Reporting during a pandemic – an auditor’s nightmare

 

From Siva Nathan

It was during one of those lockdown days that got me contemplating aimlessly and as my thoughts meandered around the Covid-19 pandemic and the recent laws introduced in Malaysia, I started questioning myself as to whether auditors have given sufficient consideration to:

a) The impact and consequences of the pandemic; and
b) The requirements to comply with Section 17A of the MACC Act 2009 (Amended 2018).

An audit report that fails to take cognizance of the above may suggest that an auditor has failed in his responsibility to ensure that the financial statements present a true and fair view of the financial transactions of the company and ultimately does not reflect an accurate financial position of an entity and/or comply with requisite legislative requirements.

In this two-part series, the writer will discuss the impact of the pandemic, followed next week by the audit implications of Section 17A of the MACC Act 2009 (Amended 2018), which came into effect on June 1, 2020.

i) Going concern

It is a fact that the pandemic has caused significant disruptions and uncertainty to businesses and, undoubtedly, the markets will take a long time to recover to their pre-crisis level. This is being compounded with businesses struggling to keep open with extended lockdowns and uncertain SOPs.

As a consequence, a decrease in turnovers and profits is expected for the year ended Dec 31, 2020 and may likewise be for the 2021 financial year.

If that is so, the first and most obvious area of apprehension would be whether the entity may still be considered a “going concern”. In cases where the company’s cash flow is blatantly in the negative and there is visibly no obvious funding support, it cries to be included in the audit report.

ISA 570 (Revised) on Going Concern provides enhanced guidance on the appropriateness of disclosures where a material uncertainty exists. So, how do we report situations where an auditor has concluded that there may be material uncertainties relating to going concern? And should the audit opinion be Modified or Unmodified, included as an Emphasis of Matter or a Disclaimer of Opinion?

The choice of the mode will be dependent on distinct two factors:

Material uncertainty adequately disclosed

ISA 570 (Revised) specifically states that where material uncertainty exists and management has adequately disclosed these, the auditor can express an unmodified opinion, provided the auditor:

• Include a separate section under the heading “Material Uncertainty Related to Going Concern”, usually immediately after the Basis for Opinion paragraph but before the Key Audit Matters section, and
• Draw attention to this in the notes to the financial statements, and state that a material uncertainty exists which may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of this matter.

Material uncertainty not adequately disclosed

However, if the uncertainty is not adequately disclosed in the financial statements, the auditor should modify his opinion in line with ISA 705, Modifications to the Opinion in the Independent Auditor’s Report.

Notwithstanding the reporting requirements under ISA 570, it is imperative that practitioners understand how issues identified regarding going concern interrelate with the requirements of ISA 701 on Key Audit Matters.

By their very nature, issues identified relating to going concern are likely to be considered a key audit matter and hence need to be expressed clearly in the auditor’s report. Where the auditor has identified conditions which cast doubt over a company’s going concern, but audit evidence confirms that no material uncertainty exists, this “close call” can be disclosed in line with ISA 701.

This is because while the auditor may conclude that no material uncertainty exists, they may establish that matters such as substantial operating losses, available financing facilities and possible debt refinancing, or non-compliance with loan agreements or related mitigating factors may constitute to be Key Audit Matters.

Consequently, if a confirmed material uncertainty exists, it must be disclosed in accordance with ISA 570 and where there is a “close call” over going concern which has been established by the auditor to be a Key Audit Matter, it will be disclosed in line with ISA 701.

An example of how this may be reported is provided below:

Basis for opinion

We conducted our audit in accordance …

Uncertainty related to going concern

We draw attention to Note 8 in the financial statements, which indicates that although the Company has had no challenges for the audit period under examination, the mere fact that it has incurred substantial losses due to the Coronavirus Pandemic at the time of signing this Audit Report (subsequent to the balance sheet date) these events or conditions, along with other matters, indicate that a material uncertainty exists that may cast significant doubt on the Company’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.

ii) Other matters that you should consider reporting

Audit judgments may also have been made for financial statements that involve
significant management inferences, which the auditor might or might not be in
agreement. For example:

• The directors’ obligations and whether they have addressed the effect of the
  pandemic in the Directors Report.
• Whether any change or disruption in activities has been reported as a significant change in activity in the Directors Report.
• Whether the effect of the pandemic has been mentioned as a post balance
  sheet event or as a note in the accounts for any financial periods ending before March 31, 2020.
• Whether any contingent liability might exist as a direct result of the pandemic, especially where contractual obligations could not beperformed

Conclusion

The objective of this article is to draw the readers’ attention to:

i) The need to recognise and address the consequence of the Covid -19 pandemic’s impact oncurrent and future financial statements, and

ii) The method of recognition and the necessary disclosures in accordance with adopted international auditing standards. - FMT

Siva Nathan is a Chartered Accountant and Auditor and is currently an Adjunct Professor at Taylors University, Malaysia. He is the author of “Auditing, Assurance Services and Ethics”. He is also Professor of Accounting, Business and Economics and adviser to the Chancellor and Examinations Board at PUET in Europe.

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.