COVID-19: The impact on Audits
The Corona Virus (COVID-19) is already impacting South Africa in various ways and many businesses are faced with operational difficulties. However, entities must remember that the restrictions resulting from the virus, will also impact financial reporting requirements and increase the focus on certain areas during audits.
This article highlights key matters and focus areas which will affect the auditing of and reporting on financial statements during this period.
Events after the reporting period
TheCOVID-19 virus, and the declaration of a national disaster, is indicative of an adjusting or non-adjusting event for entities with year-ends ending 31 December 2019 up to the date on which restrictions are lifted. In order for it to be an adjusting event, the auditor must assess whether there are any indicators that determine that the event existed at year-end.
At this current point in time, it is anticipated that the national disaster will be a non-adjusting event since impacts on businesses are rather as a result of government measures put in place to stop the spread of the virus, instead of the outbreak itself for year-ends before 15 March 2020.
Non-adjusting events should be disclosed in the financial statements if they are of such importance that non-disclosure would affect the ability of users to make proper evaluations and decisions. The required disclosure is (a) the nature of the event and (b) an estimate of its financial effect or a statement that a reasonable estimate of the effect cannot be made.
Management of an entity are required to provide the auditor with their assessment of the entity’s ability to continue as a going concern. The assessment should take into all available information about the future and cover at least 12 months from the end of the reporting period.
It may be difficult to make a meaningful Base Case economic forecast, let alone a plausible downside economic scenario. In this highly uncertain environment, going concern assessments will be more difficult for entities to make, and more companies will need to report a material uncertainty related to going concern.
The objectives of the auditor 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 presentation of financial statements; and
- to conclude on whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
The conclusion reached by the auditor may have a significant impact on the audit opinion.
If the auditor concludes that management’s use of the going concern basis of accounting is appropriate in the circumstances, but a material uncertainty exists, the auditor shall determine;
- whether the financial statements adequately disclose the principal events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and management’s plans to deal with the events or conditions; and
- disclose clearly that there is a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern, therefore it may be unable to realize its assets and discharge its liabilities in the normal course of business.
If the financial statements do not disclose or not adequately disclose the above, the auditor needs to consider the impact on the audit opinion.
The auditor must engage with management - those charged with governance to explain the implications of their proposed report and consider whether there are other procedures that could be undertaken, at a future point yet to be determined which could mitigate any modification either fully or in part.
It may be likely that the current circumstances lead to more modified opinions in auditor’s reports, than would typically be the case. Conditions may lead to an inability for the auditor to obtain sufficient appropriate audit evidence due to a limitation of scope.
Where sufficient appropriate audit evidence cannot be obtained, the opinion is modified in that respect:
- Where the possible impact on the financial statements could be both material and pervasive, then the auditor is required to disclaim their opinion.
- Or where the possible impact on the financial statements is material but not pervasive, a qualified opinion is expressed.
Estimates (including fair value accounting estimates and related disclosures) used in preparing the financial statements, may be affected by COVID-19 and/or measures put in place by Government.
Auditors are required to audit estimates with a questioning mind, specifically as to whether the entity has considered all possible scenarios, information and amendments to models used in calculating the estimate.
This will be a challenging area to audit as the impact of COVID-19, Government measures, as well as when restrictions will end, is not possible to determine at this point in time. Client must ensure that the auditors are satisfied with the information used by the entity, the extent of judgement applied, and whether there is any potential bias in the calculation of the estimate.
Fair value measurement
The fair value measurement takes place at the reporting date, which is based on either observable data or unobservable data as at reporting date.
This means that the fair value of an asset or liability reflects the conditions as at measurement date and not a future date. IAS 10 Events after the Reporting Date also notes that a change in the fair value of an instrument after the reporting date is a non-adjusting event.
When auditing the fair value measurement of an asset or liability, the auditor will need to ensure that the entity has only taken into account the information that was available at the reporting date. To this extent, entities with a 29 February 2020 year-end, will most likely not be able to bring the Government’s measurements to contain the spread of the virus, as communicated on 15 March 2020, into account when determining fair value, as this information was not yet known at the reporting date. This may however not apply to entities that operate within and outside of South Africa; other information from other countries may affect the fair value measurement.
Impairment of financial assets
Auditors are required to consider whether the COVID-19 outbreak is an impairment indicator at the reporting date, which results in an impairment assessment; and whether the disclosures in the financial statements sufficiently provide the users of the financial statements with details on the significant assumptions made by management.
Expected credit loss model
The expected credit loss model is derived from historical, current and forward-looking information. This is different from the fair value measurement discussed above as this calculation must take into account any information that became available subsequent to the reporting date. The expected credit loss model is based on the weighted average of the probabilities of default that may occur.
In addition, if the general model is used, the credit risk has significantly increased as this will determine whether the ECL is calculated for 12 months or the lifetime of the financial asset. Where an entity is significantly affected by COVID-19 and/or government measures put in place, this may result in an increased credit risk, resulting in a change in the weighted probability of default.
The auditor will consider whether the scenarios of default identified by management are still appropriate; scenarios must now to some extent include the impact of COVID-19 and the measures taken by governments.
Obtaining audit evidence
Auditors may have difficulties with accessing client premises to perform audit procedures and/or may not be able to obtain the sufficient appropriate audit evidence.
Auditors will consider performing alternative audit procedures where, for example, stock counts cannot be attended or significant delays in receiving audit confirmations are experienced.
Auditors must communicate with management and those charged with governance with respect to difficulties encountered during the audit, potential delays in the auditor’s reporting and expected modifications to the auditor’s report.
The auditor should obtain an understanding on the impact of the COVID-19 outbreak on the client’s reporting timetable. The COVID-19 outbreak may disrupt the business operations of entities and the financial reporting process may also be impacted. These matters should be discussed with clients to understand whether there is an impact on the client’s reporting timetable and the audit processes.
To date, the following reporting deadline extensions have been published:
- JSE Listed entities:
- The Financial Sector Conduct Authority (“FSCA”) has considered a request made by the Johannesburg Stock Exchange (“JSE”) to extend certain financial reporting deadlines. On 3 April 2020, the FSCA issued a market notice announcing JSE listed entities with year-ends of 31 December 2019, 31 January 2020, 29 February 2020 and 31 March 2020 will receive temporary relief for two months within which to complete their year-end financial reporting process should this be required by the JSE listed entities
- Financial statements in respect of the FAIS Act:
- The FSCA extended the period for submission of certain financial statements (for year-end up to 30 June 2020) by 4 months. This extension will not apply to Financial Services Providers (FSPs) that are registered Banks (as defined in Section 1 of the Banks Act), registered Insurers (as defined in section 1 of the Insurance Act), or Authorised Users (as defined in Section 1 of the Financial Markets Act).
- The FSCA extended the period for submission of financial statements for year-end up to 30 June 2020, in respect of Collective Investment Scheme (CIS) Managers and every portfolio of the Collective Investment Scheme that are administered by the CIS managers, by 3 months.
In closing This is unchartered territory for both businesses and auditors and the situation is ever-changing. Our firm undertakes to continuously communicate with management and those charged with governance to plan and execute audits in the most effective way possible under the current circumstances.