AUDIT IMPLICATIONS ARISING FROM COVID-19

The coronavirus (COVID-19) has been classified by the World Health Organisation (WHO) as a global pandemic. As Governments are adopting structured and precautionary actions to prevent and delay the spread of the infection, many businesses are facing significant challenges in dealing with the evolving crises.  
 
COVID-19 was initially seen as particularly relevant for Groups and individual entities either operating in (wholly or partly), dependent on supply chains linked to, or having close trading associations with, China. The zone of potential impact has now spread much wider – this is now essentially to a greater or lesser extent a global concern and it could potentially have an impact on audits and audit firms of all sizes.

Accounting regulators and bodies across the globe have been issuing specific consideration for auditors relating to COVID 19, including staff audit practice alerts by the International Auditing and Assurance Standards Board, frequently-asked questions (FAQs) by the American Institute of Certified Public Accountants, guidance set out by the Financial Reporting Council in UK, a compilation of guidance by Institute of Chartered Accountants in England and Wales in its “COVID-19 hub” webpage, alerts issued by the Hong Kong Institute of Certified Public Accountants and Institute of Singapore Chartered Accountants, FAQs by the Malaysian Institute of Accountants, etc. This article highlights some of these key risk considerations for auditors.
 

Audit Quality

 

• Audits should continue to comply fully with required standards.

• In the current circumstances additional time may be required to complete audits and it is important that this is taken, even at the risk of delaying company reporting.

• Auditors should consider the impact of COVID-19 on:

  • How they gather sufficient, appropriate audit evidence, recognising that the planned audit approach may need to change and alternative procedures developed;

  • The adequacy of disclosures made by management about the impact of COVID-19 on the company;

  • The need or to reassess key aspects of their audit as a result of the fast-changing situation, which may require management to provide further evidence.

• Entities also need to understand that it is vital auditors have sufficient time and support to carry out their work to a high standard, including reassessing work done to reflect changed circumstances. In some cases, they may need to reconsider their reporting deadlines. Communication between auditors and audited entities will be vital.

 
Presentation and Disclosure

Audited entities will need to consider carefully what disclosures regarding risks should be included in their accounts. The precise disclosures necessary will of course depend on the nature and circumstances of the entities and their operations, the financial reporting frameworks under which they operate and the risks they face arising from the current situation. Relevant factors could include:

• operations or manufacturing in an area where the impact of current events has been significant with potential staff shortages, supply chain disruption and production delays

• significant trading links or global supply chains that are dependent on the export or import or even transportation of goods or components
   

Risk Assessment

For audits currently taking place, relating to 2019 year ends, auditors may need to consider whether their existing risk assessments relating to areas including Going Concern, Debtors, Stock and Investment valuations need to be revised. For audits of 2020 year end accounts, the initial risk assessment should include consideration of the areas mentioned above. It may also be appropriate to focus on estimates, foreign exchange, loan covenants, long term contracts, the value of WIP, the use of service providers and fraud risks in the context of the current situation.

Impairment of Assets

The carrying value of assets and liabilities may be affected with a need to perform additional impairment tests and to assess whether leases have become onerous. For December year-end reporters these events may represent non-adjusting subsequent events as at 31 December 2019 however for year ends in 2020 the revised values may need to be reflected.
 

Going Concern

 

• The current situation is clearly having and will continue to have an impact on many entities – this could potentially affect their going concern status.

• Entities that continue to be a going concern may now face material uncertainties relating to their ability to maintain this in the future.

• It is unlikely to be appropriate to take a blanket approach or use boiler-plate wording: each entity must be considered based on its own nature and circumstances.

• For some entities, the impact of COVID-19 may leave management with no realistic alternative but to liquidate or cease trading. Others may need to scale back operations or seek additional finance (this could have additional audit implications including relating to fraud risk).

• It remains management’s responsibility to make the assessment as to whether an entity is a going concern.

• Management’s assessment would be expected to include detailed forecasts. These forecasts will need to be updated regularly until the financial statements are authorised for issue. They should reflect potential scenarios and management’s plans.

• The assessment should include consideration of the impact of events on issues including but not necessarily limited to, staff, suppliers and customers. It should also take into account insurance considerations (if any). This also may be a fast-changing situation.

• The financial statements should not be prepared on a going concern basis if events and conditions after the reporting date mean that an entity is no longer a going concern.

• When management is aware, in making its assessment, that the existing or potential impact of COVID-19, of there being material uncertainties which may cast significant doubt upon the entity’s ability to continue as a going concern, IFRS require those uncertainties to be disclosed in the financial statements.

• Auditors’ responsibilities are to:

  • obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements.

  • conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity’s ability to continue as a going concern.

  • where events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists.

  • consider the implications for the auditor’s report.

• The implications of material uncertainty over going concern for the auditor’s report will depend on the audit evidence obtained, the basis of preparation adopted and the disclosures made by management in the financial statements. The current situation does not actually change this – however, given the volatile and fast moving circumstances it may be worth considering the possibility of delaying the approval of financial statements until there is more certainty about the impact of COVID-19.

Estimates

Risks relating to estimates are likely to increase for many audited entities, since assumptions used in making those estimates may no longer be valid. There may also be risks relating to the availability of information or qualified individuals within the audited entity to actually perform the estimation process.
 

Debtors

The risk of bad debts may increase for some entities, depending on the nature and circumstances of their operations. This could also have an impact on going concern and cash flow.
 

Creditors

The risks relating to loan covenants may increase for entities where these are a feature of their operations and finance model, particularly where covenants include clauses relating to profit or income levels.
 

Internal Controls

The risks relating to the operation of an entity’s system of quality control are unlikely to be impacted by current events so far as 2019 year end audits are concerned. For audits or interim audits of 2020 year ends however, such risks could increase depending on the nature and circumstances of the entity’s operations. This risk could extend not just to the operation of specific control procedures but also to such areas as proper maintenance of d records. There may also be risks to data completeness and integrity particularly where cloud solutions or shared service providers are used.
 

Fraud Risks

Uncertain times can be a fraud risk indicator as can many of the circumstances caused by uncertain times – understaffing, financial pressure, potential breakdown in controls – these factors can lead to both the opportunity and the incentive for fraudulent financial reporting and, in some business sectors, misappropriation of assets especially where controls which rely on actual physical presence (e.g. security guards and checks) are compromised by staff shortages.
 

Refunds and Cancellations

For entities which sell or provide services related to for example travel, holidays, events, there may be significant reductions in their income stream at the same time as refund circumstances are triggered. Where these are significant amounts there may be heightened risks of misstatements in addition to risks to going concern.
 

The Conduct of Group Audits

Audit firms acting as group auditors may have additional challenges where the groups they audit have components in overseas jurisdictions whether or not those jurisdictions are currently particularly impacted by the current situation. This will present logistical challenges for the group auditor, particularly where an audit firm acts as group auditor for several transnational groups.
 
The particular logistical risks arising from group audits are:

• missed deadlines – if a component auditor is operating in an area where there has been a significant impact on their ability to work, they may not be in a position to provide information to previously agreed deadlines

• supervision and review – travel is currently constrained between many jurisdiction

For firms which are in this situation it will be most helpful to first identify the population of audits involved, clarify the significance of components, the interaction of deadlines and the current circumstances in relevant jurisdictions.
 
For audits in progress currently, it may be that the impact of the situation on specific components (or on component auditors) have resulted in either information or evidence not being provided or obtained, or other work being postponed. This could have a knock-on effect to the rest of the audit and also on the consolidation process. It may be possible to amend timescales or even delay the reporting date. This will of course be subject to regulatory considerations but where the possibility exists it is worth considering.
 
Group auditors should consider alternative activities to demonstrate review and evaluation of component auditor where the original plan included a physical visit by the group auditor. Alternatives could include:

• Remote file/workpaper reviewing

• Video or conference calls

• Where difficulties have been caused by lack of component auditor staff availability, the group auditor (or staff members) performing tasks originally assigned to the component audit team

Where alternative procedures are undertaken, the group auditor may need to amend the group risk assessment. The group auditor will also need to be satisfied that sufficient audit evidence has been obtained and, if there are any implications for the audit report.

Subsequent Events

Auditors will need to perform subsequent events review covering the period from the date of the financial statements and up to the date of the Auditor’s Report. In particular, auditors will need to perform audit procedures to ensure all the subsequent events have been identified, and consider the appropriateness and adequacy of disclosures in the financial statements for any material subsequent events as a result of the coronavirus outbreak.
 

Key Audit Matters

For the determination of key audit matters, auditors will need to consider any matters required significant auditor attention in performing the audit, especially for areas with higher assessed risk of material misstatement or significant risks, areas that involved significant management judgment or high estimation uncertainty.
 

Other Information

Entities may include other information or additional risk discussion in relation to the coronavirus outbreak in the financial statements that may undermine the credibility of those financial statements and the auditor’s report. The auditor will need to read the other information to identify material inconsistencies with the audited financial statements and the auditor’s report thereon and take appropriate response.
 

Quality Management

This is obviously a difficult time for everyone. Firm leadership has an overall responsibility for Quality Management - the challenges many jurisdictions are currently facing may have an impact on the conditions and events that relate to audit firms and their systems of quality management. The following points may be useful when considering how to support quality management at this time:

• Governance and leadership – as always there should be a clear message from firm leadership that the commitment to quality remains. In difficult times the temptation to cut corners is often present. Firm leadership should ensure there is a consistent message that this is not what they want to see.

• Client acceptance and continuance – existing client acceptance and continuance decisions may need to be revisited in order to confirm that firms have sufficient appropriate capacity resources and competence to perform the work required. This may be an issue for firms suffering significant staff shortages, or operating in areas where there are travel restrictions, or where clients have some or all of their operations in areas with travel lockdowns. Since this will probably only be temporary it is possible that rescheduling engagement fieldwork or performing some audit work remotely will be a suitable solution – however it will be important that firms and their staff recognise that they will need to address any issues and demonstrate that those issues have been resolved appropriately

• Resources – in those jurisdictions where there are staff shortages due to illness or travel restrictions/lockdowns firms should endeavour to ensure that jobs are either appropriately staffed or, where this is not possible, deadlines are extended to enable enough time for those present to do the work that needs to be done, and also for additional supervision and review if required. It may be that training events have to be cancelled or postponed due to the current situation and this is of course understandable however the firm should ensure that when things regularise, any missed training is rescheduled and received in a timely fashion. This would also apply to other quality related activities such as annual appraisals – there is no problem postponing them, there would be a problem if they were never rescheduled.

• Monitoring and remediation – the current circumstances may have an adverse impact on planned IMP activities. As with training events noted above – if postponement is unavoidable then it will be understandable however also as with training events, rescheduling should be a priority once the situation improves.