Authors: Ryan Magri & Daniel Camilleri
The emergence of the novel Coronavirus (COVID-19) pandemic has shook the world and changed almost every aspect of our personal and commercial world as we know it. Auditing is no exception to this, and this will undoubtedly be a key focus of many current and forthcoming financial audits given that uncertainty about the immediate outlook for many companies has increased.
Regardless, audit quality remains paramount and to achieve this we need to ensure that our audit procedures are in line with International Standards on Auditing. This could possibly mean that as audit practitioners we need to spend more time on areas such as going concern, accounting estimates and the adequacy of financial statements disclosures surrounding the Covid-19 reality of the audit client.
Due to the fluidity of the current situation, constant risk assessment should be carried out by the auditor to determine any increased level of threat to pre-existing risks and consider any new risks as a result of Covid-19. Such risks may include:
This reflects the risk that a Company might have insufficient resources to meet its financial liabilities as they fall due. This may be as a result of decreased operational activities or lower debt collection caused by Covid-19.
This reflects the risk that a counterparty will default on its contractual obligations resulting in a financial loss to the Company. This again, might be a result of decreased operational activities caused by Covid-19, high liquidity risk exposure of a Company’s main customers and a significant downfall in the value of a particular investment.
Legal risk arises out of legal constraints such as lawsuits. This might be a result of the Company’s inability to meet their performance obligations or insufficient number of personnel leading to redundancies or other HR measures made in order to decrease operational costs to an acceptable level.
Market risk arises due to movement in prices of financial instruments. The economic and operational turmoil caused by COVID-19, is expected to affect the market rates.
Going Concern and Estimation Uncertainty
Companies that have been negatively affected by Covid-19, will undoubtedly include businesses across the tourism industry, several retail shops, sports betting companies but not only. To some extent most of the businesses will be impacted negatively will need to consider going concern issues, which may result in additional disclosures. That being said, due consideration must be given to the challenges that management will possibly encounter whilst preparing forecasts due to the volatility of the situation.
A significant degree of judgment may be required in identifying situations which require more audit work especially for audits of financial statements for periods ending in 2020. Areas of judgement may include accounting estimates, fair value measurements, assets impairment, hedge accounting and more. As a result, auditors should always consider the difficulties management may have encountered in preparing forecasts and it is therefore of utmost importance for the auditor to exercise professional judgment and scepticism.
Therefore, one needs to evaluate whether it is appropriate for management to prepare the financial statements on a going concern basis. This will be determined by considering and evaluating all information available regarding future operations for at least the first twelve months following the balance sheet date, with the continued assessments and updates of these concerns, until the date the financial statements are approved.
Implications on the Auditor’s Report
Auditors must ensure that management appropriately discloses the company’s prospects and how the users of the financial statements might be affected, all whilst acknowledging the current high degree of uncertainty. As a result of management’s disclosures in the financial statements, the auditor’s report may be updated to include:
An ‘emphasis of matter’ paragraph to draw the user’s attention to a particular disclosure made in the in the financial statements, such as a material subsequent event or a significant uncertainty arising from COVID-19.
A ‘material uncertainty on going concern’ paragraph when a material uncertainty on the Company’s ability to continue to operate as a going concern exists, but it was adequately disclosed in the financial statements by management.
A modified opinion due to inadequate disclosures made by management.
Auditor’s responsibilities relating to Other Information in the Financial Statements
Auditors must ensure that management appropriately disclose the company’s prospects and how the users of the financial statements might be affected, all whilst acknowledging the current high degree of uncertainty. Auditors need to also consider their responsibilities in relation to other information presented by management with the financial statements, such as reading the other information and assess whether the other information is consistent with the financial statements or in line with the auditor’s knowledge obtained during the audit.
Key Audit Matters paragraph in the Audit Report
Where appropriate, auditors may decide to include a key audit matter in their audit report. The Audit Regulation ((EU) N°537/2014 of the European Parliament and of the Council of 16 April 2014), or local requirements may require that they report these matters to the relevant authorities or other bodies outside of the entity.
Audit of accounting implications due to COVID-19
The events related to Covid-19 will have a number of implications both from an auditing as well as an accounting perspective. These are further discussed in the article here. The auditor would need to consider whether such accounting implications have been correctly reported or disclosed in the financial statements.
Practical Limitations on Auditors’ ability to obtain sufficient and appropriate evidence
The Committee of European Auditing Oversight Bodies (CEAOB) issued guidance (CEAOB 2020-008) which also speaks about the practical difficulties for auditors to obtain sufficient and appropriate evidence due to the effects of Covid-19 especially due to social distancing and other restrictions such as reduced mobility of the auditor.
In particular, the guidance issued by CEAOB states:
‘’It is acknowledged that access and travel restrictions as well as the limited availability of personnel due to health considerations may impair the auditor’s ability to obtain sufficient appropriate audit evidence. For group audits, both the group engagement partner and component auditors should adapt their audit approach to the current circumstances. Auditors are advised to explore alternative means, including technology, to the extent possible. The completion of high quality audits under the current circumstances may require additional time, which may impact reporting deadlines. As a consequence, auditors may need to postpone the issuance of their audit report, and where this is not possible or not likely to resolve the issue, auditors may need to modify their audit report to reflect that they have not been able to obtain the necessary audit evidence.’’
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