Interface for ‘Going Concern’ between IBC and SA570
Author: Sarthak Ohri
Date: September 5, 2019.
Since the inception of Insolvency and Bankruptcy Code, 2016 (“IBC’) there have been many cases referred under this code for the resolution of stressed companies. The code requires the resolution professional to keep the entity running as a going concern during the proceedings under this code. But the matter of concern in every case is that the terms ‘Going Concern’ has not been defined anywhere in any law or judgement. Due to the lack of a rigid definition or a guiding principle to this term, the fate of a stressed company is prone to litigation. The Principle of going concern is open to interpretation to adjudicating authorities, resolution professional, Creditors and even the corporate debtor who would move an application to the appellate authority for further interpretation in the event of liquidation being ordered.
Since the inception of Insolvency and Bankruptcy Code, 2016 (“IBC’) there have been many cases referred under this code for the resolution of stressed companies. The code requires the resolution professional to keep the entity running as a going concern during the proceedings under this code. But the matter of concern in every case is that the terms ‘Going Concern’ has not been defined anywhere in any law or judgement. Due to the lack of a rigid definition or a guiding principle to this term, the fate of a stressed company is prone to litigation. The Principle of going concern is open to interpretation to adjudicating authorities, resolution professional, Creditors and even the corporate debtor who would move an application to the appellate authority for further interpretation in the event of liquidation being ordered.
Section 20(1) of IBC talks about management of operations of the corporate debtor as going concern. It reads as,
"(1) The interim resolution professional shall make every endeavour to protect and preserve the value of the property of the corporate debtor and manage the operations of the corporate debtor as a going concern."
Though it not defined what is going concern in any law. Blacks Law Dictionary1 defines it as “If a company is a going concern, it is actually doing business, rather than having stopped trading or not yet having started trading.”
Even if in the ordinary sense we understand what is Going concern, there needs to be established some principles what support the assumption of going concern.
One such work of laying down some sample principles has been done by the International Auditing and Assurance Standards Board (IAASB) and Auditing and Assurance Board of the ICAI by laying down a Standard on Auditing, “IAS-570: Going Concern (by IAASB)” and “SA-570 (Revised): Going Concern (by ICAI)”. Though both these standards were laid down for the auditors to perform their functions effectively. The text of these standards lay down some principles, an illustrative list of some indicators and a checklist which can act as a guiding principle to understand whether an entity’s going concern assumption is appropriate or not. The Standards issued by ICAI are binding on auditors as per section 143(9) of the companies act, 2013, but the Resolution Professional (“RP”) should be able to draw guidance from above-laid principles.
Principles of Going Concern:
As per para 5 of both IAS-570 and SA-570, Management should assess the entity’s ability to continue as a going concern. This assessment involves making a judgment, at a particular point in time, about inherently uncertain future outcomes of events or conditions. The following factors are relevant to that judgment:
- The degree of uncertainty associated with the outcome of an event or condition increases significantly the further into the future an event or condition or the outcome occurs. For that reason, most financial reporting frameworks that require an explicit management assessment specify the period for which management is required to take into account all available information.
- The size and complexity of the entity, the nature and condition of its business and the degree to which it is affected by external factors affect the judgment regarding the outcome of events or conditions.
- Any judgment about the future is based on information available at the time at which the judgment is made. Subsequent events may result in outcomes that are inconsistent with judgments that were reasonable at the time they were made.
Here the management of affairs vests with RP so he should take care of above points while running the business.
As per Indian Accounting Standard – 1: Presentation of Financial Statements, In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least but is not limited to, twelve months from the end of the reporting period. The degree of consideration depends on the facts in each case. When an entity has a history of profitable operations and ready access to financial resources, the entity may reach a conclusion that the going concern basis of accounting is appropriate without detailed analysis. In other cases, management may need to consider a wide range of factors relating to current and expected profitability, debt repayment schedules and potential sources of replacement financing before it can satisfy itself that the going concern basis is appropriate.
Checklist as provided in the implementation guide to SA-570 and Indicators:
A detailed analysis for testing of related indicators regarding the uncertainty of going concern
consideration is briefly enumerated in the checklist provided in the annexure below. There are some examples provided in the standard individually or collectively, may cast significant doubt on the entity’s ability to continue as a going concern. This listing is not all-inclusive nor does the existence of one or more of the items always signify that a material uncertainty exists. Such example is also made part of the checklist2.
The significance of such events or conditions often can be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counter-balanced by management’s plans to maintain adequate cash flows by alternative means, such as by disposing of assets, rescheduling loan repayments, or obtaining additional capital. Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply.
The principles and checklist are certainly designed keeping the auditors objective in view but can definitely act as an assessment mechanism for the RP and other stakeholders who would like to verify whether the entity is performing as a going concern or not.
Annexure: (Checklist for SA-570 as amended considering the requirements of RP):
Particulars | Going concern indicator present (Yes/No/Not Applicable and References, if any) |
A: Going Concern Considerations During/After Resolution Process | |
· Consider whether there is a risk that the entity will not continue as a going concern for the foreseeable future: Consider Financial Indications · Recurring operating losses during resolution process. · Negative Net Worth. · Working capital deficiencies. · Continuing negative cash flows from business activities. · Excessive reliance on short-term borrowings to finance long-term assets. · Adverse key financial ratios. · Inability to pay creditors on due dates. · Default on loans or similar agreements. · Restrictions on usual trade terms. · Restructuring of debt. · Entered into any arrangement with creditors for reduction of payment. · Arrears or discontinuance of dividends. · Excessive or obsolete stock. · Unable to obtain finance for new product development or essential investment. · Need to seek new sources or methods of financing, or fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment. · Need to dispose of substantial assets. | |
Consider Operating Indications · Loss of key management or staff. · Work stoppages or other labour difficulties. · Substantial dependence on the success of a particular project or on a particular asset. · Management intentions to liquidate the entity or cease operations. · The emergence of a highly successful competitor. · Excessive reliance on the success of a new product. · Uneconomic long-term commitments. · Loss of a major market or principal supplier. · Loss of a key franchise, license, or patent. | |
Consider Other Indications · Non-compliance with capital or other statutory requirements. · Pending legal proceedings or similar matters that might jeopardize an entity’s ability to operate. · Changes in or establishment of new legislation or government policy. · Technical developments that render a key product obsolete. | |
B: Consideration of Management’s Assessment | |
1. Evaluate management’s assessment of the entity’s ability to continue as a going concern. | |
2. Inquire of management as to its knowledge of events or conditions and related business risks beyond the period of assessment used by management that may cast significant doubt on the entity’s ability to continue as a going concern. | |
3. Evaluate the information obtained above in conjunction with other information obtained that may impact the assessment of the appropriateness of the management’s use of the going concern basis of accounting. | |
C: Consideration of Management’s Plans | |
1. If, after considering the identified conditions and events in the aggregate, it is believed that continuance as a going concern may be questionable, the person assessing should consider management’s plans for dealing with the adverse effects of the identified conditions and events and assess the likelihood of effective implementation thereof. | |
2. Obtain information about management’s plans and consider whether it is likely that the adverse effects will be mitigated for the foreseeable future. Evaluate the likelihood of effective implementation of such plans. Plans that could be considered and discussed with management may include: · Plans to dispose of assets. · Plans to borrow money or restructure debt. · Plans to reduce or delay expenditures. · Plans to increase revenues more than increases in related costs and expenses. · Plans to increase ownership equity. | |
Consider the bases on which the plans have been prepared, giving consideration as to whether they conform with facts already known and to available independent evidence. | |
3. Carry out additional procedures to update information obtained earlier. Such procedures may include: · Information on relevant material legal matters from the entity’s legal counsel. · Existence, legality, and enforceability of arrangements to provide or maintain financial support with related and third parties, and assessment of the financial ability of such parties to provide additional funds. · Consideration of the entity’s position concerning unfilled customer orders. | |
D: Consultation | |
1. If it can be concluded that an entity’s continuance as a going concern for the foreseeable future is questionable, consider consultation within the firm to consider management’s plans. | |
E: Conclusion: · Based on the tests performed and responses as noted above, a conclusion may be drawn whether management’s use of the going concern basis of accounting is appropriate. |
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