A few months before XL Leisure Group, Britain’s third-largest tour operator, filed for bankruptcy in September, leaving thousands of holidaymakers stranded, it issued a set of accounts, signed off by its auditors, that gave no hint it was about to go bust. Such experiences haunt auditors as they grapple with year-end accounts in the cruellest economic climate most have ever experienced. “Companies and their auditors have got to get used to the idea that nothing is as it used to be,” comments Will Rainey, a partner at Ernst & Young, one of the big-four accounting firms.
The problem is that year-end accounts are prepared on the basis that a business is a “going concern”, ie, that it will operate for the foreseeable future, or at least 12 months after the reporting period. That judgment is made by the board of directors, and auditors have to agree with it.
The difficulty they face is that most companies fund their operations in part through borrowing, which can stretch from simple overdrafts to huge syndicated loans. Each year, auditors will often seek letters from their clients’ bankers reassuring them that they will renew lending facilities in the ordinary course of business. But this year many banks may well refuse to write those letters because they do not want to commit to new lending. It will lead to some difficult judgment calls on the availability of funding next year, Mr Rainey says.
According to international standards, directors and auditors usually have three options with accounts: they can prepare them on a going-concern basis, which is standard but might expose them to charges of negligence if they are wrong; if they do not believe the business is a going concern, they must prepare the accounts on a break-up basis; or they can express some doubts about the company’s future, but still prepare the accounts on the going-concern basis. (Britain’s Financial Reporting Council has suggested a fourth alternative, that would express “serious doubt” about the ability of the company to continue as a going concern. But auditors say this may add to confusion.)
The temptation this year will be to express some doubts about funding uncertainties, but auditors realise that if they do that too widely, the caveat will become meaningless. Steve Priddy, of the Association of Chartered Certified Accountants, says that the onus will be on directors to be frank about any worries, even when they consider the firm a going concern. But if banks do not want their most creditworthy clients to suffer, they should be a bit bolder, too. After all, many now have the explicit backing of their governments. So they can afford to be a bit more public-spirited in these peculiar times.