Auditing going concern: COVID-19 impacts
The audit of going concern is governed by ISA (UK) 570, Going Concern. The current version of this standard is the one revised in 2016, but a new version, revised in September 2019, takes effect for accounting periods beginning on or after 15 December 2019 and is available for early adoption.
Although you may prefer not to adopt the new version yet, the increased detail it contains is useful and the FRC’s guidance for auditors in the current situation is encouraging reference to it, particularly for reporting requirements.
Whichever version of ISA (UK) 570 you use, there are some common threads:
- Risk assessment
- Auditing management’s assessment of going concern
- Auditor reporting
In the current environment, the risk assessment of going concern is likely to look very different to that from previous years. It is vital that the auditor engages with management to establish what work has already been done on the business’s viability and hence going concern status.
Many businesses will be facing enormous challenges such as:
- Enforced closures/reductions in sales levels
- Risks to the operation of internal controls due to new ways of working
- Risks of breaches of bank covenants
- Loss of supply chains
- Loss of staff due to illness/quarantine
The business and the auditor will need to allow extra time for the impact of the virus to be fully considered, meaning that sticking to the normal reporting deadline could be a problem. For this reason, private companies may apply to Companies House to seek an extension of three months to their filing deadline and listed companies have an additional two months for their accounts.
Auditing management’s assessment of going concern
For the auditor to express an opinion on the going concern status of an entity, they first need to have management’s assessment. Smaller or less complex entities may not usually prepare formal forecasts or set out all their assumptions. In the current environment this will be vital, so the auditor may have to provide some prompts to businesses less familiar with the process.
Clients may ask for their auditor’s help in preparing forecasts or carrying out sensitivity analyses on the various assumptions. However, as auditors, we need to maintain our independence and so we must consider if the FRC Ethical Standard precludes the auditor assisting, or whether adequate safeguards can be put in place.
Once management has provided a going concern assessment the auditor must look at all aspects, including (but not limited to):
- The arithmetical accuracy of forecasts
- The consistency of assumptions within the forecast and elsewhere in the business
- Whether assumptions are realistic or supportable, for instance:
- have rent holidays been agreed or is this just a hope
- is government assistance available (see below)
- can assets really be sold to create further liquidity
- Whether it looks sufficiently far ahead (at least 12 months from when the accounts will be approved)
- Terms of bank lending/new loans available
- Any related impairment reviews, such as for goodwill
The UK government has provided a package of measures to help assist businesses and so management may have included assumptions about which of these it will use. Examples included in the COVID-19 UK business support package include:
- Furloughing of staff
- Delays in tax payments
- Business rates holidays
The auditor will need to gather evidence for these and other mitigating actions, remembering to challenge management rather than just take their word. It is vital that the auditor is sceptical when carrying out their audit work on going concern and that their working papers show evidence of that scepticism. For instance, if the client says that there will be a rent holiday, ask for documentation from the landlord to confirm this.
It will be important for auditors to spend sufficient time on the audit of going concern and accept that it will take much longer than normal for most clients. This work can be complex and therefore the right level of staff with the right support will need to be utilised, generally requiring much more partner and manager input than for other areas. Due to the fast-changing nature of the situation also ensure that the subsequent events review goes right up until the moment the audit report is signed.
The auditor needs to form an opinion about:
- Whether the going concern basis of accounting is appropriate for the entity
- If so, are there material uncertainties that may cast significant doubt on the entity’s ability to continue as a going concern and
- Whether those material uncertainties have been adequately disclosed in the accounts.
Reporting on going concern issues can be a tricky matter and there are lengthy requirements in ISA (UK) 570. All examples of audit report are possible when it comes to going concern, including:
- An unmodified report with no material uncertainty regarding going concern;
- an unmodified report with a “Material Uncertainty Related to Going Concern” paragraph;
- a qualified opinion due to disagreement or uncertainty, perhaps due to poor disclosure;
- an adverse opinion where the auditor disagrees that the accounts give a true and fair view, for example because the entity is not a going concern in the auditor’s opinion; or
- a disclaimer where the auditor cannot form an opinion on the accounts, perhaps due to huge inherent uncertainties or a lack of audit evidence.
As auditor it will be especially important at this time, to carefully consider whether you have enough evidence to conclude on going concern and which opinion is appropriate.