Supporting International Standards

Summary of Covid-19 Audit Considerations

Christopher Arnold | June 3, 2020

 

The consequences of the Covid-19 pandemic on financial statement reporting and audit engagements are complex and have resulted in challenges for management, those charged with governance (TCWG) and auditors. There is an unprecedented level of uncertainty about the economy, future earnings and many other inputs that represent fundamental elements of financial reporting. There will likely be substantial and multiple financial reporting implications to be considered by preparers of financial statements for the purposes of reporting in the short and potentially medium term.

The uncertainty arising from the current environment may increase the challenge in obtaining the sufficient appropriate audit evidence needed to form an independent view about the reasonableness of management’s estimates and judgments. It is important for preparers and auditors to engage in discussions assessing the impact early in the preparation timeframe and audit process, as there are likely to be issues that have not been previously encountered that may now need to be considered.

Both preparers and auditors are likely to be affected by restrictions on travel and requirements to stay at home, which present practical challenges to the audit engagement. Companies may obtain information in new or different ways and/ or operate controls over the production of financial information differently. Audit firms may also have pivoted to remote working, utilizing various technology tools available.

This web page covers some of the key audit challenges and implications from Covid-19 and highlights various resources which are available on the dedicated IFAC Covid-19 website. It is not an exhaustive list or intended to cover all the practical and technical issues in an audit in the current environment. References and quotes are given from numerous international standards. Not all aspects of those international standards are discussed – as such, readers should refer to those international standards for all the requirements.

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Auditors will have to exercise significant professional judgment and professional skepticism and must remain focused on their ethical responsibilities and the public interest. The IAASB’s International Standards on Auditing (ISAs) are principles-based and continue to apply in full. Auditors also need to consider national legal and regulatory requirements. The application of the IESBA International Code of Ethics for Professional Accountants (including International Independence Standards), including compliance with the fundamental principles (integrity, objectivity, professional competence and due care, confidentiality and professional behavior), is key to preservation and expansion of public trust in all auditors.

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  • Professional Judgment and Professional Skepticism

    The importance of the exercise of professional skepticism by auditors in the current environment cannot be over-emphasized. There is likely a significant change in the judgments made by management and TCWG, in particular in light of the continually changing environment and in many cases the significant uncertainty looking forward. It is likely that auditing areas such as going concern, accounting estimates (e.g., impairment, fair value etc.) and other areas where significant judgment is involved will be considerably more challenging for auditors. In addition, auditor’s experts may need to be brought in to support a team which may not have the experience and competency in an area where professional judgment will need to be exercised.

    ISA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing deals with the overall objectives of the auditor in conducting an audit of the financial statements, including to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level. It requires the auditor to exercise professional judgment in planning and performing an audit, and to plan and perform an audit with professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated. In the current environment both of these concepts in an audit play a fundamental role, and the documentation thereof is critical, in particular as circumstances continue to change.

    Many aspects of the audit will be impacted by the Covid-19 pandemic, in particular those where sound professional judgment is needed. For example, determining materiality involves the exercise of professional judgment. In some circumstances, the chosen benchmark previously used to determine materiality may need to be adjusted for significant changes in the circumstances. It is important for materiality to be based on metrics that are important to users of the financial statements (e.g., revenue, pre-tax income), which may differ from metrics used in the past.

    Documentation of the professional judgments made, where significant, serves to explain the auditor’s conclusions and reinforce the quality of the judgment. This may include the basis for the auditor’s conclusion on the reasonableness of areas of subjective judgments. Given the challenges many auditors will likely encounter with their audits in the current environment (some of those challenges likely for the first time) and resultant professional judgments they will need to exercise, it would be strongly advisable for auditors to be further mindful as to documentation requirements under ISA 230. Audit Documentation. For more detail see the section on Audit Evidence.

    Another area where significant judgment will be needed is in relation to accounting estimates. Actual results in the future may differ significantly from those estimated by preparers – both having been based on judgments that when prepared were reasonable and supportable, made in good faith, and guided by sound application of the accounting standards. Judgments should be considered in the context in which they are made and on the basis of information available at that time, and the auditor’s consideration in relation to management’s judgments documented. For more detail see the section on Auditing Accounting Estimates.

    A number of financial reporting regulators have acknowledged the uncertainties being faced by preparers and auditors. For example, the US Securities and Exchange Commission highlighted that “in many cases actual financial and operational results may differ substantially from what would now appear to be reasonable estimates.  Given the uncertainty in our current business environment, we would not expect to second guess good faith attempts to provide investors and other market participants appropriately framed forward-looking information.”

    Judgment is also needed when determining the impact of the auditor’s evaluation of the audit evidence obtained in the auditor’s report. Early actions taken by many regulators to provide appropriate Covid-19 related guidance is helpful. To address some of the areas of judgment certain regulators have introduced prescriptive requirements setting out standard language in auditor’s reports to address certain circumstances (e.g. emphasis of matter or other paragraphs). This can be useful but may also limit auditors’ ability to demonstrate professional judgment in determining how to appropriately reflect the effects of Covid-19 on the business and the audit in the auditor’s report.

    Ethics

    Auditors are required to comply with the five fundamental principles in the IESBA International Code of Ethics for Professional Accountants (including International Independence Standards), namely integrity, objectivity, professional competence and due care, confidentiality and professional behavior. They are also required to apply the Code’s conceptual framework to identify, evaluate and address threats to compliance with the fundamental principles. The conceptual framework also requires the auditor to be alert for new information and for changes in facts and circumstances that might affect their conclusions about whether any safeguards applied continue to be appropriate.

     

 
  • Planning‒Risk Identification and Assessment

    The auditor’s risk identification and assessment process is iterative and dynamic. Auditors are required to revise risk assessments and modify responses and further audit procedures, based on audit evidence or new information obtained. Throughout the engagement, auditors need to be constantly vigilant due to the fast-changing and complex circumstances as it may be necessary to revisit risk identification and assessment in the current circumstances.

    Planned safeguards to address threats to independence may also need to be reconsidered in light of changing circumstances.

    Understanding the Entity and its Environment

    The auditor’s understanding of the entity and its environment has likely changed from previous periods due to the implications of Covid-19. There may be changes to the entity’s objectives, strategy, organizational structure, governance arrangements and business model and it is important that the auditor considers how these changes impact the audit. Changes may also be needed if the auditor has already completed planning and risk assessment before the onset of the Covid-19 pandemic and may also be necessary during the audit as the environment continues to evolve. Examples of risks increasing the susceptibility to risks of material misstatement that may be heightened in the current environment include:

    • Inappropriate objectives or ineffective execution of strategies
    • A failure to recognize the need for change or lack of expertise to deal with the changes
    • Reduction or expansion of the business and demand has not been accurately estimated or appropriate due diligence undertaken on new products or services
    • Loss of financing due to entity’s inability to meet requirements
    • Regulatory requirements resulting in increased legal exposure
    • Incentives and pressures on management, which may result in intentional or unintentional management bias
    • Increased risks of fraud

    Auditors should discuss with management and TCWG how they have assessed the impact of Covid-19 on the business and evaluate whether there are new or changed risks that could be material. Understanding how TCWG are addressing the new or changed risks is essential for the auditor in understanding where changes may be needed to the audit. Ongoing communication throughout the audit is also essential as the entity’s circumstances may change.

    It is also important to understand how any relevant changes in laws or regulations impact the entity and how it operates, including extension of reporting periods in some jurisdictions. There may also be changes to the applicable financial reporting standards in different jurisdictions that may need to be considered. 

    Materiality

    The auditor may need to consider the impact of any changes brought on by the pandemic on materiality, including the basis on which materiality is determined in accordance with ISA 320 Materiality in Planning and Performing an Audit. The auditor may also need to revise materiality for the financial statements as a whole during the audit in the event of becoming aware of information that would have caused the auditor to have determined a different amount initially, which could occur as the entity’s circumstances change. As materiality is adjusted for the current circumstances, consideration will also be needed about the impact of previously unadjusted differences which may now become material and need to be adjusted for.   

    Controls 

    An understanding of the entity’s system of internal controls relevant to the audit assists when identifying potential misstatements. This understanding is required even when auditors do not plan to rely on the operating effectiveness of controls because it helps identify where possible misstatements could occur. In the current environment, it is likely that there have been changes to various components of the system of internal control, and a thorough understanding of what is changed will assist the auditor in their risk identification and assessment process. In particular, the control environment will likely be different—many organizations have had to change the way they operate and so would have had to change their oversight processes and how controls operate. These changes may lead to additional risks of material misstatement.

    If the auditor does intend on relying on the operating effectiveness of controls, again this may have changed and further insight as to the control and how it operates, as well as the auditor’s intended reliance, may also change. Further insights can be found when obtaining audit evidence about the design and implementation of identified controls (including IT controls). However, although this may be difficult because of a lack of access to certain information (e.g. documents or reports) or company personnel (e.g. ability to enquire or observe the application of specific controls), the relevant work still needs to be undertaken in an alternative way or the risk identification or assessment changed accordingly. For example, obtaining an understanding of controls could be achieved remotely using alternative procedures, however inquiry is not sufficient to determine whether such controls have been placed in operation. Auditors will need to consider what evidence can be obtained remotely to determine if effectively designed controls have been placed in operation to mitigate the applicable risks.

    Internal controls may not have operated consistently throughout the audit period because of the changed circumstances of many companies. Therefore an understanding of any control changes, as well as new and additional controls now relevant to the audit will be important (e.g., different personnel involved, documentation differences for working remotely etc.) in helping to understand whether controls are still operating as they did, and whether any new risks arise because of the changes. In addition, new significant risk areas could be identified, which were not assessed as significant risks in prior audits. If the auditor has determined that a significant risk exists, they are required to obtain an understanding of the entity’s controls, including control activities, relevant to that risk.

    If the auditor is unable to perform walkthroughs to confirm their understanding of the information system, or where applicable undertake tests of controls onsite (where the auditor intends to rely on the operating effectiveness of controls), they may need to identify additional risks of material misstatement that will need to be considered and where they were intending relaying on controls they may need to change their audit response and increase substantive testing.

    Fraud

    The circumstances that many companies find themselves in may have increased the risk of fraud. Companies have had to quickly change the way they operate, including changes to controls, all of which may allow for greater opportunities for fraud. The auditor’s exercise of professional skepticism is particularly important when considering fraud risks on the entity in the current environment.

    ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements requires the auditor to make inquires of management, and others within the entity as appropriate, to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity. If the auditor is unable to conduct fraud interviews in person due to Covid-19, these inquiries could be done utilizing technology such as video conferencing. This may be preferred to only telephone conversations because auditors can still see management’s body language.

    Other Considerations

    In the current environment, the auditor may face additional pressure to reduce the level of the audit fee for services in progress or to be provided. The IESBA publication highlights that there may be threats to compliance with the fundamental principles of professional competence and due care if the fee quoted is so low that it may be difficult to perform the engagement in accordance with applicable technical and professional standards for that price. The level of fees (or if they are overdue) might create a self-interest or intimidation threat to independence and auditors should apply the conceptual framework to identify, evaluate and address such threats.

    If auditors are unable to obtain evidence to perform and complete the risk identification and assessment process, they may have scope limitations and will need to consider the effect on the planned audit procedures and the impact on the auditor’s report (see section on Auditor Reporting).

 
  • Audit Evidence

    ISA 500, Audit Evidence requires the auditor to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion.

    In agreeing the terms of engagement in accordance with ISA 210, Agreeing the Terms of Audit Engagements, management agrees to provide the auditor with access to all the information of which management is aware that is relevant to the preparation of the financial statements, any additional information the auditor may request from management for the purpose of the audit, and unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.

    Covid-19 has resulted in many challenges for auditors in obtaining sufficient appropriate audit evidence. For example, travel restrictions may have impacted physical access (e.g. attending inventory counts), the ability to obtain original documents (e.g. inspection of records for evidence of authorization as a test of controls) and availability of client staff.

    If the auditor cannot obtain evidence in the way that the evidence was obtained before, consideration should be given to alternative procedures. When the auditor is unable to obtain sufficient appropriate audit evidence that is necessary for the auditor to be able to conclude, consideration will need to be given to the impact on the auditor’s report, including whether a modified opinion is needed (see section on Auditor Reporting).

    ISA 500, Audit Evidence explains that the reliability of information to use as audit evidence, and therefore of the audit evidence itself, is influenced by its source and its nature, and the circumstances under which it is obtained, including the controls over its preparation and maintenance where relevant. In the current environment, obtaining audit evidence may be more challenging and different to how it may have previously been obtained. However, the basic principles of ISA 500 still apply, and additional consideration by the auditor about the reliability of the audit evidence provided may need to be considered, i.e., has the evidence been:

    • Obtained from a source independent of the entity.
    • Generated internally and if so, what controls were in place over its preparation.
    • Obtained directly by the auditor.
    • Obtained in a documentary form.
    • Provided in original (i.e. not photocopied etc.).

    Judgment will then be needed to determine whether the evidence is reliable for the purpose for which it has been obtained. Auditors will need to exercise professional skepticism about the evidence obtained electronically and may need to design other audit procedures in order to test the reliability of electronic evidence in the absence of the original physical source document, as well as considering the controls over the process from which the electronic evidence was produced.

    Early indications are that Covid-19 has accelerated the adoption of technology and remote techniques to perform engagements. Secure web portals are being utilized to review clients’ documents and some have the functionality to permit questions and answers between the auditor and the client. The reliability of evidence obtained in this way is still considered in terms of ISA 500 as set out above.

    Inventory

    One practical issue that has emerged is the attendance of the auditor at inventory counts. In accordance with ISA 501, Audit Evidence-Specific Considerations for Selected Items if inventory is material to the financial statements, the auditor is required to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by attendance at physical inventory counting unless it is impracticable.

    Considerations related to inventory and obtaining sufficient appropriate evidence in the current environment include:

    • Whether physical inventory counts can be observed on an alternative date if attendance cannot be performed at the year end, with audit procedures on intervening transactions performed.
    • Using technology where the client is able to perform a physical inventory count, but auditors are unable to attend, such as live camera feeds or web or mobile-based video conferencing to observe the inventory count.
    • Performing alternative audit procedures where attendance is impracticable, for example inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting, reviewing and testing inventory rollforwards, obtaining assurance that the inventory location was not accessible for a period of time, e.g., from security camera footage.

    Group Audits

    ISA 600, Special Considerations-Audits of Group Financial Statements (Including the Work of Component Auditors) includes requirements for obtaining sufficient appropriate audit evidence, including the documentation of work undertaken by component auditors, to be able to form a basis for the group audit opinion.

    With the Covid-19 travel restrictions in place, group auditors may be unable to visit the component audit team, where it had originally planned to do so, to evaluate and review key audit working papers, which may cause a significant delay or impact the auditor’s ability to obtain sufficient appropriate evidence. In some countries, legal restrictions may also limit the transfer of data (including audit working papers) outside of the jurisdiction.

    If it is not possible to review the necessary component audit workpapers (whether in person or electronically), the group auditor will need to undertake other measures, which will likely involve additional work. This could include one of more of the following:

    • Uploading files (e.g. into the cloud) with access provided to the group audit engagement team
    • Video calls and/ or screen sharing to review the component auditor work or use of remote access
    • A more detailed memorandum or questionnaire provided to the component auditor, corroborated with more detailed discussions with the group engagement team
    •  Information from the client provided directly to the group engagement team so they can perform their own procedures on the financial information of the component (if possible).

    The current circumstances may also provide an opportunity for group audit teams to reevaluate and potentially redesign the way in which they communicate and engage with component audit teams, in the same way that many audit teams are changing the way in which they engage with clients.  

    If sufficient appropriate evidence cannot be obtained to enable the auditor to conclude, the auditor will need to consider the impact on the auditor’s report arising from the limitation of scope (see section on Auditor Reporting).

    Documentation

    In accordance with ISA 230, Audit Documentation the auditor is required to prepare documentation that provides a sufficient and appropriate record of the basis for the auditor’s report and evidence that the audit was planned and performed in accordance with ISAs, and applicable legal and regulatory requirements. In the current environment documenting professional judgments and the exercise of professional skepticism, as well as discussions with management and TCWG related to the impact of Covid-19, is critical. This may provide evidence of the auditor’s exercise of professional skepticism, including the specific procedures performed to corroborate management’s response to inquiries, at the time the evidence was obtained.

    Documentation of the professional judgments made, where significant, serves to explain the auditor’s conclusions and reinforce the quality of the judgment in the circumstances at the time that the judgment was made. This may include the basis for the auditor’s conclusion on the reasonableness of areas of subjective judgments (for example, the reasonableness of significant accounting estimates or going concern). Given the challenges many auditors will likely encounter with their audits in the current environment (some of those challenges likely for the first time), and in light of the continually changing environment, the importance of documenting the auditor’s considerations in making those judgments in accordance with ISA 230 is essential.

 
  • Auditing Accounting Estimates

    Accounting estimates are pervasive in financial reporting. Accounting estimates and related disclosures are the responsibility of management (see separate web page on Financial Reporting)

    The uncertainty of the current environment and the continual changing nature of the impact of the Covid-19 pandemic has added further complexity and challenges when auditing accounting estimates. The exercise of professional skepticism will be essential in considering management’s judgments in relation to accounting estimates.

    In accordance with ISA 540 (Revised) Auditing Accounting Estimates and Related Disclosures the objective of the auditor is to obtain sufficient appropriate audit evidence about whether accounting estimates and related disclosures in the financial statements are reasonable in the context of the applicable financial reporting framework (a similar objective would apply if extant ISA 540 is being used).

    As ISA 540 (Revised) is new (effective for financial statements for periods beginning on or after December 15, 2019) and the significant accounting impact on estimates due to Covid-19, audit firms should ensure that staff receive appropriate training on the revised standard and might want to reassess whether additional training is now required.

    The information below is based on the revised standard and may be considered when the extant standard is still applicable as it will assist with more robust audit procedures which may be needed in this environment relating to accounting estimates.

    ISA 540 (Revised) explains how inherent risk factors can assist the auditor in identifying and assessing risks of material misstatement in accounting estimates. The inherent risk factors focused on in ISA 540 (Revised) include estimation uncertainty, complexity, and subjectivity (there are others, but these have been focused on in ISA 540 (Revised) and are particularly relevant in the current environment). The Covid-19 pandemic will likely heighten the impact of all three factors, in particular uncertainty and subjectivity (because of the extreme uncertainty).

    The degree of estimation uncertainty may increase because there is uncertainty about the associated economic impact of the pandemic, including for how long this impact will continue. The changing circumstances and uncertainty may also impact the selection and application of the method or data used and obtaining reliable data may be more challenging. In addition, when there is more uncertainty, the subjectivity in the selection of method, assumptions, and data increases. When there is a high degree of subjectivity the accounting estimate may be susceptible to management bias. More may be needed from management, such as different considerations about assumptions and models used, as well as in some cases stress testing the accounting estimates.

    The IAASB’s Staff Practice Alert: Auditing Accounting Estimates further explains how inherent risk factors can assist the auditor in their required procedures in the current environment.

    Key considerations for auditors about accounting estimates in the current environment include:

    • Focusing on all accounting estimates, even when in prior periods a focus may not have necessarily be needed (e.g., how debts are recoverable even where there is a stable history of collecting debts).
    • Whether inputs and assumptions are appropriate in the circumstances and in the context of the applicable financial reporting framework (e.g., cash flow forecasts, discount rates, etc.). Historic experience is not likely to be representative of the current and future environment. Assumptions on the duration of lockdown measures represent critical and uncertain inputs when developing estimates (e.g. impairment testing).
    • Changes to regulatory factors that may affect accounting estimates.
    • Whether data being used by the entity is relevant and reliable. There is a risk that management will assert that the uncertainty is so great that it is not possible to determine a reliable fair value or value in use, with the amount determined at a previous reporting date being retained. In addition, if management is unable to determine a value for estimates it is likely to lead to questions on how they can make a reliable assessment of the entity’s ability to remain as a going concern.
    • How the specific entity in a particular jurisdiction is being affected - the experience of one geography may not necessarily be representative of the experience of another geography. The impacts of the pandemic are also not uniform, in particular in relation timing, for example some economies may open up before others.
    • Whether valuation specialists are needed, for example where there is no market data available to evaluate an accounting estimate.
    • Whether valuation specialists used are including caveats in their reports in light of uncertainty in the current environment. Auditors may need to consider the impact of these caveats on the range of estimates and/or the sufficiency of audit evidence.
 
  • Going Concern

    Going concern assessments (and related disclosures) are often complex analyses that frequently involve significant judgments related to future cash flows. Containment measures in numerous jurisdictions and disrupted supply chains have significantly influenced supply and demand in many industries, sometimes resulting in losses of income and other cash flow difficulties, such as the ability to collect debts when they fall due. Furthermore, the uncertainty about how economies will open up have affected the ability to reliably forecast future income and cashflows.

    Management’s Responsibilities

    Management is responsible for the assessment of the entity’s ability to continue as a going concern and any necessary disclosures required by the applicable financial reporting framework. IAS 1 Presentation of Financial Statements, sets out the requirements for management to assess a company’s ability to continue as a going concern. Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future, unless management intends to liquidate the entity or cease operations, or has no realistic alternative but to do so.

    The going concern assessment by management:

    • Needs to be performed up to the date on which the financial statements are issued.
    • Relates to at least the first twelve months after the balance sheet date, or after the date the financial statements will be signed, but the timeframe might need to be extended.

    The deteriorating economic conditions, extremely challenging business environment and level of uncertainty about future earnings over the next 12 months will, in many cases, likely make the going concern assessment by management extremely challenging

    The applicable financial reporting framework sets out the specific disclosure requirements related to the going concern of the entity, including significant judgments and assumptions used in management’s assessment.

    Specific disclosures are ordinarily required when management concludes that there is a significant doubt as to the entity’s ability to continue as a going concern. In the current circumstances more financial statements will likely include expanded disclosures about events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.

    Auditor’s Responsibilities

    ISA 570 (Revised), Going Concern, sets out the auditor’s responsibilities with respect to going concern. The procedures for the auditor set out in ISA 570 (Revised) largely focus on management’s assessment of the company’s ability to continue as a going concern and the related disclosures within the financial statements.

    The current circumstances also make it more difficult for auditors to reliably audit management’s assessment of going concern in light of the many and significant uncertainties. In the event that conditions are identified that may cast significant doubt on the company’s ability to continue as a going concern it is  likely that auditors may need to perform the additional procedures, and consider the impact of their findings on the auditor’s report. The IAASB has published a Staff Audit Practice Alert (the IAASB Staff Alert on Going Concern) to highlight issues and challenges for auditors relating to going concern in the current environment, including the periods that need to be considered by the auditor, as well as the impact on the auditor’s report of the findings from their procedures. 

    It should be highlighted that the IAASB Staff Alert on Going Concern notes “While the impact of the COVID-19 pandemic may amplify events or conditions giving rise to modifications to the auditor’s report or opinion, it does not in itself mean a modification is inevitable-this will depend on the facts and circumstances of each entity.” For that reason, it is important that the auditor works through the procedures in ISA 570 (Revised) regardless of the expected outcome.

    An integral part of the auditor’s considerations are the disclosures relating to going concern. The auditor uses professional judgment in determining the adequacy of the disclosures in the circumstances of the company based on the work they have performed on management’s assessment, and the implications of inadequate disclosures on the auditor’s opinion or the auditor’s report.

    Examples of the challenges for auditors in evaluating management’s assessment of the company’s ability to continue as a going concern and the related disclosures that may exist in the current environment include:

    • Evaluating whether an entity has access to sufficient liquidity and can remain solvent through the period of public health restrictions and beyond. Previously prepared budgets and forecasts may require significant revision by management before being considered by the auditor. Changes may include the terms of financing facilities and government support, if any, and whether such support gives rise to future obligations, and when the obligations become due.
    • There is often a lag between a general announcement of government relief programs, the details behind the programs and when the support is forthcoming. Companies need to make judgments as to the ultimate relief that will be provided, which can change when additional details about the relief become available. Not including government relief programs to which the company may be eligible in the assessment could result in conclusions that are inappropriate when determining whether the going concern basis of accounting is appropriate. Auditors may consider the extent to which an entity is relying on such support (if available) and whether it is sufficient to cover any short-term liquidity issues, as well as if the conditions attached to any support are likely to be met by the entity.
    • There may be consequences for the availability of financing and/or government financial assistance if a reference by the auditor to going concern uncertainty in the auditor report results in a breach of banking covenants.
    • It may be difficult to obtain a meaningful baseline economic forecast to develop estimated future cash flow scenarios, including further plausible downside economic scenarios specific to the entity. A focus may be needed on any assumptions used and how any sensitivity analysis has been performed.
    • There is likely to be insufficient reliable data on the potential length of time of closures (or whether there will be future closures), and the duration of the economic downturn affecting both the estimates of future cash flows and the relative weight of various scenarios.
    • Evaluating the degree of business disruption is complex (i.e., will correlations from past consumer behavior and business practices still apply after the crisis, or does this require a reassessment and recalibration of models used).
    • Aligning the going concern evaluation for group and subsidiary reporting purposes, if filing deadlines differ, may represent a challenge (in particular where filing deadlines have been extended in some jurisdictions and not others.)

    Reporting

    If there is a modification to the auditor’s opinion (e.g. a qualification or an adverse opinion or disclaimer of opinion) because of going concern issues (i.e. inadequate disclosures or limitation on scope in obtaining sufficient appropriate audit evidence) this is reported with ISA 705 (Revised). For other considerations of changes to the auditor’s report the Appendix to ISA 570 (Revised) Going Concern provides illustrative examples. The IAASB Staff Alert on Going Concern also sets out all the implications in a table. Broadly:

    • If the financial statements have been appropriately prepared on a going concern basis, a material uncertainty has been identified and appropriate disclosures have been made, an unmodified opinion is expressed. A separate section is included under the heading ‘Material Uncertainty Related to Going Concern’, which also draws attention to relevant disclosures within the financial statements.
    • If the financial statements have been appropriately prepared on a going concern basis, a material uncertainty has been identified, but appropriate disclosures have not been made, a qualified or adverse opinion is expressed. The ‘Basis for Qualified (Adverse) Opinion’ section of the report states that a material uncertainty exists that may cause a significant doubt on the entity’s ability to continue as a going concern and that the matter is not appropriately disclosed in the entity’s financial statements.
    • If the financial statements have been prepared on a going concern basis, but the use of the going concern basis of accounting is inappropriate an adverse opinion is expressed.
    • If the entity is not a going concern, the financial statements have been appropriately prepared on a basis other than going concern and the alternative basis of accounting is appropriate in the circumstances, an unmodified opinion may be able to expressed if there is adequate disclosure about the basis of accounting on which the financial statements are prepared. An emphasis of matter paragraph may be considered drawing the user’s attention to the alternative basis of accounting and reasons for its use.

    A matter giving rise to a material uncertainty related to going concern is by its nature a key audit matter as contemplated in ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. In accordance with ISA 701 matters giving rise to a modified opinion in accordance with ISA 705 (Revised) Modifications to the Opinion in the Independent Auditor’s Report or a material uncertainty related to going concern in accordance with ISA 570 (Revised) Going Concern, shall not be described in the Key Audit Matters section of the auditor’s report. Rather, the auditor shall report on these matters as required by ISA 705 (Revised) or ISA 570 (Revised), respectively, and include in the Key Audit Matters section a reference to the relevant sections included in the auditor’s report in accordance with these ISAs.

 
  • Auditor Reporting

    The purpose of the audit is to obtain reasonable assurance that the financial statements have been prepared, in all material respects, in accordance with the applicable financial reporting framework (i.e., the auditor plans and performs the audit to obtain reasonable assurance that the financial statements, including disclosures, are free from material misstatement).

    Covid-19 may arguably result in a rise in modifications to the auditor’s opinion due to, for example, issues related to material misstatement of the financial statements or more circumstances where there is an inability to obtain sufficient appropriate audit evidence. Similarly, there could arguably be more ‘modified’ audit opinions and more ‘material uncertainties’ highlighted in audit reports in relation to going concern, and more ‘emphasis of matter paragraphs’ for other Covid-19 related disclosures. In addition, it is a reasonable expectation that for listed entities there will be an impact on KAMs included by auditors in relation to the impact of Covid-19, including more areas of the audit that will likely require significant auditor attention or the nature of KAMs previously reported may change.

    ISA 700 (Revised), Forming an Opinion and Reporting on Financial Statements, sets out the requirements relating to the auditor forming an opinion and the content of the auditor’s report. ISA 700 (Revised) also provides illustrative example reports for situations when no modifications are needed to the opinion or the auditor’s report.

    Modifications to the Auditor’s Opinion

    The IAASB Staff Alert Auditor Reporting in the Current Evolving Environment Due to COVID-19 highlights examples of when modifications to the auditor’s opinion may arise as a result of Covid-19. This includes modifications for:

    Material misstatement of the financial statements

        • The appropriateness or adequacy of disclosures in the financial statements. For example, when the financial statements do not include all of the disclosures required to appropriately describe effects of current circumstances on the entity resulting from the Covid-19 pandemic, including sufficient description of relevant risks, estimates and judgments applied for that entity.
        • The proper application of the entity’s accounting policies. For example, inappropriate recognition and measurement in accordance with an entity’s accounting policies, of assets and liabilities.

    Inability to obtain sufficient appropriate audit evidence

        • Circumstances beyond the control of the entity or circumstances relating the nature or timing of the auditor’s work. For example, access to the entity’s accounting records or the ability to obtain audit evidence may be restricted due to government imposed lockdowns and travel bans during the Covid-19 pandemic (e.g., access to information or people, information which may relate  to the entity or its components, including associates and joint ventures etc.)

    ISA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report, sets out the requirements for modifying the auditor’s opinion when the financial statements are not free from material misstatement or the auditor is unable to obtain sufficient appropriate audit evidence. The types of modifications to the auditor’s opinion are set out in ISA 705 (Revised) and explain the circumstances for each (i.e. a qualified opinion, adverse opinion and a disclaimer of opinion) based on the auditor’s judgment in the particular situation.

    Material Uncertainty Relating to Going Concern

    If there is a modification to the auditor’s opinion (e.g. a qualification or an adverse opinion or disclaimer of opinion) because of going concern issues (i.e. inadequate disclosures or limitation on scope in obtaining sufficient appropriate audit evidence) this is reported with ISA 705 (Revised). For other considerations of changes to the auditor’s report the Appendix to ISA 570 (Revised) Going Concern provides illustrative examples. The IAASB Auditor Reporting Staff Alert on Going Concern also sets out all the implications in a table. Broadly:

    • If the financial statements have been appropriately prepared on a going concern basis, a material uncertainty has been identified and appropriate disclosures have been made, an unmodified opinion is expressed. A separate section is included under the heading ‘Material Uncertainty Related to Going Concern’, which also draws attention to relevant disclosures within the financial statements.
    • If the financial statements have been appropriately prepared on a going concern basis, a material uncertainty has been identified, but appropriate disclosures have not been made, a qualified or adverse opinion is expressed. The ‘Basis for Qualified (Adverse) Opinion’ section of the report states that a material uncertainty exists that may cause a significant doubt on the entity’s ability to continue as a going concern and that the matter is not appropriately disclosed in the entity’s financial statements.
    • If the financial statements have been prepared on a going concern basis, but the use of the going concern basis of accounting is inappropriate an adverse opinion is expressed.
    • If the entity is not a going concern, the financial statements have been appropriately prepared on a basis other than going concern and the alternative basis of accounting is appropriate in the circumstances, an unmodified opinion may be able to expressed if there is adequate disclosure about the basis of accounting on which the financial statements are prepared. An emphasis of matter paragraph may be considered drawing the user’s attention to the alternative basis of accounting and reasons for its use.

    Emphasis of Matter Paragraphs

    The auditor may consider it necessary to draw users attention to a matter appropriately presented or disclosed in the financial statements, that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements. ISA 706 (Revised), Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report, explains the circumstances when such paragraphs may be necessary and provides illustrative examples of such paragraphs. The IAAB Staff Alert on Auditor Reporting sets out circumstances in the current environment where this would be appropriate, as well as when emphasis of matter paragraphs should not be used.

    Key Audit Matters (KAMs)

    ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report, deals with the auditor’s responsibility to communicate matters of most significance in the audit of the financial statements of listed entities or other entities for which law or regulation requires communication of key audit matters. In other circumstances, auditors may also decide to communicate key audit matters.

    When ISA 701 applies, additional focus may be needed on the key audit matters reported in the auditor’s report because of the changing circumstances due to Covid-19. The areas that were significant in the KAMs in a prior year may require expansion to include consideration for the current year audit response in that area for Covid-19, as well as consideration of other KAM arising from Covid-19 impacts (e.g. valuation reports, materiality calculations, government support).

    Given the uncertainties, auditors will be challenged to evaluate certain disclosures, particularly those related to significant estimates and assessment of going concern. Additional KAMs (e.g., close calls relating to going concern) may be warranted.

    A matter giving rise to a material uncertainty related to going concern is by its nature a key audit matter as contemplated in ISA 701. In accordance with ISA 701 matters giving rise to a modified opinion in accordance with ISA 705 (Revised) Modifications to the Opinion in the Independent Auditor’s Report or a material uncertainty related to going concern in accordance with ISA 570 (Revised) Going Concern, shall not be described in the Key Audit Matters section of the auditor’s report. Rather, the auditor shall report on these matters as required by ISA 705 (Revised) or ISA 570 (Revised), respectively, and include in the Key Audit Matters section a reference to the relevant sections included in the auditor’s report in accordance with these ISAs.

 
  • Subsequent Events

    Management’s Responsibilities

    IAS 10 Events After the Reporting Period contains requirements for when adjusting events (those that provide evidence of conditions that existed at the end of the reporting period) and non-adjusting events (those that are indicative of conditions that arose after the reporting period) need to be reflected in the financial statements. Amounts recognized in the financial statements are adjusted to reflect adjusting events, but only disclosures are required for material non-adjusting events.

    Management exercises judgment in determining whether events that took place after the end of the reporting period are adjusting or non-adjusting events. This will be highly dependent on the reporting date and the facts and circumstances of the entity. Management may need to continually review and update the assessments up to the date the financial statements are issued given the fluid nature of the crisis and the uncertainties involved. Correspondingly, there may be a need for auditors to design and perform enhanced or additional procedures.

    If management concludes the impact of non-adjusting events are material, the company is required to disclose the nature of the event and an estimate of its financial effect. If it cannot be reliably quantitively estimated, there still needs to be a qualitative disclosure, including a statement that it is not possible to estimate the effect. Examples of non-adjusting events that would generally be disclosed in the financial statements include breaches of loan covenants, management plans to discontinue an operation or implement a major restructuring, significant declines in the fair value of investments held and abnormally large changes in asset prices, after the reporting period.

    Auditor’s Responsibilities

    In accordance with ISA 560, Subsequent Events auditors are required to perform procedures designed to obtain sufficient appropriate audit evidence that all events requiring adjustment of, or disclosure in, the financial statements, occurring between the date of the financial statements and the auditor’s report, have been identified and appropriately reflected in the financial statements in accordance with the applicable financial reporting framework.

    The IAASB Staff Alert Subsequent Events in the Current Evolving Environment―Audit Considerations for the Impact of COVID-19 notes that auditors will likely require a greater focus on events occurring the date of the financial statements and the date of the auditor’s report (i.e. subsequent events) and the effect, if any, on the entity’s financial statements. As some jurisdictions have granted extensions for filing financial statements, auditors may be required to undertake procedures to cover the longer period to the date of the auditor’s report.

    Auditor’s will have to work with management and TCWG to ensure subsequent events have been accurately identified and reflected in the financial statements. If the auditor determines that the financial statements are materially misstated or is unable to obtain sufficient appropriate audit evidence to determine whether the financial statements are materially misstated, a modification to the opinion in the auditor’s report is required.

    The auditor has no obligation to perform any audit procedures regarding the financial statements after the date of the auditor’s report unless a fact becomes known to the auditor that, had it been known at the date of the auditor’s report, may have caused the auditor to amend their report.

 

This webpage will continue to evolve. Readers are invited to share experiences on areas covered, additional challenges and other resources which they have found particularly helpful.

General Resources

The following general resources, providing high-level insights to some of the challenges and issues being experienced, may be helpful (please note that all resources are listed alphabetically by author and reflect no order of relative importance):

Professional accountants may also be interested in the dedicated IFAC Covid-19 Financial Reporting considerations web page.

 
 

Christopher Arnold

Head of SME/SMP and Research, IFAC

Christopher Arnold is the head of SME/SMP and Research at IFAC. He was previously an Audit Manager for Deloitte and qualified as an accountant in a mid-tier accountancy practice in London (now called PKF-Littlejohn). Christopher started his career as a Small Business Policy Adviser at the Association of Chartered Certified Accountants (ACCA). See more by Christopher Arnold

 

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