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Is Covid-19 expected to impact financial reporting?
The Institute’s Financial reporting Implications of Coronavirus webpage has further information of the implications of the current situation.
The Financial Conduct Authority (FCA), Financial Reporting Council (FRC) and Prudential Regulation Authority (PRA) issued a joint statement on 26 March in which they announced a series of actions to ensure that information continues to flow to investors and to support the continued functioning of the UK’s capital markets.
The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, has issued a Public Statement on the implications of the COVID-19 pandemic on the deadlines for publishing financial reports which apply to listed issuers under the Transparency Directive, ESMA expects NCAs during this specific period not to prioritise supervisory actions against issuers in respect of the upcoming deadlines set out in the TD regarding:
a. annual financial reports referring to a year-end occurring on or after 31 December 2019 but before 1 April 2020 for a period of two months following the TD deadline; and
b. half-yearly financial reports referring to a reporting period ending on or after 31 December 2019 but before 1 April 2020 for a period of one month following the TD deadline.
ESMA also recommended on 11 March 2020 that entities, particularly issuers, should provide transparency on the actual and potential impacts of Covid-19, to the extent possible based on both a qualitative and quantitative assessment on their business activities, financial situation and economic performance in their 2019 year-end financial report if these have not yet been finalised or otherwise in their interim financial reporting disclosures. The FRC communicated a similar sentiment to companies on 18 February 2020 and auditors on 16 March 2020.
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How is financial reporting expected to be impacted?
The financial reporting impacts will depend on facts and circumstances, including the degree to which an entity’s operations are exposed to the impacts of Covid-19.
Particular areas expected to be impacted are as follows:
- Management’s assessment of the entity’s ability to continue as a going concern;
- The potential need for additional disclosures, including subsequent events, in the financial statements and other information, as well as principle risks and uncertainties.
- Accounts and disclosures related to judgements and estimates and/or dependent on cash flow forecasts and discount rates (e.g. fair value assessments, impairments, asset valuations, expected credit losses, inventory obsolescence, recovery of deferred tax assets, debt covenants, etc);
- Changes to internal control over financial reporting may be affected due to the impact of Covid-19 in respective group locations.
- Reporting or filing timelines may be impacted by the inability to prepare financial information or to audit that information.
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Going Concern and subsequent events
Responsibilities of those charged with governance/management
Management of audited entities are required to make a specific assessment of the entity’s ability to continue as a going concern; this should include a comprehensive and timely assessment of the Covid-19 threat to their business. The entities should produce clear documentation that sets out the impact on their business operations, risk mitigation processes and impact on financial reporting. Management’s going concern assessment may be affected by an increased risk to supply chain, access to markets or from a potential macro-economic downturn. Working capital could also come under pressure due to labour difficulties, export/import restrictions and collection of cash. Entities with significant supplier and/or customer bases in higher risk countries are likely to be at particular risk whilst entities with smaller headroom under “business as usual” conditions are also expected to be impacted. For example, the temporary closure of businesses and the cancellation of events may have a significant negative impact on the cashflows of an entity and therefore the related going concern assessment.
Responsibilities of auditors
Audit teams should robustly assess the going concern and viability risks relating to Covid-19 threat in compliance with ISA570. This includes evaluating whether there is adequate support for the assumptions underlying management's assessment and the consistency of these assumptions across the entity’s business activities.
ISA (Ireland) 570 requires the auditor to obtain sufficient appropriate audit evidence regarding, and to conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements, and to conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity’s ability to continue as a going concern.
The auditor cannot form this conclusion until management have made its own assessment and conclusion on this matter. Therefore, the auditor needs to ask management for this assessment and “challenge” its appropriateness in the current situation.
Auditors may consider the following steps
- Inquire of management as to what assessment they have made of the entity’s ability to continue as a going concern, in light of the current circumstances with Covid-19.Clear documentation that sets out the impact on their business operations, risk mitigation processes and impact on financial reporting is required;
- Evaluate this assessment, in particular whether there is adequate support for the assumptions underlying management's assessment and the consistency of these assumptions across the entity’s business activities;
- Consider the adequacy of disclosures that management plan to make. Auditors will need to call out where the disclosure is not specific enough and does reflect the uncertainties that exist in respect of going concern; and
- Form a conclusion and determine the impact on Audit Reporting, see below.
Reporting
The Covid-19 threat may require auditors to make amendments to auditor’s reports for all companies given the unprecedented reach of impact and uncertainty.
This may have an impact on the following areas in particular.
- Key Audit Matters
Narrative included within KAMs will need to include tailored detail on facts specific to the company’s circumstance and emphasise the relevant disclosures in the financial statements.
- Uncertainty
There may be more material uncertainties – particularly if there were pre-existing challenges around the going concern status.
- Disclosures
Auditors will need to call out where the company narrative that the Board presents is not specific enough and does not “tell the whole story” of the various scenarios and level of uncertainty specific to the companies operations.
- Subsequent events up to the date of signing
Given the level of uncertainty and speed of increasing impact of Covid-19, teams need to critically consider the current position at the point of sign off as part of the subsequent events review right up to the point of signing the auditors report, and may need the provision of further evidence and information by management, including updating financial models.
If the client is disclosing in their subsequent events disclosures that an estimate of impact cannot be made due to the evolving situation, this may result in a material uncertainty on going concern within the audit report.
- Audit report
See the decision tree in the appendix to this document, specific to Going Concern.
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I have a 31 December 2019 year end audit. Do the financial statements require adjustment?
The timing of the Covid-19 outbreak was not, for most entities with December 2019 year ends, an adjusting post balance sheet event. However, this may not be the case for entities with year ends from January 2020 onwards.
Given the potential magnitude of these events, auditors will need to carefully consider what evidence they will require in support of the disclosure of such events and any adjustments made as a result.
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If no adjustment is required for a 31 December 2019 year end audit, is specific disclosure needed?
When the impact of Covid-19 is considered a non-adjusting event, entities will need to make appropriate disclosures in their financial statements to reflect new events or changes in conditions after the reporting date, including an estimate of their financial effect if that can be determined. For example, disclosure of the possible unforeseen effects on asset valuations, impairments, etc if these are expected to be material.
To the extent that events and conditions are identified that may cast significant doubt on an entity’s ability to continue as a going concern, but the going concern assumption is still appropriate, disclosure would be required if these events constitute material uncertainties or management’s conclusion involved significant judgement (i.e. a ‘close call’ scenario).
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What about the auditing issues for periods ending after 31 December 2019?
For periods ending after this current disruption there may be ongoing issues that have implications for future audits.
For example:
The current difficulties in carrying out stocktakes may have implications for future periods and opening balances in inventory. (See question 12 below)
Where internal controls are operating differently for this period it may be necessary to take account of these when planning future audits. For example, currently large volumes of the workforce are currently working from home and this may have an impact on the operation of controls.
This may also have implications for controls around fraud within companies.
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How is other information in the annual report expected to be impacted?
Management will be expected to disclose the principal risks, uncertainties and, where relevant, longer term viability issues triggered by Covid-19. Under ISA(Ireland) 720 the auditor is required to assess whether these disclosures are materially consistent with the financial statements and the knowledge obtained during the audit. This includes considering the consistency of the information set out in the other information (e.g. directors’ report) with the financial statements, including note disclosures, as well as with the underlying inputs, assumptions and judgements. This may result in delays to timetables and reporting deadlines missed until such time as these matters are resolved. The auditor should be mindful of any commentary in the annual report which does not reflect updated disclosures in the financial statements.
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Additional considerations for Group Audits
Component auditors
Component auditors could face significant challenges completing their audits due to challenges obtaining information, access to management and others, difficulties accessing client premises or audit procedures not providing anticipated results (such as bank/debtor confirmations not being received).
These challenges may cause significant delays in the completion of component audits and may also impact the ability of component auditors to obtain sufficient appropriate audit evidence. Consequently, the group engagement team may not be able to meet the group reporting deadline, may need to make changes to the group audit strategy and plan, and may need to consider the implications for the auditor’s report on the group financial statements.
Group auditors
ISA(Ireland) 600 requires group auditors to review and evaluate the work of the component auditors and currently group audit teams may find it challenging directing, supervising and reviewing the work of component auditors due to travel restrictions, availability of component auditors and restrictions in relation to cross border access to, or transfer of audit working papers. This may result in delays to timetables and reporting deadlines missed until such time as these matters are resolved.
Guidance available to auditors
ICAEW
The ICAEW have produced a guide dealing with the particular issues facing group audits, it is designed for UK group auditors with component auditors based in jurisdictions impacted by Coronavirus (COVID-19). It offers practical considerations in relation to the work of component auditors to address the requirements in ISAs (UK). It may also be relevant for group auditors in other jurisdictions with similar requirements
https://www.icaew.com/technical/audit-and-assurance/audit/group-audit/coronavirus-guidance
FRC
https://www.frc.org.uk/news/march-2020-(1)/guidance-on-audit-issues-arising-from-the-covid-19
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How are 31 December 2019 audit reports expected to be impacted?
Non-going concern matters
It is expected that entities with 31 December 2019 year ends will in most instances not adjust their financial statements for the impact of Covid-19. The resulting risk of misstatement will therefore be around appropriate disclosure, or lack thereof, and engagement teams should challenge management and perform appropriate procedures to ensure these disclosures have been made within the financial statements and other information. These disclosures should be specific to individual circumstances, avoiding broad or generic language.
Going concern impact
As events that occurred after the reporting date to respond to Covid-19 have caused a significant deterioration in economic conditions for some entities, and an increase in economic uncertainty for others, management may need to re-assess whether these events or conditions, individually or collectively, cast significant doubt on the entity’s ability to continue as a going concern or, in severe cases, whether the going concern assumption is still appropriate as a basis for the preparation of the entity’s financial statements.
Engagement teams consider whether management’s assessment has been updated to consider all relevant information available up to the date the financial statements are authorised for issue and whether previous “clean” assessments and close call scenarios have not now deteriorated into close calls or material uncertainty scenarios respectively.
The implication for the audit report may therefore include:
- An unmodified opinion;
- An emphasis of matter paragraph to highlight a significant subsequent event disclosed in the financial statements or relating to a significant uncertainty arising from Covid-19;
- A Material Uncertainty in Relation to Going Concern paragraph;
- A qualification or adverse opinion in respect of inadequate disclosures in the financial statements.
- A qualified opinion or a disclaimer of opinion as a result of a scope limitation in the event of an inability to obtain sufficient appropriate audit evidence
See the Going Concern Audit Reporting decision tree in Appendix 1
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Inventory Count
When inventory is material to the financial statements, ISA(Ireland) 501 requires that the auditor attends a physical inventory count, unless impracticable, to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory. Covid-19 may make attendance at inventory counts more challenging or, in some cases, impracticable.
There are a number of possible scenarios for auditors.
• Where management does not conduct an inventory count
If management advises that it is not feasible to conduct an inventory count in the circumstances, then the auditor understands the reasons why. If the auditor agrees that a count is not feasible before completion of the audit (e.g. the local authorities require factories to be closed and employees to stay away from work for the foreseeable future), then the auditor documents the rationale for why the inventory count will not be performed and why it is therefore impracticable to attend.
In a different scenario, management may advise that they do not plan to perform an inventory count to minimize the risks arising from a large number of personnel working in close proximity at the same location. In this scenario, the auditor would exercise professional scepticism when evaluating the reasonableness of management’s explanations for not performing the count. In many cases, in Ireland, this may be considered reasonable. (See below “What do we do when it is impracticable to attend in person”? for more guidance)
However, if the conclusion is that management’s explanations do not appear to be reasonable in the circumstances, then the auditor requests management to perform an inventory count. If they refuse, the auditor considers the impacts on the audit, including risk assessments and the ability to obtain sufficient appropriate audit evidence. If the auditor concludes a management-imposed scope limitation exists, this is communicated this to those charged with governance.
• Management conducts an inventory count but the auditor does not attend in person
If management conducts an inventory count, then the auditor attend in person unless it is impracticable. Factors such as general inconvenience, difficulties, time or cost may present challenges, but are insufficient to conclude that attendance is impracticable. However, actions taken to respond to Covid-19, such as changes to laws and regulations, member firm policies or policies implemented by management could make it impracticable for travel to locations where inventories are held. In addition, travel may not be possible if transportation links to locations where inventories are held have been severed. In these situations, the auditor may consider the facts and circumstances when assessing whether it is reasonable to conclude that it is impracticable to attend the count in person.
When the auditor concludes that it is impracticable to attend in person, this is documented in the audit work papers.
- What to do when it is impracticable to attend in person?
As described above, it may not be feasible for management to perform an inventory count and/or it may not be practicable for the auditor to attend in person. In these situations, the auditor performs alternative audit procedures to obtain audit evidence as to the existence and condition of inventory
Other alternative procedures may include, for example, inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting. When designing the audit procedures, consider multiple factors such as:
- The carrying amount of inventories relative to performance materiality;
- The nature of inventories (e.g. raw materials, WIP, Finished Goods) as well as whether they are separately identifiable, require judgment to determine quantities, the types and number of items in the population, the frequency and volume of movements;
- The results of management’s inventory count, if one was conducted
- Whether production and/or sales have been halted;
- Controls over inventory movements and whether one is able to test and place reliance on them;
- When the auditor last attended an inventory count, and whether one can perform roll forward procedures
- If inventory is held at multiple sites, whether the auditor was able to attend inventory counts at some locations and can perform alternative procedures to address the remaining population; and
- Whether inventory at period end has since been sold.
If the auditor determines that it is not possible to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory from alternative audit procedures, they evaluate whether this is due to a scope limitation imposed by circumstances or by management, and modify the audit report accordingly.
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How are subsequent interim reporting or audits reports for periods ending after 31 December 2019 expected to be impacted?
Should Covid-19 not be contained within the near future, the uncertainty around the exposure to Covid-19 will categorise audits into one of the following broad categories:
- No or immaterial exposure to the impact of Covid-19;
- Risk(s) of material misstatement arising from exposure to the impact of Covid-19;
- Significant risk(s) of material misstatement arising from exposure to the impact of Covid-19; or
- Material uncertainty regarding the going concern assumption arising from exposure to the impact of Covid-19.
Depending on the circumstances of a listed entity audit engagement, a new Key Audit Matter paragraph may therefore be required describing:
- the approach for group audits, particularly how group engagement teams were able to be involved in and evaluate the work of component auditors despite potential travel and data sharing restrictions being in place; or
- when it is concluded that no material uncertainty, relating to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern, exist, but the auditor determines that one or more matters relating to this conclusion are key audit matters.
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