Going concern and pension scheme financial statements: why it matters
The going concern basis of preparation of financial statements has come to prominence for pension schemes and their trustees in a way that it hasn’t done before.
This is due to changes to UK auditing requirements rather than changes to UK accounting standards or the Pensions SORP. The impact of the pandemic on the financial health of sponsoring employers is an additional relevant factor.
A new focus on going concern
By now most pension scheme trustees are likely to have had discussions with their auditor about preparing a going concern assessment and will have noticed that a bit more is being asked of them than in previous years. It is understandable that trustees will be keen to understand why this process is more onerous and why more audit work on going concern is needed.
The reasons are two-fold:
- A revised auditing standard on going concern, requiring auditors to undertake additional procedures. Revised International Standard on Auditing (UK) 570 applies to audits of financial statements for periods commencing on or after 15 December 2019.
- General concerns about the enduring impact of the COVID-19 pandemic on the financial health of sponsoring employers.
The Financial Reporting Council (FRC) has also issued guidance on the financial reporting aspects of going concern.
Worthy of note is the FRC’s Guidance on the going concern basis of accounting and reporting on solvency and liquidity risks (April 2016). The guidance is addressed to the directors of companies that do not apply the UK Corporate Governance Code to assist them in preparing a going concern assessment.
While these developments primarily focus on the corporate sector, private sector pension schemes are impacted as they prepare their financial statements in accordance with UK accounting standards and any audit work must be undertaken in accordance with the FRC’s auditing standards, known collectively as ISAs (UK).
Early dialogue between trustees and auditors is essential to ensure that trustees understand what they need to do to undertake a going concern assessment and to factor in time to collate the information needed to support the assessment.
The auditor’s primary focus of attention when considering a pension scheme’s going concern status will be to establish whether circumstances have arisen which have triggered the wind up of the scheme or that provide evidence that winding up may occur.
Assessing going concern
An entity is considered a going concern if its operations will continue for the foreseeable future. Its assets and liabilities are then recorded in the financial statements on the basis that the entity will be able to realise its assets and discharge its liabilities in the normal course of business. Where this is the case, it will be appropriate for the pension scheme financial statements to be prepared on a going concern basis.
In order to conclude whether the scheme is a going concern and to identify any related material uncertainties (including the impact of the pandemic), the trustees must make an assessment. The level of effort required in concluding on these matters will depend on the circumstances of individual schemes, for some schemes this process should be relatively straightforward.
The going concern assessment must meet the requirements of both UK accounting standards (FRS 102) and the Pensions SORP. This includes consideration of all available information about the future of the scheme, which looks forward at least twelve months from the date the financial statements are signed off.
Although the trustees’ responsibility for undertaking the assessment has not changed, the auditor’s approach to their work on going concern has been strengthened by changes to auditing requirements. Therefore, trustees should notice an increased emphasis on going concern matters by their auditor from the planning stage throughout the audit process.
Guidance on pension schemes and going concern
ICAS, ICAEW and the Pensions Research Accountants Group (PRAG) issued joint guidance on Pension scheme reports and financial statements in the context of the COVID-19 pandemic (May 2020). The going concern aspects of this guidance should be read in conjunction with PRAG’s going concern guidance. The joint guidance is available on the ICAS website.
PRAG updated its guidance on Pension scheme financial statements and going concern in December 2020 in response to both the revised auditing requirements and the possible implications of the pandemic on pension schemes. The PRAG guidance and the joint guidance are available to PRAG members on its website.
More about revised ISA (UK) 570
Among the changes to the revised ISA (UK) are greater emphasis on the need for the auditor to demonstrate how they have challenged management’s going concern assessment, and to thoroughly test the adequacy of the supporting evidence and evaluate the risk of management bias.
There is an overarching requirement for the auditor to obtain sufficient appropriate audit evidence to support their opinion on the financial statements and this standard of evidence applies to the auditor’s work on going concern.
In evaluating the trustees’ assessment, the auditor will likely consider and conclude on factors including:
- The relevance and reliability of the underlying data used to make the assessment.
- The underlying assumptions used by the trustees in making their assessment and evidence in support of those assumptions.
- Trustees’ future plans for the scheme, including whether the plans are likely to strengthen the financial health of the scheme and be feasible in the circumstances.
- Any additional facts or information which have become available since the trustees made their assessment.
In context, the auditor’s evaluation of the trustees’ assessment will likely include consideration of the nature and extent of the governance arrangements surrounding the assessment and oversight of those arrangements by the trustees.
Both the trustees’ assessment and the work undertaken by the auditor will vary significantly depending on the nature of the pension scheme and its sponsoring employer. For example, the size of the scheme, its complexity, that type of investments held, funding arrangements, employer covenant strength, employer industry sector and reliance on third parties.
Trustees will need to make complex and sometimes difficult judgements about the going concern status of their scheme. The PRAG guidance will support them in doing so by providing examples of matters and circumstances that may lead to non-going concern or material uncertainty disclosures.
The PRAG guidance provides a template for a going concern assessment and includes examples of:
- Key matters which may be considered by the trustees in making their assessment. These include employer covenant strength; scheme cash flow forecasts; and funding levels.
- Evidence to support conclusions reached.
Where the non-going concern basis is adopted, its impact on items in the financial statements must be reported. In these circumstances, it is likely that the value of most scheme investments will not change as a result, as investments are usually valued on an exit basis.
In order for the trustees’ report to be consistent with the financial statements, where the non-going concern basis of preparation is used, the trustees will need disclose this in their trustees’ report with an explanation as to why the non-going concern basis is appropriate.
The auditor’s report
Trustees will also notice changes in the wording of the auditor’s report around going concern. The auditor must state in their report that the trustees’ use of the going concern basis of accounting is appropriate and explain how they have evaluated the trustees’ going concern assessment, along with the key observations from their own evaluation.
There is also an existing requirement for the auditor to report whether any material uncertainties relating to events or conditions that, individually or collectively, may cast significant doubt on a scheme’s ability to continue as a going concern for a period of at least 12 months from the date the financial statements are signed off.
Where any material uncertainties exist and have been adequately disclosed in the financial statements, the auditor must include a separate heading in their auditor’s report ‘Material uncertainty related to going concern’, which draws attention to the related note in the financial statements. This does not mean that the auditor’s report has been qualified or modified in any way.
When any material uncertainties have been identified, it is important for the trustees and auditors to discuss any additional evidence that the trustees should provide and any additional work to be undertaken by the auditor to assess the evidence.
In context, the auditor’s evaluation of the trustees’ assessment will likely include consideration of the nature and extent of the governance arrangements surrounding the assessment and oversight of those arrangements by the trustees.
In conclusion
By now the majority of schemes are likely to have established governance arrangements around the trustees’ assessment of going concern. Early discussion between trustees and auditors each year about the going concern assessment will be important in respect of each scheme year, and reference to the available guidance should continue to be of assistance.
An earlier version of this article was published by the Pensions Management Institute in September 2021.