Going concern disclosures and audit implications
This is the latest article in a series of financial reporting and auditing in the shadow of COVID-19. The first article focused on the business landscape, government incentives and financial reporting and auditing considerations.
The Coronavirus pandemic has had an impact on all businesses and some will be feeling the financial strains and pressures more than others. It has not changed the definition of, or responsibilities for, directors and auditors around going concern and due to the effect of Coronavirus on the ability for both directors and auditors to make assessments and draw conclusions around going concern, companies may want to consider deferring the approval and filing of their accounts until there is more certainty.
Going concern basis of accounting
Financial statements are prepared on a going concern basis unless management intends either to liquidate the entity or to cease trading, or has no realistic alternative but to do so.
When assessing whether the going concern assumption is appropriate, management must take into account all available information about the future, which is at least, but not limited to, 12 months from the date that the financial statements are authorised for issue.
Formal assessments and cash flow forecasts
Evidence regarding going concern is often provided in the form of cash flow models and/or budget forecast models, as well as details of future sales pipeline projections. Unless you are in the fortunate position of not being negatively impacted by COVID-19, it will be necessary to adjust the cash inflows and outflows of the business to take account of changes in circumstances that are both specific to the sector in which you operate (e.g. interruption to supply chains from abroad) as well as the wider economic environment (e.g. a drop in demand generally and an inability for customers to pay debts as they fall due).
Given the large amount of uncertainty as to what the emergence from lockdown will look like, this modelling will not be an exact science. The key is to document any assumptions made in preparing the forecasts and to ensure that they are applied consistently. This will assist auditors with their review and when undertaking sensitivity analysis and stress testing procedures. A cautious approach to forecasting is generally best.
Material uncertainties and disclosure
Accounts should always present a true and fair view of the financial position of the business and in the current climate this is likely to necessitate the requirement for additional disclosures within the notes to the accounts and within the directors’ report and strategic report, where required. This will enable the users of the accounts to understand the impact that COVID-19 has had or may have on the business going forward. This will be particularly relevant where significant judgements were made when preparing the forecasts and where material uncertainties remain in relation to the future of the business.
Auditing going concern
Several months before we were aware of the pandemic, the FRC revised its going concern standard, ISA UK 570, in response to a string of corporate failures where auditors failed to warn that companies were on the brink of collapse. The revised standard requires greater work on the part of the auditor including a more robust challenge to management’s assessment of going concern, thoroughly testing the adequacy of the supporting evidence and evaluating the risk of management bias.
Auditors are likely to view going concern as a heightened and/or significant risk area and will need to ensure that they obtain sufficient, appropriate audit evidence when testing management’s assumptions and forecasts. They will need to continue to remain professionally sceptical throughout the audit and consider the potential additional challenges the business faces due to COVID-19.
Auditors are required to refer to any material uncertainties related to going concern in their audit report and so it is likely to be quite common place in the coming months to see this paragraph included by auditors, reflecting the difficulties and uncertainties faced by the business. Where the auditor considers that there is insufficient evidence to support or disclosure to explain that the business is a going concern, then auditors will need to decide whether a qualified audit report is appropriate instead.
Working with your auditor
COVID-19 doesn’t just impact on how we do business, it changes the way that companies interact and communicate with their auditors. The increased levels of social distancing and uncertainties regarding the future economic climate mean that it is more important than ever to discuss any potential going concern issues with your auditor at an early stage in the audit process.
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