Anuranjan Sahni*

Impact of Corona Virus (COVID-19) on Audit of Financial Statements for the Financial Year ending March 31, 2020

Background

The global pandemic COVID-19 has already had a significant impact on global trade and economy with consequential impact on global and Indian financial markets. This may also have accounting, disclosure, internal control and auditing implications for many entities. There is a great deal of uncertainty as to how the COVID-19 situation will continue to evolve and the scenario is rapidly changing. The uncertainty arises primarily from interruptions in production, supply chain disruptions, unavailability of personnel, closure of offices due to the rapid outbreak of COVID-19, decline in demand, liquidity, business continuity issues, etc. The resultant outbreak though started outside of India impacts entities in India as well.

To enable the auditors to perform audits, additional me may be required and alternate audit procedures may need to be performed in order to obtain sufficient appropriate audit evidence. 

Areas which require special attention of auditors in current scenario are cited below along with reference of relevant Standards on Auditing (SAs):

1. Identifying and Assessing the Risk of Material Misstatement and Materiality in Planning and Performing an Audit (SA 315 and SA 320)

Entities and auditors would have to evaluate additional risks arising from the following areas:

  • Operational disruption resulting in any changes to the business model arising from significant drop in demand, reduced customer base, disruption in supply chain, employee’s absence or work from home, public lock down etc.
  • Contractual non-compliance resulting in contractual breaches
  • Liquidity and working capital issues given the reduced/ impaired ability to service debt or replenish working capital requirements due to possible lower cash flows.
  • Asset valuations – downward asset valuations may trigger legal and compliance issues or lead to liquidity challenge.

In applying SA 315 – Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment, the auditor should consider the implications of the above matters when obtaining an understanding of the entity and its environment, in light of its objectives, strategies and other business risks.

The auditor should also discuss with TCWG and management whether the impact of the COVID-19 has been incorporated into their risk assessment processes and how they have identified and assessed the significance of the emerging business risks. 

2. Assessing Financial Impact and their Reasonable Estimation (SA 540)

Specific accounting issues could arise in the following areas :

a) Impairment of Goodwill, Property Plant and Equipment, Intangible Assets and Valuation & impairment of receivables, loans and advances.

b) Valuation of defined benefit plans and obligations – due to significant changes in employee strength or de- valuation of underlying plan assets.

c) Contractual penalties.

d) Employment termination benefits

e) Insurance recoveries related to business interruptions

f) Onerous contract provisions

g) Allowance for expected credit losses.

The above items are likely to have significant accounting estimates to be made by the management. Significant assumptions including projected cash flows, used in these accounting estimates may be affected by the impact of COVID-19. Hence, the auditor should use procedures as prescribed by SA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures to check whether :

(a) the accounting estimates, including fair value accounting estimates, in the financial statements, whether recognised or disclosed, are reasonable;

(b) related disclosures in the financial statements are adequate

3. Valuation of Inventory on date other than date of financial statements i.e 31st March 2020 (SA 501)

  • Due to government-imposed shutdowns or due to unavailability of the client personnel, it may not be practicable for most of the business entities to conduct physical verification of inventory as on the date of the financial statements i.e. 31st March, 2020.
  • The auditor must plan procedures depending on the underlying circumstances wherein the inventory count date could be advanced prior to the year- end or deferred to a date after the year-end.
  • The auditor would need to comply with the procedures given in SA 501 which says that If physical inventory counting is conducted at a date other than the date of the financial statements, the auditor shall, in addition to the procedures prescribed, perform audit procedures to obtain audit evidence about whether changes in inventory between the count date and the date of the financial statements are properly recorded. 

4. Subsequent Events or Events occurring after Reporting Date (SA 560)

Adjustments to assets and liabilities are required to be made for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date.

However, adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. Disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date that represent material changes and commitments affecting the financial position of the enterprise.

Entities must disclose significant recognition and measurement uncertainties that might have been created by the outbreak of the COVID -19 in measuring various assets and liabilities. They should also disclose how they have dealt with the impact of COVID -19 on the financial position and financial performance of the entity.”

5. Going Concern (SA 570)

COVID-19 is resulting in significant operational disruption and presents an existential threat for many businesses. Entities and audit teams need to consider the implications on the assessment of going concern and viability in the financial report and whether these circumstances will result in prolonged operational disruption which will significantly erode the financial position of the entity or otherwise result in failure. This is critically important for the going concern assessment.

Auditors will need to consider whether the threat to liquidity as a result of supply/demand disruption presents a material uncertainty to the going concern status for the 12 months look forward period. SA 570(Revised) also requires auditors to consider events that may cast significant doubt on the entity’s ability to continue as a going concern beyond the period of management’s assessment. Audit teams should robustly assess the going concern and viability risks relating to COVID-19 threat in compliance with SA 570(Revised). This includes evaluating whether there is adequate support for the assumptions underlying management’s assessment and the consistency of these assumptions across the entity’s business activities.

6. Written Representation (SA 580)

  • As per SA 580, the auditor should obtain written representations from the management regarding the various estimates and assessments made by the management.
  • The written representations should be exhaustive, containing the occurrence, method of measurement, completeness of transactions recorded and the disclosure of financial impacts in the financial statements.
  • Auditors need to assess whether any specific representations may be required to be obtained from the Management in relation to Managements’ assessment of impact from the ongoing outbreak of COVID-19 on the financial statements for the year ending March 31, 2020 as well as for the reasonable foreseeable future.

7. Auditor’s Opinion (SA 700, SA 705, SA 706)

Some situations where the Auditor may need to express a modified opinion due to COVID-19 are cited below:

  • The auditor is unable to obtain sufficient appropriate audit evidence relating to material component audited by the other auditor as per SA 600 due to COVID-19 pandemic.
  • The financial impact arising out of the COVID-19 outbreak are not accounted or reported or disclosed as per the prescribed AS, in the financial statements.
  • If the auditor is unable to obtain sufficient appropriate audit evidence relating to the impact of COVID-19 in the financial statements and is of opinion that there are misstatements that are material to the financial statements.
  • The auditor has communicated misstatements to the management and those charged with governance relating to COVID-19 and the management or TCWG refuses to correct such misstatements, that are individually or in aggregate, material to the financial statements.

8. Internal Control Consideration

In case of companies, where the auditors have to issue a Report on the Internal Financial Controls over Financial reporting, because of the impact of COVID-19, there could be additional considerations that need to be considered as below:

  • Companies may need to implement new internal controls or modify exisng internal controls over financial reporting.
  • Evaluate whether any of the controls is not operating effectively on account of absence of concerned person due to illness/quarantine/ working from home/isolation/travel inaccessibility.
  • Identify alternate controls.
  • Company’s ability to close financial reporting process in me.
  • Company’s ability to design and implement controls related to selection and application of Generally Accepted Accounting Principles (GAAP) for accounting and disclosure issues arising from COVID-19.

9. External Confirmation (SA 505)

SA 505, External Confirmations provides guidance regarding the process of seeking external confirmations and evaluating the results of the process. Due to the impact of COVID-19 it is more likely that this key audit procedure which provides significant independent audit evidence may be ineffective due to the inadequate responses or non-responses to the confirmation request sent out.

In the case of each non-response, the auditor shall perform alternative audit procedures to obtain relevant and reliable audit evidence as per the procedures prescribed under SA 505.

10. Risk of Fraud (SA 240)

SA 240 states that “An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the SAs.”

The auditor shall maintain professional skepticism throughout the audit, recognizing the possibility that a material misstatement due to fraud could exist, notwithstanding the auditor’s past experience of the honesty and integrity of the entity’s management and those charged with governance.

The impact of COVID-19 on businesses could be very significant and could put pressures on management to meet performance targets or market expectations. This raises the risk of the likelihood of fraud in the financial statements to a higher level which requires the auditor to exercise a much higher degree of skepticism and carry out extended audit procedures to eliminate the possibility of fraud or material error in the financial statements. 

Conclusion

The role of auditors at times like this is under increased scrutiny as the auditors have a public interest obligation to complete the audit work in accordance with professional standards and ethics requirements. Under the current circumstances, auditors must recognise that the manner in which they conducted the audits in the past may need significant modification to address the challenges and uncertainties arising out of the impact of COVID-19.

Irrespective of the challenges and uncertainties, there should not be any dilution or non-compliance with the auditing standards in carrying out the audits.

*(Author ‘Anuranjan Sahni’ is associated as Analyst-Direct Tax with International Business Advisors, Delhi)

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