COVID-19 Effect On Audits

Economies worldwide have been hard hit by the spread of the COVID-19 virus, with direct consequences for the clients of audit firms. Consequently, auditors need to adapt their audit approach for each client by considering the effect on audits as identified by the IRBA, as well as taking the appropriate considerations into account when implementing quality control.

Analysis of the effects

The effects as identified by the IRBA have been analysed, in order to determine the influence on the audit quality control system (Q), and the audit methodology and approach (M).

The effects overlap and should not be seen in isolation. They should be considered in all the areas mentioned, with specific focus on the headings under which they appear, as each client is experiencing unique circumstances.

• Only upon consideration and risk assessment should the necessary documentation be completed.
• Where circumstances imply an increased risk, these considerations should also be documented, even if the outcome is not an increase in risk of appropriateness to the relevant section.

LEAF audit methodology templates are in the process of being amended, in line with the recommended considerations described below, which include extracts on the subject taken from the IRBA newsletter.

1. Timetable

Reporting deadlines may be postponed.

Points for consideration:

• Communicate with management and those charged with governance, on a timely basis, so that they may fully understand the situation and determine the appropriate course of action.

Q: Communication register
M: Budget, deadlines, risk assessment, audit approach and audit report consideration

• If the client’s reporting timeline is delayed, will you, as the auditor, be able to realistically complete a quality audit of the financial statements, in order to adhere to regulatory reporting deadlines?

Q: Threats register, client continuance at firm level and client risk assessment
M: Budget, deadlines, risk assessment and audit approach

• Has the client communicated, on a timely basis, with the relevant regulatory authority, e.g. the JSE, the South African Reserve Bank, the Prudential Authority or the Estate Agencies Affairs Board?

Q: Reportable irregularity consideration and client continuance (management integrity)
M: Laws and regulations, reportable irregularity consideration and overall fraud risk

2. Risk Assessment

Original risk assessment on an audit may not be valid anymore.

Points for consideration:

• Any new risk(s) to be identified that were not assessed during the planning phase.

Q: Client continuance at firm level (firm capacity, integrity of management) and ethical compliance (independence from accounting functions and management decisions)
M: Risk assessment and audit approach (quality of evidence)

• Any risk assessed during the planning phase which has now become a significant risk; and any additional work effort required to address the significant risk.

Q: Client risk assessment at firm level
M: Risk assessment, audit approach, controls over significant risks and quality of evidence to reduce audit risk

• Modify the responses to these risks.

Take care to address all the overall risks, risks at balance and assertion level, going concern risk and the entity’s risk assessment procedure.

3. Evidence

Gathering of evidence may be challenging.

Points for consideration:

• Observe some physical inventory counts on an alternative date, if the attendance of physical counting cannot be performed at the year-end date; or perform alternative audit procedures where attendance of physical inventory counts is impracticable. Refer to ISA 501.

Q: Modified reports register and client continuance at firm level
M: Inventory audit approach, inventory risk assessment and consideration of evidence

• Consider performing alternative audit procedures when there is a significant delay in receiving audit confirmations. Refer to ISA 505.

Q: None, unless material impact and no alternative procedures available
M: Consideration of evidence, audit approach (substantive analytic review, internal controls) and risk assessment (reduction of audit risk)

• Consider any scope limitation that may lead to a modified audit opinion, in terms of ISA 705.

Q: Modified audit reports register and client continuance at firm level
M: Consideration of evidence, audit report consideration and client continuance

• Communicate with management and those charged with governance, on a timely basis, with respect to significant matters, such as difficulties encountered during the audit, potential delays in the auditor’s reporting and expected modifications to the auditor’s report.

Q: Communication register
M: Communication with TCWG

4. Group audits

Group audit considerations may need to be revised.

Points for consideration:

• Communicate with component auditors as soon as practicable to discuss potential impacts arising from the COVID-19 outbreak.

Q: None
M: Group instructions (scope, timing, evidence) and component auditor confirmations

• Consider any increased risk of material misstatement that financial information for those components may be inaccurate or incomplete, owing to the COVID-19 outbreak.

Q: Client continuance at firm level
M: Overall risk, consolidation process and quality of evidence to reduce audit risk

• Revise the risk assessment, modify the audit strategy and plan accordingly.

Q: Client continuance at firm level
M: Audit approach, risk assessment and controls over significant risks

• Evaluate the adequacy of component auditors’ work performed and consider additional work or any scope limitation that may lead to a modified audit opinion.

Q: Modified audit reports register and client continuance at firm level
M: Consideration of evidence, audit report consideration and client continuance at firm level

• Communicate with management and those charged with governance, on a timely basis, with respect to significant matters, such as difficulties encountered during the audit, potential delays in the auditor’s reporting and expected modifications to the auditor’s report.

Q: Communication register
M: Communication with TCWG and group audit opinion (ISA 600 Appendix 1)

5. Going concern

Going concern assessment needs to be carefully considered.

Points for consideration:

• Evaluate management’s assessment of the entity’s ability to continue as a going concern and consider whether management’s assessment includes all relevant information the auditors are aware of, as a result of the audit. Management’s assessment of the entity’s ability to continue as a going concern should at least cover a period of 12 months from the date of the financial statements.

Q: Client continuance and client risk assessment
M: Going concern evaluation and subsequent events

• Consider probing management about their knowledge of the events or conditions beyond the period of their assessment./

Q: Client continuance and client risk assessment
M: Going concern evaluation, consideration of evidence, audit approach, audit report consideration, subsequent events, estimates, impairment of assets, recoverability of financial assets and representations

• Maintain professional scepticism, and objectively challenge management’s plans and significant assumptions regarding events, or conditions affecting the entity and its environment, including uncertainties associated with the COVID-19 outbreak.

Q: Ethics (management approach towards suppliers) and client continuance (management integrity)
M: Kick-off meeting, consideration of evidence, going concern evaluation, audit report consideration, estimates, impairment of assets, recoverability of financial assets and representations

• Paragraph 16 of ISA 570 (Revised) sets out additional audit procedures when events or conditions are identified.

Q: Client continuance and client risk assessment
M: Going concern evaluation, evidence consideration, audit report consideration and representations

• Evaluate the adequacy of the disclosures related to a going concern.

Q: Technical review, EQCR and monitoring reviews
M: Directors’ report, AFS, going concern evaluation, audit report consideration and consideration of evidence

• Paragraphs 21-24 of ISA 570 (Revised) outline the implications of the auditor’s report.

Q: Client continuance and client risk assessment
M: Audit report consideration: going concern assumption inappropriate (adverse audit opinion), assessment period not long enough, long delay in issuing financial statements and communication with TCWG

6. Subsequent Events

Subsequent events need to be carefully considered.

Points for consideration:

• Discuss with management and those charged with governance, on a timely basis, the potential impact of the COVID-19 outbreak on the financial statements.
• Consider carefully the situation, in the context of the requirements of IAS 10, as follows:

i) If conditions exist at the end of the reporting period and an impairment indicator has been identified, consider whether an impairment test has been performed based on reasonable and supportable assumptions reflecting these conditions.

ii) If conditions exist after the reporting period and the financial effects are material, consider whether appropriate disclosures have been made for each material category of a non-adjusting event after the reporting period.

• While there is no obligation to perform any audit procedures regarding the financial report after the date of the auditor’s report, there are specific requirements auditors must fulfill to ensure the auditor’s report remains appropriate, if matters associated with COVID-19 become known after the date of the auditor’s report, but before the financial statements are issued. Refer to ISA 560.
• The auditor has no obligation to perform any audit procedures regarding the financial statements, after they have been issued. However, if the impact of the COVID-19 outbreak became known after the financial statements were issued and, had it been known on the date of the auditor’s report, may have caused an amendment to the auditor’s report, additional consideration by the auditor is required. Refer to ISA 560.

Q: Communications register
M: Subsequent events, directors’ report, AFS, evidence consideration and audit report consideration

Recommended paragraph in the directors’ report:

i. No material impact

In December 2019, a novel strain of coronavirus was reported to have surfaced in China. The spread of this virus began to cause some business disruption through reduced net revenue in the international market in January and February 2020. The virus reached South Africa in March 2020 and has caused significant disruption, due to the countrywide lockdown imposed by the president to prevent further spread of the virus. However, since the company is providing essential services, it is not significantly impacted by the lockdown restrictions. This is, therefore, not expected to have a material financial impact on the company’s operating results.

ii. Material impact which cannot be quantified yet

In December 2019, a novel strain of coronavirus was reported to have surfaced in China. The spread of this virus began to cause some business disruption through reduced net revenue in the international market in January and February 2020. The virus reached South Africa in March 2020 and has caused significant disruption, due to the countrywide lockdown imposed by the president to prevent further spread of the virus. While the disruption is currently expected to be temporary, there is considerable uncertainty surrounding its duration. Therefore, while the company expects this matter to negatively impact its operating results, the related financial impact and duration cannot be reasonably estimated at this time.

iii. Material impact which can be quantified – business may close, owing to material financial losses

In December 2019, a novel strain of coronavirus was reported to have surfaced in China. The spread of this virus began to cause some business disruption through reduced net revenue in the international market in January and February 2020. The virus reached South Africa in March 2020 and has caused significant disruption, due to the countrywide lockdown imposed by the president to prevent further spread of the virus. While the disruption is currently expected to be temporary, closing all stores for the duration of the lockdown period has a material impact on subsequent profits, cash flows and solvency of the company. The loss of revenue caused by these closures will result in an estimated net loss of RXXX, as disclosed in note xxx to the financial statements. The cash flow of the company is expected to be dramatically reduced and the company may be forced to permanently close some of its stores to reduce costs, and may need to further renegotiate repayment terms with creditors.

7. Accounting Estimates

Estimates may need to be considered.

Points for consideration:

• Auditors may consider what information about the outbreak was known by market participants at the reporting date, which would have impacted the fair-value measurement of assets and liabilities, as well as the financial disclosures.
• Auditors may consider the impact of the outbreak on the entity’s measurement of expected credit losses, as well as the qualitative and quantitative disclosures, to enable users of the financial statements to understand the effect of the credit risk on the amount, timing and uncertainty of future cash flows.
• Auditors may consider whether the COVID-19 outbreak is an impairment indicator at the reporting date, which results in an impairment assessment; and whether the disclosures in the financial statements sufficiently provide users of the financial statements with details on the significant assumptions made by management.

Q: Client continuance, client risk assessment
M: Risk assessment (risk assessment may be increased, due to effect of estimates), audit approach, going-concern evaluation, subsequent events, estimates (estimates used in going-concern evaluations), impairment of assets (effect on residual values of PPE), recoverability of financial assets, consideration of evidence, audit approach, audit report consideration and representation with creditors.

8. Audit Report

Reporting impact needs to be considered.

Points for consideration:

• Depending on the circumstances, consider including a separate section, ‘Material uncertainty related to going concern’, in the auditor’s report. Refer to ISA 570.
• Depending on the resolution of accounting and auditing matters, due to the impact of the COVID-19 outbreak, consider expressing a modified opinion, in accordance with ISA 705 (Revised).
• Revisit the key audit matters to be disclosed in the auditor’s report and identify any need for them to be updated to reflect new responses. Refer to ISA 701. These key audit matters need to be updated AFTER updating communication with TCWG, and extracted from that.
• Other information accompanying the financial statements may include an additional discussion of risks associated with the COVID-19 outbreak – consider whether there is a material inconsistency between this additional information and the financial statements, and report, in accordance with ISA 720 (Revised).
  Q: Modified audit reports register and client continuance at firm level
  M: Audit report consideration

Conclusion

The effects of COVID-19 are clearly significant and should be considered in all audits during this time. If you have any questions, or need assistance in this regard, you are welcome to contact LEAF for expert technical advice, thorough file reviews and practical guidance.

References

1. IRBA Newsletter: Implications of the COVID-19 outbreak on audits and auditors, 20 March 2020
2. IRBA Communiqué: Implications of the COVID-19 outbreak on audits, audit firms and regulatory requirements, 26 March 2020

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