An ongoing concern for firms
As we enter both the key auditing period and release of financial results for Gulf companies over the next couple of months, one of the main focus areas for auditors, company directors and investors will be "going concern" statements included as part of international auditing standards.
A going concern assessment involves consideration of the facts and circumstances of an individual company. Directors need to ensure that they prepare thoroughly for their assessment of going concern and make appropriate disclosures; auditors need to ensure that they consider fully the going concern assessments and refer to going concern in the auditor's report only when appropriate; and investors and lenders need to be prepared to read and evaluate all of the relevant information in annual reports and financial statements before reacting. Directors of subsidiary companies of a group need to make their own going concern assessment taking into account the specific facts and circumstances of the subsidiary company and in particular the need for support from the parent company and the ability and willingness of the parent company to provide such support.
Despite the recovery or semblance of stability returning to both regional and global financial markets, many companies are still under pressure, whether that be financial, liquidity or debt pressure, or a combination of all. Specific challenges for regional companies include negotiating successful refinancing with facilities becoming due over the next 12 or so months with still ongoing financing and liquidity pressure despite some improvement over the past six months.
The validity of the going concern assumption in the preparation of reports continues to be a significant issue in current market conditions despite the more stable financial markets. An emphasis of matter paragraph is a section which highlights and draws attention to a matter affecting the financial report. A number of Gulf companies had such paragraphs in their 2008 audited reports and again in their June interim reports for those companies listed. Common reasons for the emphasis of matter paragraphs were: negative or minimal net assets or net current assets; uncertainty over the recoverability of the value of assets; and a debt refinancing or purely financing requirement.
As well as debt refinancing, the value of asset write-downs will remain an issue, as it was last year, but not to the same extent. That said, the recent surprising revelation of France's SocGen that it will need to take further provisions on the value of its collateralised debt obligations and credit default swaps, indicates there are still market challenges, particularly connected to valuation of market assets. However, although some Gulf institutions hold "toxic" asset type securities, the overall level is low and generally has already been adequately provisioned for.
Auditors issue "going-concern opinions" when they have determined that there is substantial doubt about a company's ability to meet its obligations and continue as a going concern for the next 12 months.
The economic downturn and significant corporate leverage has put a large number of companies at risk of receiving a going-concern opinion. Going concern opinions can create troubling issues for the companies that receive them, including the loss of trade credit, customer defection, non-compliance with debt covenants, repricing of outstanding debt and the inability to obtain additional financing. Most damaging of all, investors and other key stakeholders may view the going concern opinion as an indication that the business will ultimately fail.
Auditors must consider several factors during their annual client reviews that may signal that a company won't be in existence 12 months from now. Among them: negative recurring operating losses, working capital deficiencies, loan defaults, unlikely prospects for more financing, and work stoppages. Auditors also consider such external issues as legal proceedings and the loss of a key customer or supplier.
Much depends on both the toughness and scrutiny of regional regulators and auditors in regard to debt refinancing, liquidity and asset valuation assumptions for company accounts and, in turn, going concern approval. Particularly in regard to Gulf investment properties, many firms are unrealistic about growth and discount rates connected to cash flow projections as well as being opaque about the calculation of the fair value of assets.
Although the period for the going concern outlook is theoretically 12 months, directors need to take into account a firm's prospects over and above a year, particularly in respect to refinancing if debts are coming due outside one year and, without refinancing, the firm would struggle as a going concern. Where the ability of a firm to continue as a going concern is subject to refinancing, the firm should keep the market informed about the status of finance negotiations, and particularly if the company is listed.
Liquidity risk is a major element of going concern confirmation, perhaps the most important factor. Although market liquidity in the wider Gulf financial system has improved recently, it is still very tight and banks are still cautious about increasing exposures or even maintaining current levels. In some cases they realise they need to rollover debt to allow the company to continue in business, in other cases overt pressure from official agencies have pushed financial institutions to maintain support for entities.
An analysis of borrowing documentation should be undertaken to ensure that all critical terms and conditions are identified so that the risks to continued compliance can be assessed. If there is uncertainty over the contractual arrangements with lenders and other providers of finance, directors should seek confirmation from the lenders of the principal terms and conditions.
Moderate stability has returned to the region but there are still many Gulf companies facing financial and strategic challenges. This is likely to see a number a going concern qualifications for firms' 2009 financial reports.
- The writer is a US-based commentator on international business affairs
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