SA 701 & SA 570: Auditor special considerations with respect to covid-19 pandemic

SA 701 & SA 570: Auditor special considerations with respect to covid-19 pandemic

In light of the corona virus pandemic various tragedies and sufferings are currently faced by the community and there is also economic slowdown having significant impact on the economy resulting in halt down the GDP of the country, the users of the financial statements are now concerned with financial results of the entities for their financial and operating decisions, in order to maintain the credibility and confidence among the stakeholders, the entities may tend to engage in window dressing practices, thus as per SA 200 “ Overall objectives of the independent auditor and the conduct of auditor in accordance with standard of auditing” , it cast primary responsibility on the auditor to obtain sufficient and appropriate evidence to obtain reasonable assurance weather the financial statements are free from material misstatement and presents a true and fair view as per applicable financial reporting framework.

Financial Statements are prepared on the basis of three fundamental principles of accounting:

• Going Concern
• Consistency
• Accrual

With respect to going concern principle it states that the operations of the entity will continue for a foreseeable future, assets and liabilities are recorded on the premise that entity will be able to realize its assets and discharge its liabilities in the normal course of business, unless otherwise states that entity is not to intend to liquidate and shut down its operations.

This principle has gain weightage in the current financial and economic conditions, in light of the corona pandemic, temporary business shutdowns, suspension in the manufacturing unit, sudden hike in unemployment and various other parameters, Auditor in the course of preparing risk assessment procedures and related activities for the purpose of designing responses according to SA-315 and SA-330, for the purpose of collecting sufficient and appropriate evidence in order to determine and evaluate on the appropriateness of the going concern basis of accounting, The Institute of Chartered Accountant of India have notified SA-570: Going Concern, which laid the scope and duties of the auditor as laid down there under:

Auditor’s need to identify weather events or conditions that may cast significant doubt on the entity ability to continue as going concern, if the auditor encounters some indicators that may cast material uncertainty in the preparation of financial statement on the going concern basis of accounting, auditor shall inquire whether  management has performed assessment, if performed, management has identified any events or conditions weather individually or collectively, that may cast significant doubt on the entity ability to continue as going concern, the indicators are broadly classified into three categories:

1. Financial Indicators: Negative Net worth/working capital, Arrears/discontinuance of Dividends, Adverse financial ratio, substantial operating losses, short term borrowing for long term asset financing, No payment to creditors on due date, Negative cash flow from operations.

2. Operating Indicators: Loss of key management and no replacement available, Loss of major market or supplier, Labour unrest, strikes.

3. Other Indicators: Pending legal proceedings, Change in Government policy, affecting the entity adversely, Non-compliance with Statutory requirements.

Auditor may perform additional audit procedures that are appropriate to identify any events or conditions that may cast significant doubt in the entity ability to continue as going concern and material uncertainty exist in the preparation of financial statements, the auditor may perform following procedures

• Analyzing and discussing cash flow, profit and other relevant forecast with management.
• Analyzing and discussing the entity latest available interim financial statements.
• Reading the terms of debentures and loan agreement and determine whether any have been breached.
• Reading minutes of the meeting of shareholders, those charged with governance and relevant committees for reference to financial difficulties.
• Inquiring of the entity legal counsel regarding the existence of litigations and claims and the reasonableness of management assessments of the outcome and the estimate of their financial implications.
• Confirming the existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such persons to provide additional funds,
• Evaluating the entity’s plans to deal with unfilled customer orders.
• Performing audit procedures regarding subsequent events to identify those that either mitigate or otherwise affect the entity ability to continue as going concern.
• Confirming the existence, terms and adequacy of borrowing facilities.
• Obtaining and reviewing report of regulatory actions.
• Determining the adequacy of support for any planned disposal of assets.

If based on the audit procedures and additional audit procedures, sufficient and appropriate evidenced have been identified that cast material uncertainty relating to going concern, the auditor shall take into considerations the following pre-requisites:

(a) Where management has not yet performed an assessment of the entity’s ability to continue as a going concern, requesting management to make its assessment.

(b) Evaluating management’s plan for future actions in relation to going concern assessment, whether the outcome of these plans is likely to improve the situation and whether management’s plans are feasible.

(c) Where the entity has prepared a cash flow forecast:

(i) Evaluating the reliability of the underlying data generated to prepare the forecast; and

(ii) Determine whether adequate support for the assumptions underlying the forecast.

(d) Consider whether any additional facts or information have become available since the data on which management made its assessment.

(e) Requesting written representations from management and TCWG, regarding their pland for future actions and feasibility of these plans.

Auditor Conclusions:

The auditor shall evaluate whether sufficient appropriate audit evidence has been obtained regarding, and shall conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements.

Based on the audit evidence obtained, the auditor shall conclude whether a material uncertainity exists that may cast significant doubt on the entity ability to continue as going concern.

Adequacy of disclosures when events or conditions have been identified and material uncertainty exists

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;

(a) Disclose the events or conditions that may cast significant doubt on the entity’s ability to continue as going concern and management’s plan to deal with them; and

(b) Disclose clearly that there is material uncertainty and, therefore, that it may unable to realize its assets and discharge its liabilities in the normal course of business.

Adequacy of disclosures when events or conditions have been identified but No material uncertainty exists

If the events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as going concern but, the auditor concludes that no material uncertainty exists, the auditor shall evaluate whether, in view of the requirements of the applicable FRF, the financial statements provide adequate disclosures about these events or conditions.

Implications for the Auditor’s Report

Use of going concern basis of accounting is inappropriate

• If the Financial Statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of going concern basis of accounting in the preparation of the financial statements is inappropriate, the auditor shall express an adverse opinion.

Use of going concern basis of accounting is appropriate but a material uncertainty exists

(A) Adequate disclosures of a material uncertainty is made in the financial statements

• • If adequate disclosure about the material uncertainty is made in the financial statements, the auditor shall express an unmodified opinion and the auditor report shall include a separate section “ Material Uncertainty Related to Going Concern” to

(a) Draw attention to the note in the financial statement that discloses the matter; and

(b) State these events or conditions indicate that a material uncertainty that may cast significant doubt on the entity ability to continue as a going concern and that the auditor’s opinion is not modified in respect of that matter.

(B) Adequate disclosures of a material uncertainty is not made in the financial statements

• • If adequate disclosure about the material uncertainty is not made in the financial statements, the auditor shall:

(a) Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705; and

(b) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that a material uncertainty exist that may cast significant doubt on the entity ability to continue as a going concern

(C) Management Unwilling to make or Extend its assessment

• • If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor shall consider the implications on the auditor report.

Some practical illustration of auditor report with context to going concern

Gati Kausar India Ltd 2018 Annual Report

Material uncertainty related to going concern

“ we draw attention to note 35 in the financial statements, which indicate that a company has incurred a net loss of Rs.222.83 million during the year ended 31^st March, 2018 and as of the date has a negative net worth of Rs.244.74 million. The company current assets exceeds its current liabilities as at 31^st March, 2018 but only without considering the liability towards the commitment fee discussed in ‘Basis of qualified opinion’ section above. These conditions along with other matters set forth in such note, indicate the material uncertainty that may cast significant doubt about the entity ability to continue as going concern. However, in view of the mitigating factors as fully described in the aforesaid note including the revised business plan, the management is of the view that going concern basis of accounting is appropriate. Our opinion is not modified in respect of that matter.”

Audit report of f Enedo Plc FY2019-2020,

Material uncertainty related to going concern basis

We would like to draw attention to the accounting principles for the consolidated financial statements “going concern” section stating amongst other that:

• After the balance sheet date, on16 February 2021, the company announced the planning of EUR 12 million share issues and related EUR 8.6 million loan arrangement whereby the company would pay back debts EUR 5.3 million and EUR 3.3 million debts would be cancelled. The planned share issues and loan arrangement, if implemented, will have a significant impact on the company’s solvency and liquidity. There is uncertainty about the completion of the overall arrangement.
• At the time of publishing the financial statements on 10 March 2021, the company did not have sufficient working capital to finance the next 12 months of operations without the planned share issues and loan arrangements. Enedo Plc Auditor’s Report for the year ended 31 December 2020 2 – The realization of the company’s cash flow forecast for the next 12 months and thus ensuring going concern require the completion of the share issues, debt arrangements and additionally increase in net sales and improved profitability.
• uncertainty about the impact of the Covid-19 pandemic on business and uncertainty about the realization of the subscription and directed issue are significant uncertainties that may cast significant doubt on the entity’s ability to continue as a going concern. At the date of the auditor’s report the execution of the share issues and debt arrangements are pending. In our opinion, the abovementioned events and circumstances involve material uncertainty that may cast significant doubt upon Enedo Plc and the Group to continue as a going concern. Our opinion has not been qualified by this matter.

TRS INVESTMENTS LTD FY 2019-20 Audit Report

Material Uncertainty Related to Going Concern We draw attention to Note 16 to the financial statements, which indicates that TRS’s current liabilities exceeded its current assets by $459,000 (2019: current liabilities exceeded current assets by $594,000) and that if it does not secure a transaction for a takeover of the Company then the Company is dependent on the support of its shareholders to discharge its obligations to third parties. As stated in Note 16, these events or conditions, along with other matters as set forth in Note 16, indicate that a material uncertainty exists that may cast significant doubt on TRS’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.

In light of the corona pandemic another standard that got emphasis and gain prominence is SA-701 “Communicating Key Audit Matters in the Independent Auditor’s Report” at the common and general parlance its meaning is those matters in the auditor professional judgment were of most significance in the audit of the financial statement of the current period, these are selected from the matters communicated with TCWG.

Scope: Auditor’s judgment as to what to communicate in the auditor’s report and the form and content of such communication

Objectives: Auditor professional judgment to determine key audit matters and, having formed an opinion on the financial statements, communicate those matters by describing them in the auditor’s report.

Determining KAM: The auditor shall determine, from the matters communicated with TCWG, those matters that required significant auditor attention in performing the audit.

In making this determination, the auditor shall take into the following:

• Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with SA-315
• Significant auditor judgments relating to areas in the financial statement that involved significant management judgment, including accounting estimates having high estimation uncertainty.
• The effect on the audit of significant events o transactions that occurred during the period.

Communicating KAM: The auditor shall describe each key audit, using an appropriate subheading, in a separate section of the auditor’s report under the heading ‘Key Audit Matters’

The introductory language in the section of the auditor’s report shall state that:

• Key audit matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statement; and
• These matters were addressed in the context of the audit of the financial statement as a whole, and in forming the auditor opinion thereon, and the auditor does not provide a separate opinion on these matters.

Auditor’s special considerations in reporting KAM in auditor’s report:

• The auditor shall not communicate a matter in the key audit matters section of the auditor’s report when the auditor would be required to modify the opinion in accordance with SA-705 as a result of the matter.
• The description of ach KAM in the KAM section of the auditor’s report shall include a reference to the related disclosures, if any, in the financial statement and shall address:

(a) Why the matters was considered to be one of the most significance in the audit and therefore determined to be a KAM; and

(b) How the matter was addressed in the audit.

• The auditor shall describe each key audit matter in the auditor’s report unless:

(a) Law or regulation preclude public disclosures about the matter, or

(b) In extremely rare circumstances, the auditor determines that the adverse consequences of communicating the matter would reasonably be expected to outweigh the public interests benefits. This shall not apply if the entity has publicly disclosed information about the matter.

In light of the current economic scenario, the responsibilities of the auditor with respect to key audit matters have increased, in response to the matters that are communicated with management and TCWG, the auditors need to identify the most significant matters that have a material effect on the entity as the users of the financial statement tends to focused on the events or conditions for making financial and operating decisions, thus auditor needs to establish an overall audit strategy in performing more nature, timing and extent of audit procedures in relation to significant events or conditions that are material and fundamental for the primary users of financial statements. Auditor needs to report appropriately based on his professional judgment in the auditor report.

Practical Illustration of KAM

GODFREY PHILLIPS INDIA LTD. (GODFRYPHLP) – AUDITORS REPORT Fy 2019-20: Key audit matters extract

KEY AUDIT MATTERS	HOW OUR AUDIT ADDRESSED THE KEY AUDIT MATTER
RECOVERABILITY OF CARRYING VALUE OF NET ASSETS RELATING TO RETAIL AND CHEWING BUSINESS (AS DESCRIBED IN NOTES 5 (D) (I) AND 5 (D) (II) OF THE STANDALONE IND AS FINANCIAL STATEMENTS)
AS AT MARCH 31 2020 THE CARRYING VALUE OF NET ASSETS RELATING TO RETAIL AND CHEWING BUSINESS WAS RS. 8603.17 LAKHS AND RS. 6386.99 LAKHS RESPECTIVELY.	OUR PROCEDURES AMONGST OTHERS INCLUDED THE FOLLOWING:
RECOVERABILITY OF CARRYING VALUE OF ASSETS RELATING TO RETAIL AND CHEWING BUSINESS HAVE BEEN IDENTIFIED AS A KEY AUDIT MATTER DUE TO:	OBTAINED AND ASSESSED MANAGEMENT ANALYSIS OF INTERNAL AND EXTERNAL FACTORS IMPACTING THE COMPANY’S RETAIL AND CHEWING BUSINESS IN LINE WITH IND AS 36.
THE SIGNIFICANCE OF THE CARRYING VALUE OF ASSETS BEING ASSESSED.	IN RELATION TO THE RETAIL BUSINESS OBTAINED AND EVALUATED THE VALUATION REPORT OF MANAGEMENT APPOINTED EXPERT FOR THE PURPOSE OF TESTING THE KEY ASSUMPTIONS AND VALUATION METHODOLOGIES USED TO DETERMINE THE RECOVERABLE AMOUNT BY ENGAGING VALUATION SPECIALISTS.
SIGNIFICANT LOSSES BEING INCURRED IN THE RETAIL BUSINESS AND CONTINUING LOSSES IN THE CHEWING BUSINESS.
THE ASSESSMENT OF THE RECOVERABLE AMOUNT OF THE COMPANY’S CASH GENERATING UNITS (CGUS) INVOLVES SIGNIFICANT JUDGEMENTS AND ESTIMATES INCLUDING THE POTENTIAL IMPACT OF COVID 19 ON THE FUTURE CASH FLOWS. THE KEY JUDGEMENTS IDENTIFICATION OF AND ESTIMATES CENTRED INDICATORS OF IMPAIRMENT AND FUTURE PROJECTIONS RELATING TO THE AFORESAID BUSINESS.	IN RELATION TO THE CHEWING BUSINESS CRITICALLY EVALUATED THE KEY ASSUMPTIONS USED BY THE MANAGEMENT INCLUDING FORECASTED REVENUES APPROPRIATENESS OF THE WEIGHTED AVERAGE COST OF CAPITAL USED TO DISCOUNT THE FUTURE CASH FLOWS BY ENGAGING VALUATION SPECIALISTS.
	ASSESSED THE INDEPENDENCE COMPETENCE AND OBJECTIVITY OF THE MANAGEMENT APPOINTED EXPERT USED FOR DETERMINING THE RECOVERABLE AMOUNT. -COMPARED THE RECOVERABLE AMOUNT OF THE ASSETS RELATING TO RETAIL BUSINESS TO THE CARRYING VALUE IN BOOKS.
	ASSESSED THE DISCLOSURES MADE IN THE FINANCIAL STATEMENTS BY THE COMPANY IN THIS REGARD.

Reliance Industries limited- Audit report Fy2019-20-Key Audit matter extract

A. Capitalisation of property, plant and equipment During the year ended March 31, 2020, the Company has incurred significant capital expenditure. Further, out of the total additions to property, plant and equipment of ` 1,13,300 crore in the current year, significant part of the capitalisation pertains to the Gasification project, including modification of power plant equipments i.e. Gas Turbines, Auxiliary Boilers, HRSGs, Process Furnaces, etc. to make them compatible to multiple feedstock, including those received from petcoke gasifier. All units of the gasification complex and related integrated projects have been successfully commissioned and capitalised during the year. Significant level of judgement is involved to ensure that the aforesaid capital expenditure/additions meet the recognition criteria of Ind AS 16 – Property, Plant and Equipment, specifically in relation to determination of trial run period and costs associated with trial runs for it to be ready for intended use. As a result, the aforesaid matter was determined to be a key audit matter.

• Our audit procedures included and were not limited to the following:
• Performed walk-through of the capitalisation process and tested the design and operating effectiveness of the controls in the process.
• Assessed the nature of the additions made to property, plant and equipment and capital work-in-progress on a test check basis to test that they meet the recognition criteria as set out in para 16 to 22 of Ind AS 16, including any such costs incurred specifically for trial run.
• Assessed that the borrowing cost capitalised (including foreign exchange loss to the extent it is considered as an adjustment to interest cost) is in accordance with the accounting policy of the Company.
• Reviewed the project completion/handover certificate provided by the management to determine whether the asset is in the location and condition necessary for it to be capable of operating in the manner intended by the management.

In nutshell, Auditor’s need to demarcate that the events or conditions that have material effect on going concern basis of the business needs to be reported as per SA-570, other than those, matters having higher assessed risk of material misstatement and events or conditions, like transition from Accounting standard to Indian Accounting standard or transition from Indian Accounting standard 17 leases to revised Indian accounting standard 116 leases needs to be reported as per SA-701, the primary consideration of both the standard is auditor cannot express opinion on these matters, it is relevant for the users understanding of the entity and its applicable environment for making rational decisions.

Abbreviations:

GDP:- Gross domestic product

SA:- Standards on Auditing

TCWG:- Those charged with governance