March 2020 has been a challenging month for all UK businesses. Quite rightly, the focus has been on survival across the business community, adapting quickly to the new normal of freedom of movement restrictions and huge measures being taken by the UK government to mitigate the economic impact of COVID 19.
We have also seen significant interventions by the UK financial reporting regulator, the Financial Reporting Council (FRC), as well as the Financial Conduct Authority (FCA), providing advice to company directors and auditors on what actions they should be considering in these unprecedented times.
Due to the current environment and the number of different business challenges facing individuals we take a look at some of the changes in approach your auditors may take when completing the audit of your financial statements.
With widespread restrictions on freedom of movement, both in the UK and abroad, UK auditors and overseas component auditors may struggle to gain sufficient and appropriate audit evidence to form an audit opinion. However, we are fortunate in 2020 that we have many remote working options open to us, which has alleviated some of the challenges in this area. With the advancement of accounting packages moving from a desktop to a cloud based product it allows audit firms to access the client systems remotely on a read only basis. Conference or video call facilities such as Skype, Teams and Zoom allow for regular communication with clients and enables the audit team to ask relevant questions face-to-face.
Therefore, be prepared for unusual requests, potentially around using FaceTime and similar solutions to be able to show the auditors, in real time, assets or processes that would normally require physical access.
For the upcoming year end of 31 March, there are considerable challenges faced by the company and their auditors around the physical verification of the existence of stock. As we know, currently physical access is now widely restricted for both the company and the auditor. Therefore, alternative procedures to gain comfort over the existence of stock may be possible depending on specific circumstances, for example delaying a stocktake might be an option until later in the year, with a reconciliation performed to the year-end stock valuation.
Whether your audit fieldwork has been completed or is yet to start, expect impairment considerations to be a key audit issue due to the impact Coronavirus has had on the economy. Do not be surprised if there are more questions and challenge around the testing of impairment. We have set out below some of the specific areas where you should be prepared for further scrutiny:
Trade debtors: Attention will be given to the recoverability of the trade debtors at the year-end date due to the likely cash issues that will be experienced across all sectors. Therefore, correspondence with customers will be important in determining the likelihood of payment. Your auditors will also want to both written and verbal communication with your customers so please do document telephone calls and video conferencing. The policy used to determine the provision is also likely to be scrutinised and challenged by the auditor.
Stock: There is a higher risk of stock obsolescence arising from recent events. Importance will be placed on the ageing of the stock and the policy that is in place to determine the provision. Like trade debtors, the process that you use to determine the provision will be scrutinised and challenged by the auditor.
Fixed assets: Whilst the current issues faced by businesses are expected to be temporary, attention will need to be paid as to whether assets used in the business are still capable of delivering the desired future economic benefit. For instance, a lessor may find significant defaults within its portfolio which may impact the carrying value of the leased assets. It is important that you clearly document and provide evidence to support the carrying value of material assets, either by reference to their value in use within the business or through sale.
Intangible assets: Given the negative cash flow implications of the pandemic, and the potential for discount rates used in modelling impairment reviews to increase, management should expect significant scrutiny of impairment review models supporting the carrying value of intangible assets. Try to make the process as easy as possible by having support for the various assumptions being modelled.
Where a business utilises valuations to support the fair value of an asset (such as property) on the balance sheet, consideration will be given by the auditor as to whether the valuations are reliable in the current environment. Given the current property market situation, property valuers are already needing to caveat the reports they provide because the property market is not functioning properly. This will mean that you may well need to give alternative evidence to your auditors, such as recent sales of similar properties or discussion with local estate agents.
Businesses applying any form of long-term contract accounting methodology can expect estimates of the costs to complete a project, or assumptions on timings to be challenged. Therefore, it is important that the project managers provide the finance team with the appropriate evidence to support the cost of completion percentage.
With travel restrictions in place, businesses may have contractual usage or supply provisions in contracts which an entity may no longer be able to fulfil. This may result in penalties being triggered. Auditors will need to understand the position and whether there is a contractual liability to provide in the financial statements. Your auditor will ask to see correspondence between you, your lawyer and the contract provider to help determine the potential liability and will need to review boards minutes to obtain updates on the approach the company is taking.
In challenging economic times, the inclination or pressures to commit fraud, whether transactional or financial reporting-related, can increase significantly. Be prepared for your auditor to be considering the pressures which are emerging in this economic landscape and how they impact your business. They may need to undertake further or different tests than you may have experienced in previous audit visits.
Finally, the going concern concept may be the most significant and challenging judgement for management to make in the current environment. The ICAEW has written a helpful article that reiterates management’s responsibility to conduct a going concern assessment and an auditors role to conclude on the appropriateness of management’s use of the going concern basis of accounting when preparing the financial statements. We would suggest that the guidance is reviewed to ensure that the directors are correctly discharging their responsibilities as directors when applying the going concern concept.
Due to the current environment and the uncertainties, expect your auditor to want to see a detailed profit and loss account, balance sheet and, most importantly, cash flow forecasts for at least 12 months from the anticipated date of signature of the financial statements and for these forecasts to be stress tested.
Due to the increased scrutiny on going concern the approach may be to delay the signing of financial statements, enabling further sufficient and appropriate audit evidence to emerge to support (or otherwise) the viability of the business.
If you have any queries about your audit, please speak to your usual Saffery Champness contact.