Marek Grabowski Director of Audit Policy Financial Reporting Council 5Th Floor, Aldwych House 71

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Marek Grabowski Director of Audit Policy Financial Reporting Council 5th Floor, Aldwych House 71 – 91 Aldwych London WC2B 4HN

1 May 2013

By email: [email protected]

Dear Marek

Implementing the Recommendations of the Sharman Panel: Revised Guidance on Going Concern and revised International Standards on Auditing (UK & Ireland) (‘the draft guidance’)

Introductory remarks

Chartered Accountants Ireland (‘the Institute’) is pleased to respond to the above consultation.

In framing our response, both in terms of general comments and in answering the specific questions in the Consultation, we have had regard to the particular circumstance of Chartered Accountants Ireland which has significant membership both in the United Kingdom and in Ireland. We are also grateful to staff of the Financial Reporting Council (‘FRC’) who took the time to visit Dublin recently to meet with various Irish stakeholders to discuss both these proposals and other FRC proposals for amending ISA 700 (UK & Ireland) ‘The Auditor’s Report on Financial Statements’. This meeting has been helpful to us in finalising our comments, as has the public meeting held by the FRC in London on 25th April.

The Institute has previously expressed its support for a key aim of the Sharman Inquiry, namely to address questions that have been previously raised about the ‘quality of information provided on companies financial health and their ability to withstand economic and financial stresses in the short, medium, and longer term’. In our comments on the original Sharman Inquiry ‘call for evidence’ the Institute expressed the view that enhanced disclosures of an entity’s financial risks

would be of benefit to stakeholders in assessing the sustainability of an entity. Such disclosures might include comprehensive information in relation to projected liquidity ‘headroom’ and sensitivity analyses demonstrating an entity’s ability to withstand adverse developments.

We also commented on further enhancements to the role of audit committees and/or risk committees in overseeing the provision of such information.

While the Institute also supports further enhancements and development of the role of the auditor in ‘going concern’, such measures need to take place as part of global reforms and include appropriate ‘safe harbour’ provisions – likely only to be provided via legislation, such as that which already affords protection to directors of UK companies when reporting in accordance with company law. We continue to support this overarching objective.

General remarks

Our responses to the questions asked in the Consultation are set out in the Appendix to this letter. However, we do have a number of general and overarching issues we would like to raise and which also provide some context for our answers to specific questions. These relate to;

 Different uses of the term ‘going concern;  The introduction of new terminology;  Application date;  Clarification of the responsibilities of the statutory auditor;  Accessibility of the Guidance to SMEs;  International considerations; and  Application of the Guidance in Ireland (including the Supplement for Banks).

Different uses of the term ‘going concern’

The ‘going concern basis’ for the preparation of financial statements is a long established concept in financial reporting, referenced in extant UK/Irish GAAP, FRS 100-FRS 102, and in IFRS. While this concept and its use is familiar to those with a close association with financial reporting and statutory audit, the financial crisis has demonstrated that generally there continues to be misunderstanding and confusion around the application of the going concern concept to financial statement preparation and the role of statutory auditor in addressing going concern issues.

The revised guidance proposes two different uses of this term and for different purposes (financial reporting and stewardship) along with two sets of disclosure requirements that relate to these.

As drafted, we do not support the approach of a single term applying to two separate purposes. We believe this will result in further confusion among users and other stakeholders. Instead, we would encourage the FRC to consider ‘decoupling’ the narrative reporting relating to liquidity, solvency, sustainability risks etc. from ‘basis of preparation’. We suggest, therefore, that the disclosures now envisaged that relate to ‘stewardship’ be referred to by a different descriptor than ‘going concern’. While we acknowledge that this may necessitate amending or clarifying the Listing Rules UKLA, not to do so will, we believe, result in further confusion and misunderstanding and lead to a further widening of the expectation gap.

Introduction of new terminology

The revised guidance contains a number of terms which, in the context of their assessment of going concern, directors may find difficult to apply and indeed, may be applied inconsistently from one entity to another. Specifying that a ‘high level of confidence’ is needed before an entity can be regarded as a going concern implies a degree of certainty that is, at least, challenging in current economic conditions. When this is then applied to the ‘foreseeable future’, now with potentially longer term and qualitative aspects, entities, as well as their directors and auditors may well need additional time (which may include the need to take advice) compared to the current effective date to appreciate fully the implications of the revised guidance. Irrespective of the application of this threshold to listed companies, SME’s in particular, face a greater vulnerability to general factors such as the continuing availability of bank finance or the viability of their customer base that may make this threshold unachievable in a meaningful way.

Application Date

The Institute is not supportive of retrospective application of the revised guidance. Quite apart from a departure from normal practice, the revisions to the Guidance are sufficiently significant from the 2009 Guidance it is replacing that entities and their directors included within its scope will require appropriate time to consider its implications.

Clarification of the responsibilities of the statutory auditor

We welcome comments made by FRC staff during the above mentioned meeting in Dublin recently that the responsibility of auditors in communicating to audit committees views on the ‘robustness’ of going concern assessments is derivative from the work currently undertaken for the purposes of issuing their audit opinion on financial statements. There is no intention that the scope of audit work will change. The current wording of proposed amendments to ISA 260 (UK & Ireland) could be misinterpreted in this regard. We would therefore like to see some clarificatory wording inserted to ISA 260 to reflect this intention. However, it should be recognised that the

work effort involved, if the proposed guidance is implemented, could be significant even if the audit scope remains unchanged.

International Considerations

We note that both the Sharman Recommendations and the Consultation Paper itself make reference to international developments. In particular, we note Sharman Recommendations 2(a) and 2(c) which may ultimately impact on the interpretation of ‘going concern’ and the significance of ‘material uncertainties’. We also note the reference to the IFRS Interpretations Committee considering possible changes to IAS 1.

The FRC is also familiar with ongoing discussions at European Union level particularly with regard to the auditor’s role in respect of ‘going concern’.

In view of the above ongoing considerations we have reservations about immediate application of the revised guidance and amendments to auditing standards and the cost and inconvenience these may cause when potentially further amendments may be needed in the near future to accommodate further change internationally.

We have noted also comments by the representative of the Investment Management Association at the meeting of 25th April on the potential for misconception and misunderstanding by international investors when considering annual reports of companies who have applied the revised Guidance in its current form. We have some sympathy with the argument that UK/Irish entities applying the revised Guidance could appear less attractive to such investors when making asset allocation decisions.

Application of Guidance to SMEs

As drafted, the revised guidance is confusing in terms of its application to small and medium sized entities and also to private companies who are not subject to the UK Corporate Governance Code (’the Code’) (nor choose voluntarily to comply with its provisions).

While clearly there is overlap, confusion arises by conflating reporting requirements of the Code with those of company law. There is little attempt to distinguish between requirements common to all companies and those additional reporting requirements applicable to those within the scope of the Code.

Some revision to Section 4 of the revised Guidance on reporting would be helpful which would distinguish between the broader based ‘business review’ required by company law (which does not specify an overt statement as to whether the company is a going concern), and the more specific requirements of the Code.

We note that at the FRC meeting on the 25th April, there was some acknowledgement of the SME issue and an apparent willingness on the part of the FRC staff in attendance to reconsider this matter. We would encourage the FRC’s efforts in this regard.

Application of Guidance in Ireland

The FRC may be aware that its 2009 Guidance was issued subsequently in Ireland (with the permission of the FRC) by the Institute as representing ‘best practice’. The original FRC Guidance was amended solely to reflect Irish specific company law references.

While the legal responsibilities of directors and others with regard to ‘going concern’ remain unchanged, recent changes proposed in the UK with regard to reporting – eg BIS Narrative Reporting Requirements will not have been reflected in Irish legislation. In addition, the requirement for UK directors to have regard to ‘ the need to foster the company’s business relationships with suppliers, customers, and others’ in section 172 of the UK Companies Act 2006, does not, we believe, have a direct equivalent in Irish law. To the extent, however, that reporting requirements reflect extant European legislation requirements, this will also be addressed in Irish legislation.

Some further thought may be necessary as to how and whether the revised Guidance may apply in Ireland.

The ‘Supplement for Banks’ included with the proposed revised Guidance has been written in the context of the UK regulatory environment. We understand that there has already been some contact between the FRC and the Central Bank of Ireland with a view to assessing the implications of this Guidance in an Irish banking environment and are supportive of efforts in this regard.

Please contact me if you would like to discuss any of the points raised in our response.

Yours sincerely,

Aidan Lambe Director, Technical Policy

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Appendix

Question 1: Do you agree that the Guidance appropriately provides the clarification recommended by the Panel as to the purposes of the going concern assessment and reporting and is appropriate?

If not, why not, and what changes should be made to the Guidance?

As stated above, the Institute supports enhancements to the quality of disclosure of liquidity, solvency and viability/ sustainability risks in narrative reporting. However, we consider that the proposals as currently drafted lack clarity, particularly by the use of the term ‘Going Concern’ to refer to both the narrative reporting in the ‘front end’ of the annual report and the basis of preparation of the financial statements. As a result, there is a significant risk of confusion among users of annual reports and financial statements and a widening of the expectations gap.

Given that the Going Concern basis for the preparation of financial statements is a basic principle in IFRS, extant UK GAAP and FRS 100 to 102, we do not support use of the term ‘Going Concern’ to describe the narrative reporting on liquidity, solvency and viability/sustainability risks. Using a more appropriate alternative term would serve to de-link the two issues and address the significant risk that exists within the current proposals for confusion amongst market participants.

Question 2: Do you agree with the description in the Guidance of when a Company should be judged to be a going concern? Do you agree in particular that this should take full account of all actions (whether within or outside the normal course of business) that the board would consider taking and that would be available to it; and that, if the underlying risks were to crystallise, there should be a high level of confidence that these actions would be effective in addressing them? Is the term ‘a high level of confidence’ sufficiently understandable? If not, why not, and how should the description or term be modified?

Question 3: Do you agree with the approach the Guidance takes to the implications and nature of actions within or outside the normal course of business? Do you consider that the Guidance explains their nature sufficiently clearly? If not, why not and what changes should be made to the Guidance?

See also our covering letter.

Certain ‘new’ expressions and terminology are introduced by the paragraph 12 of the proposed guidance are likely further consideration. These include the terms ‘high level of confidence’, ‘reasonably predictable’ and ‘foreseeable future’. The distinction between actions ‘within or outside the normal course of business’ also needs further explanation, particularly if this is considered alongside FRS 3/FRS 101 treatment of the distinction between ‘exceptional ‘ and ‘extraordinary’ items.

As mentioned in our covering letter, the term ‘high level of confidence’ may be regarded as being such a high threshold that it may be difficult for many company directors to comment positively on whether they believe a company to be a ‘going concern’. This could, in turn, have ‘self-fulfilling prophecy’ implications.

As we have repeated in our covering letter, the Institute is supportive of enhanced disclosures of financial risks (including liquidity and solvency risks, as well as mitigating factors) by companies which would be of greater benefit to stakeholders in assessing the sustainability of an entity. The emphasis in the revised Guidance might be better directed towards how directors can improve on providing better quality disclosures that are already required by various legal and regulatory measures. In so doing, this might obviate the need for any ‘definition’ of going concern or facilitate the use of an alternative description.

Question 4: Do you agree with the approach taken to interpreting the foreseeable future and is this sufficiently clear in the Guidance? If not, why not and how should the Guidance be changed?

FRC should consider linking the ‘foreseeable future’ to the strategic planning process and economic planning cycle of the reporting entity. Transparent disclosures addressing the period considered are of critical importance.

We note that no consideration has been given in the proposals to the issue of disclosing prejudicial/commercially sensitive information. Guidance on this issue would be useful.

Question 5: Do you agree that the use of the term ‘going concern’ in the phrase ‘going concern basis of accounting’ is sufficiently clearly distinguished in the Guidance from its use in the Code requirement for a statement that the company ‘is a going concern’ and from its use in the accounting and auditing standards in the context of material uncertainties about the company’s ‘ability to continue as a going concern’? Is it clear from the Guidance that the statement the directors are required to make under the Code (that the Company is a going concern) should

reflect the board’s judgement and is not intended to be absolute? If not, why not and what changes should be made to the Guidance or the Code requirement?

As discussed in detail in the covering letter and in the response to question 1, the Institute does not consider that the distinction between the use of the phrase Going Concern with regard to the basis of preparation of financial statements and the Code requirement is clearly drawn. Indeed, in our response to question 3, we suggest that consideration be given to focussing on the quality of the disclosures required rather than requiring any form of positive statement on the reporting entity being a going concern, absolute or otherwise.

Question 6: Do you agree that the judgemental approach in the Guidance to determining when there are material uncertainties to be disclosed is the appropriate interpretation of the relevant accounting standards? Do you agree that the factors and circumstances highlighted respectively in paragraphs 2.30 and 2.31 are appropriate? If not, why not and what changes should be made to the Guidance?

We consider that the interpretation of accounting standards lies within the remit of the IFRS Interpretations Committee.

More fundamentally, we note that the IASB is currently considering the issue of ‘material uncertainty’ and whether and how the current approach in IAS 1 is in need of amendment.

Question 7: Do you agree that the interpretations adopted in the Guidance in implementing Recommendation 2(b) are consistent with FRS 18 and ISA (UK and Ireland) 570? If not, why not and what changes should be made to the Guidance or those standards?

As discussed earlier in this response, the concept of going concern as a basis of preparation for financial statements and the description of going concern in the Code are two distinct issues and therefore cannot be made consistent. Reference to going concern in auditing standards needs to be consistent with the accounting term and therefore cannot also be consistent with the Code requirement.

Question 8: Do you agree that Section 2 of the Guidance appropriately implements Recommendation 3? Do you agree with the approach to stress tests and the application of prudence in conducting them? Do you agree with the approach to identifying significant solvency and liquidity risks? Do you agree with the description of solvency and liquidity risks? If not, why not and what changes should be made to the Guidance?

Subject to earlier comments about removing references to going concern in narrative reporting and focussing on disclosures regarding liquidity, solvency and viability, the guidance appropriately

implements the recommendation to the going concern assessment of public interest entities (‘PIEs’). As also discussed earlier we would, however, suggest that more appropriate guidance may be necessary to assist non-PIEs and SMEs in particular in their application of the Guidance.

Question 9: Do you agree that the approach taken in Section 4 of the Guidance in implementing the disclosures in Recommendation 4 is appropriate? Is the term ‘robustness of the going concern assessment process and its outcome’ sufficiently clear? Do you agree that the approach the board should adopt in obtaining assurance about these matters is appropriately reflected in Section 3 of the Guidance? Do you agree that the board should set out how it has interpreted the foreseeable future for the purposes of its assessment? If not, why not and what changes should be made to the Guidance?

As mentioned in our comments above, we have an overarching concern in the revised Guidance of a ‘blurring’ of the different obligations on the generality of companies and those that are listed. This distinction needs to be clarified better. Indeed, in its final report, at paragraph 25, the Sharman Panel of Inquiry is quite specific that, initially at least, Recommendations 4 & 5 should apply only to those companies that are within the scope of the FRC’s Effective Company Stewardship requirements.

We believe some further guidance will be necessary on the meaning of the term ‘robust’. In this regard, we are also concerned that there may be a misunderstanding of the role of the auditors in some way providing ‘assurance’ to the board on the robustness of the going concern assessment.

As we have understood from discussions with FRC staff, the role of the auditor in this regard is derivative from a normal scope audit and that there is no suggestion of this scope being extended as a result of the revised Guidance. There may be more for the auditor to review, but the scope of the statutory audit remains unchanged.

We agree that the board should disclose how it has interpreted the term ‘foreseeable future’, subject to judgements having to be made about what information can be placed in the public domain.

Question 10: Do you agree that the proposed amendments to the auditing standards appropriately implement the enhanced role of the auditor envisaged in Recommendations 4 and 5? If not, why not and what changes should be made to the auditing standards?

We would have a strong preference for any modifications to the role of the auditor in this area being undertaken in an international context.

As referred to in our answer to Question 9 above, we do have a concern that the role of the auditor in this process will be misunderstood with the potential to add to the expectation gap.

It should be explicit in the revised Guidance that the role of the auditor in this process is purely ‘derivative’ in nature and that there is no extension to audit scope.

Question 11: Do you agree that it is appropriate for the Supplement to confirm that central bank support for a solvent and viable bank does not necessarily constitute a material uncertainty? In particular, do you agree that central bank support (including under ELA) may be regarded as in the normal course of business where the bank is judged to be solvent and viable? Do you agree that the approach set out in the Supplement to assessing whether there is a material uncertainty is appropriate and consistent with the general approach in the Guidance? If not, why not and what changes should be made to the Supplement to the Guidance?

Please note our earlier comments about the involvement of the Bank of England in the drafting of the Supplement and the need for appropriate consultation with regard to the Irish banking legal and regulatory environment.

Question 12: Do you consider the proposed implementation date to be appropriate? If not, why not and what date should the application date be?

The Institute does not consider the date of implementation to be appropriate. Indeed, one would not normally associate a ‘hard’ implementation date with a guidance document, rather a standard.

We do not support retrospective application of the guidance. In the event that our recommendations are not reflected in the final guidance, we believe that a lead-in period of a minimum of six months would be appropriate

Question 13: Do you believe that the Guidance will deliver the intended benefits? If not, why not? Do you believe that the Guidance will give rise to additional costs or any inappropriate consequences? For example, as compared with the 2009 Guidance, do you believe that the Guidance will give rise to fewer companies being judged to be a going concern and/or more companies disclosing material uncertainties? If so, what are the key drivers and can you give an estimate or indication of the likely cost or impact? Do you believe that such additional costs or impact would be justified by the benefits?

The Institute notes that there is potential for high costs associated with the proposals, particularly with regard to the “high level of confidence” that the Board requires in order to be able to judge that the company to be a going concern. Such costs, which would clearly impact on the profitability of these companies, may include fees to professional advisers in obtaining the necessary assurance. The proposals also risk diverting significant Board attention away from growth and job creation.

The Institute refers to the experience in the US following the implementation of the Sarbanes-Oxley requirements.

Question 14: Do you agree with the approach to SMEs in the Guidance? If not, why not and what changes should be made to the Guidance?

No. Please see our comments above.

Question 15: Are there any other matters which the FRC should consider in relation to the Guidance and the Supplement? If so, what are they and what changes, if any, should be made to address them?

We are somewhat puzzled by the assertion in paragraph 32 of section 2 of the revised Guidance that ‘when the board is unable to obtain a high level of confidence…but the going concern basis of accounting is appropriate…there will be material uncertainties to disclose.’ We would welcome clarification of this issue.