the IDG members who took a more measured view to the matter – I can’t see any point in slapping full-blown going concern uncertainty language on an entity just because, to put it broadly, it doesn’t have much going on. Practically speaking, as some IDG members mentioned, this would only mean the disclosure becomes standardized and meaningless (if it isn't already, for entities at the smaller end of the scale). The OSC thinks these disclosures “provide warnings about significant risks that the issuer is facing and may help investors avoid or minimize negative consequences when making investment decisions.” But this seems to me an odd statement to say the least, implying that the specific “going concern” label (on financial statements potentially appearing several months after the events they depict) will resonate with investors, saving them from “negative consequences,” in a way that other disclosures about risk and uncertainty (such as those in the MD&A, or news releases) won’t. It’s hard to see why the OSC would even want that to be true.
And anyway, I don’t think going concern disclosures are primarily designed to achieve that. As I wrote at greater length here, their core purpose is less about communicating operating risk than about the integrity of the accounting. The Framework sets out the concept as follows: “The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed” (my emphasis). The point of the italicized passage is that if the entity knows it’s going to (say) liquidate, then some of the values that would otherwise be included in the statements will make no sense – for instance, it will be obviously wrong to show carrying values for property, plant and equipment calculated on assuming an extended useful life. But the “if so” acknowledges that even if a liquidation is pending, the financial statements won’t necessarily have to be prepared on a different basis – for instance, if the statement of financial position consists entirely of financial instruments measured at fair value for which no adjustment would be necessary. In this case, that passage of the Framework, read literally, wouldn’t require any additional disclosure; it would be indifferent in effect to whether a liquidation is pending or not.
IAS 1.25 expands on this: “When management is aware, in making its assessment (of the ability to continue as a going concern), 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.” But the point here, again, is about the relevance of those uncertainties to assessing the recognition and measurement decisions taken in preparing the statements, not about their implications as a whole. This is logical because any number of reasons might exist why a particular set of financial statements provides a poor guide to the future (changes in economic conditions, enhanced competition, departures in key personnel, and so on), but none of these would typically be disclosed there. That’s the importance of MD&A and other aspects of the continuous disclosure regime.
Against this backdrop, the regulatory focus on going concern disclosures gets to seem a bit illogically neurotic - if investors don’t realize at the outset that buying into struggling penny stocks generates a risk of losing everything, then they’re not going to be helped by a few more disclosure elaborations. I’m still drawn to the same conclusion I expressed before: “It seems clear to me that rather than trying to cater to investors who need a neon warning sign on top of obvious operating challenges, regulators should be telling them they’re in over their heads. But the OSC doesn’t like to send that kind of message, because I suppose it seems too interventionist (or grim!) Consequently, it ends up catering to a weird and marginal concept of an investor who’s supposedly basically capable of investing in highly risky companies and yet too dumb to understand the danger signals unless they’re laid out in a prescribed, programmatic manner. It’s all done with the best intentions of course. But if you ask me, there’s no point trying to save people from themselves.”
The opinions expressed are solely those of the author.
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