Auditors raise doubts over 'going concern' concept during slump
June, 09th 2009
The growing complexities in companies balance sheets due to the global economic crisis and foreign exchange volatility have triggered a debate over one of the basic premises of financial accounting every company is a going concern that will not go out of business or liquidate in the foreseeable future.
There is no doubt that financial statements have become complex due to factors such as the economic situation and the forex volatility, says chartered accountant Suresh Surana, who is also head of accounting firm RSM Astute. Today, one cannot say with certainty that all companies are going concerns.
Every accounting standard is based on the premise that companies are going concerns, with an ability to function as business entities and are capable of continuing operations in the foreseeable future; these firms are also considered capable of realising their assets and meeting their liabilities.
But recent instances of many Indian companies, including a Mumbai-based drugmaker and a Chennai-based retail firm, starting talks with financial institutions to restructure debt after failing to pay off creditors and the collapse and bankruptcy filing of global leaders like Lehman Brothers and General Motors are threatening the universality of the going concern concept, say auditors.
Volatility in the forex market is one of the triggers. It can be explained by the fluctuations seen in the rupee-dollar trade; from Rs 40, to a peak of Rs 51, before falling to Rs 47, the greenback saw extreme movements in a span of 20 months.
For a company that had an existing forex liability of Rs 100 crore, the exposure fluctuated from Rs 400 crore, to Rs 510 crore, before ending at Rs 470 crore. Such volatility prompted the government to defer the accounting treatment for forex losses, called AS11, by two years, giving all Indian companies a big breather.
Even on impairment of assets, the basic tenets of the going concern concept are being overlooked.
As per accounting standard AS11, an impairment test should be done on assets, including fixed assets and goodwill, at the end of each reporting year.
Although most large-scale transactions in the last two years have seen major erosion in value due to the economic environment, not all companies are doing an impairment review, says Vaibhav Manek, a co-founding partner at accounting firm KNAV that audits Indian as well as international companies.
In the case of accounts receivables too, no provisions have been made on doubtful debts, he said.
Viren Mehta, a director at professional services firm Ernst & Young India, however, says that an accountant or auditor can always challenge the going concern assumption. A going concern assumption is one of the three fundamental accounting assumptions that are typically considered while preparing financial statements. The other two are consistency and accrual. When you prepare a financial statement, you should be aware of these assumptions, and depending on the circumstances, both external and internal affecting the company, the assumption of going concern should be appropriately challenged, he said.
If there is sufficient case to suggest that going concern concept need not be considered, the alternate premise, liquidation basis, can be opted for, which then evaluates asset values on a realisable estimate, Mr Mehta added.