Liverpool FC are in the news at the moment with their manager Rafael Benitez leaving by mutual consent last night. Liverpool are one of the most famous football clubs in the world. Last month they released their accounts for the year to 30 July 2009.
Their financial results weren’t very impressive with their accounts showing the biggest loss in their history (£55 million) as well as significant loans (£250 million).
Their auditors, KPMG, stated that Liverpool are now “dependent on short-term [bank loan] facility extensions” and “this fact indicates the existence of a material uncertainty which may cast significant doubt upon [Liverpool’s] ability to continue as a going concern”.
Most of you will know that going concern is a fundamental accounting assumption. In the normal run of things, the financial statements make no mention of it. Similarly, the audit opinion makes no specific mention of going concern, except in unusual circumstances.
Ignoring the specific issues involving Liverpool, going concern generally presents a tricky problem for the auditor. If an auditor mentions going concern as a specific worry, it is likely that the company will fail. The act of mentioning it could become a self-fulfilling prophesy.
Some would argue that there’s a significant divergence between what auditors actually say and what readers hear.
Looking at the three ways of reporting on going concern under ISA 705:
Situation 1: The company appears likely to be a going concern.
What auditors say: Nothing.
What auditors mean: The company appears to be a going concern, but there are no guarantees.
What investors hear?: All is well. Invest with no fear of possible insolvency. Go forth and be merry.
Situation 2: Additional disclosures about elevated uncertainty about going concern.
What auditors say: The financial statements give a true and fair view, but we emphasise the disclosures by the directors about the elevated going concern risk in note x…
What auditors mean: The company’s continuing existence depends on the outcome of this external event. It could go one way or the other, but it’s impossible to say which. Take caution.
What investors hear?: The company is in serious trouble. Run away. If you are a depositor in a bank, get all your money out right now before it’s too late.
This difference in what we say and what people hear means that this option is hard to use.
Situation 3: The company is not a going concern
What auditors say: Either an adverse opinion (if the accounts aren’t prepared on a break up basis) or unqualified opinion with emphasis of matter (if they’re produced on a break up basis).
What auditors mean: The company is probably not a going concern. It might be in the process of an orderly winding down in order to return money to investors. Take extreme caution in investing, as there’s a very short time to recover your investment.
What investors hear?: RUN FOR THE HILLS! If you have already invested money in this company’s bonds or shares, you’ve lost it; make your peace with your grief and move on.
So in effect, mentioning going concern could be the kiss of death for many companies.
Could there be a better system to use? The international market for bonds for example has long had a well understood and much more subtle system, using gradings such as the Standard and Poor’s grading system of grading risk of default on bonds from AAA rating (virtually no risk) to BBB (becoming speculative) to D (virtually dead).
In the current high risk, post recessionary environment, might it be better for to adopt a similar system for going concern and thus the company’s shares as well as bonds? The directors could present a separate report on going concern and assign their own S&P style grading, which the auditor could then perform a review engagement upon under ISRE 2400, giving investors explicit but limited assurance on the directors’ classification. By doing that, the spectrum of risk that going concern represents could be more accurately reflected in the financial statements.
Going back to Liverpool, there’s a view that some football clubs are too big to go out of business and I’m sure that most Liverpool supporters believe they will still be cheering on their team for many years to come and the subject of “Going Concern” isn’t top of their agenda.