Going concern basis of reporting in a Start-up Enterprise

Under section 134 (5) of the Companies Act 2013 it is desirable as part of the responsibility statement for the Board of Directors to state in their report that the annual accounts are drawn or prepared  on a Going Concern Basis. It is further required upon the Board to state in their report that in the preparation of the annual accounts, the applicable accounting standards have been followed along with proper explanation relating to material departures.

Paragraph 9-10 of the Accounting Standard 1 which details the Fundamental Accounting Assumptions in the preparation of financial statements state as under:

9. Certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed.

10. The following have been generally accepted as fundamental accounting assumptions:—

1. Going Concern

The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.

1. Consistency

It is assumed that accounting policies are consistent from one period to another.

1. Accrual

Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate.

In the parallel Paragraph 25-26 of the Ind AS 1 provide the following broad requisites in carrying out assumption of going concern:

Going concern

25. When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.

26. 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.

Both the Companies Act as well as the accounting standard therefore necessitates preparation of financial statements on going concern basis of assumption in all cases barring the following case instance:

1. Liquidation scenario;
2. Closure of trading operations without any sign of revival.

Other than this the standard does not provide for any start up period before when it is mandatorily desirable to express on the going concern basis in the preparation of annual accounts.  Under Government of India Gazette Notification No. G.S.R. 127(E) dated 19 February 2019 an entity shall be considered as a Startup:

1. Upto a period of ten years from the date of incorporation/ registration, if it is incorporated as a private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India.
2. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees.

• Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

Start ups by their very nature face high level of continued uncertainty since the time of their set up and they have high rates of failure. But until the expiry of period of 10 years they hold on to their start up recognition and remain entitled to various benefits and entitlements under the start up India scheme of the Government of India. This kind of recognition would hold good even till the time the turnover of the given entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees meaning therefore that they are given a certain period of gestation time during which the various rules and regulations shall stand relaxed for them.

Given this well established scenario is it fair therefore that:-

‘A start up entity before it matures into an age of 10 year be subject to basis of opinion in each of the 10 gestation years for material uncertainty related to going concern or for occurrence of material uncertainty?’

As per the revised CARO reporting it is now desirable for an auditor to make a separate reporting disclosure of the material uncertainties related to events or conditions that may cast significant doubt upon an entity’s ability to continue as a going concern. In the absence of adequate disclosure of material uncertainty by the management the auditor would be required to bring an adverse or qualified opinion.

Standard on Auditing (SA) 570 (Revised) Going Concern

Paragraph 21-24 of Standard on Auditing (SA) 570 (Revised), Going Concern brings out following implications for the auditor’s Report.

21. If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the preparation of the financial statements is inappropriate, the auditor shall express an adverse opinion. (Ref: Para. A26–A27) Use of Going Concern Basis of Accounting Is Appropriate but a Material Uncertainty Exists Adequate Disclosure of a Material Uncertainty Is Made in the Financial Statements

22. If adequate disclosure about the material uncertainty is made in the financial statements, the auditor shall express an unmodified opinion and the auditor’s report shall include a separate section under the heading “Material Uncertainty Related to Going Concern” to: (Ref: Para. A28–A31, A34) (a) Draw attention to the note in the financial statements that discloses the matters set out in paragraph 19; and (b) State that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of the matter. Adequate Disclosure of a Material Uncertainty Is Not Made in the Financial Statements

23. If adequate disclosure about the material uncertainty is not made in the financial statements, the auditor shall: (Ref: Para. A32–A34) (a) Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705 (Revised)4; and (b) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the financial statements do not adequately disclose this matter. Management Unwilling to Make or Extend Its Assessment

24. If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor shall consider the implications for the auditor’s report. (Ref: Para. A35)

A start up entity is designed to make a foot in a period of ten years until which time there should in all fairness be no requirement to make a judgment about inherently uncertain future outcomes of events or conditions during such period. It will therefore be wise to exclude a start up registered entity from reporting on going concern. Necessary relaxing amendment may be made in the Companies Act 2013 as well as in the follow through Standard of Auditing 570.

Gopal Nathani

FCA