The nation and the globe are only just coming to terms with the initial shock of COVID-19 and its extraordinary impact on our society and economy. As financial year ends are either reached or approach, boards must now consider how they will report on how it affects their organisations. For many, the coronavirus crisis will complicate meeting reporting deadlines, while for a worrying number of entities, making the directors’ declaration of solvency will not be a straight-forward task. Similarly, assessing going concern given the high degree of uncertainty generated by COVID-19 will require focused attention. We outline some of the key considerations for boards in these areas.
Declaration of Solvency
At least annually, and half yearly in the case of listed companies, boards are required to pass a solvency declaration declaring that they have reasonable grounds to believe the company is solvent; that is whether they have reasonable grounds to believe the company can pay its debts as and when they become due and payable. A published directors’ report must refer to that resolution. In audited financial statements, the auditor is required to publish their opinion on the board’s declaration. A board that makes a negative statement of solvency would need to consider immediately moving to a voluntary administration or winding up.
Many boards may, for the first time, be considering issuing qualified statement to solvency. ASIC has said previously that such qualified statements are permissible, and their Regulatory Guide 22 - Directors’ statement as to Solvency, explicitly deals with the issue. Notably that ASIC guidance, issued in June 1992, may need to be re-visited if the economic shock of COVID-19 is as large, and long-lasting, as some experts fear.
A qualified statement as to solvency may give boards some flexibility when they are trying to turn a difficult situation around in COVID-19 circumstances. The nature of that qualification could then be the subject of discussion with the auditor, particularly if circumstances have changed between when the board made the declaration and when the director’s report is being audited. Auditors also have the option of issuing an unqualified opinion with an “emphasis of matter” paragraph pointing to the qualifications in the solvency declaration.
In practice of course, directors may be very reluctant to qualify their solvency declaration given the practical, commercial and legal implications that could follow. For example, a qualified solvency declaration may lead to a qualified audit opinion, which in turn leads to a breach of debt covenants.
In the AICD’s opinion, preparers of financial statements, directors, accountants and auditors will need guidance to assist them in navigating these difficult questions. The form that that disclosure might take, and the considerations that go into it, will need to form part of that guidance. More information on current and proposed guidance is set out below.
Given the Government has legislated a temporary safe harbour for directors from insolvent trading (see here), the AICD believes that broader policy settings, including with respect to solvency declarations, need to align with the Commonwealth’s objective of encouraging organisations to trade through the current crisis. Specifically, the desired impact from turning off insolvent trading liability could be undermined if directors rush towards voluntary administration given fears regarding solvency declarations. Importantly, it remains an offence for a director to provide a declaration of solvency without having reasonable grounds for his or her opinion.
Assessment of Going Concern
In addition to a solvency declaration, directors are required to assess going concern; that is whether the company can continue in operation for the next 12 months without any intention or necessity to liquidate or otherwise wind up its operations. Directors are required to publish this view in their financial statements and the auditor is required to form an independent view on its reasonableness. Assuming the entity is a going concern the accounts will then be prepared on a going concern basis.
To project out over 12 months directors, will need to form judgments on matters such as:
- liquidity risk;
- impairments of tangible and intangible assets including goodwill;
- the extent of potential operational disruption;
- potential diminished demand for products or services;
- access to capital;
- recovery of receivables and bad debt.
In the current COVID-19 environment, with circumstances changing daily and governments making previously unheard-of policy interventions, it will be very difficult for many entities to project out over 12 months with any degree of certainty. For many reporting entities, any projection will have to be so heavily qualified that users of financial statements will be able to gleam very little information as to the true prospects of the company. The disclosures also raises the potential for conflict with auditors because of the difficulty of making judgments over these issues and changing circumstances between director declarations and auditor’s assessment.
Directors may be able to deal with the going concern assessment by making a going concern statement with a material uncertainty around COVID-19 related issues. This will require disclosure by directors of some details of how COVID-19 has created a material uncertainty. For further guidance see this publication from the Auditing and Assurance Standards Board (AUASB). Auditors might react by issuing an unqualified opinion with an emphasis of matter paragraph detailing the COVID-19 material uncertainties set out by directors. Alternatively, and perhaps more worryingly for directors, the auditor may feel unable to accept the director’s judgment on prospects over the next 12 months and issue a qualified opinion. This might cause unnecessary reputational and financial damage to companies.
In the AICD’s opinion, the form and nature of the disclosures that directors may need to make around the going concern assessment and the material uncertainty it creates should be the subject of urgent guidance. Some initial guidance has already been provided by the Australian Accounting Standards Board (AASB) and the AUASB (see AICD summary here). The AASB and AUASB have advised that they are in the process of considering further guidelines, and the AICD will contribute to that process.
We also think it is important for the markets and users of financial statements to come to terms with the fact that many financial statements are like to have material uncertainty around going concern from directors and an emphasis of matter from auditors (if not qualified audit opinions). A measured approach from users of that information will facilitate and encourage proper disclosure from boards and entities. This should not necessarily be a black mark against an entity, but rather an acknowledgment of an extraordinary degree of uncertainty and a desire from entities for a full disclosure of those challenges.
For many boards, meeting reporting deadlines poses significant challenges in a COVID-19 environment. ASIC has the power to make both individual and class exemptions for deadlines for filing and/or publication of financial reports. The AICD’s position, is that a two-month extension should be provided for all entities balancing on 31 March and 30 June.
This will give entities the time and space to deal with some of the uncertainties around COVID-19 including the effects of impairments and asset write downs. Some companies may be severely affected and some less so; in those circumstances a form of blanket relief would level the playing field. An exemption will allow firms more time to complete their financial reports and/or audits, which may be impacted by physical distancing or workforce issues. We do not know, for example, how easy it will be conduct stocktakes over the next few months. Relief would also provide entities some time to undertake forward looking cash flow estimates on matters that may be very uncertain.
Regulators in the U.S., U.K., the E.U., Canada and New Zealand have all made blanket exemptions to reporting deadlines, albeit sometimes conditional on certain requirements.
ASIC’s current position is that a blanket exemption is unnecessary and that companies should apply individually, although it is continuing to monitor the situation. The AICD will continue to advocate to the regulator to provide such relief proactively rather than waiting for a wave of companies to make costly and resource-intensive applications for exemptions on an individual basis.
Thus far, only limited relief has been granted. On 9 April, ASIC announced a one month extension of reporting deadlines for unlisted entities whose financial years ended 31 December 2019 to 31 March 2020. Those entities normally have four months to file reports, meaning an unlisted entity with a 31 December year end would have had to file by the end of April.
However, no similar relief has been granted to listed entities. Listed entities with balancing dates of 31 December have already reported and, as yet, there has been no extension for those who balanced on 31 March. Listed entities can apply to ASIC for individual relief from their reporting obligations if they feel they are unable to meet their normal deadlines and are encouraged to do so as soon as possible. Listed entities will also need to comply with listing rules and should refer to the ASX’s guidance on extending reporting dates (see the AICD’s update here)
The Australian Charities and Not-for-profits Commission has provided blanket extensions to charities whose 2019 Annual Information Statement is due between 12 March and 30 August 2020 to 31 August 2020.
Keeping financial reporting front of mind
COVID-19 related issues around financial reporting are evolving rapidly. The AICD has been heavily engaged in policy discussions with government and regulators on behalf of the director community. We have sought to put forward sensible and balanced solutions that recognise the need to provide Boards, and their management teams, with time and space to grapple with the challenges confronting them, while providing users with the necessary reporting to make informed decisions. We will continue to bring the director voice to bear in policy discussions and will keep members informed of material developments.
Directors must think long and hard about their legal obligations with respect to financial reporting, as well as directors’ duties more broadly in times such as these. While directors must always pay close attention to their organisation’s financial situation, COVID-19 means the risk of failing in their duties becomes more acute. All diligent directors would be well-advised to receive regular updates on the financial state of their organisation during COVID-19, and not rely solely on management assurances or the working of audit or risk committees.