Organisations and their auditors are facing unprecedented practical challenges in a number of areas as a result of the COVID-19 pandemic. As entities face a myriad of challenges to remain in business and prepare financial statements given the impact of COVID-19, auditors also have practical difficulties. These difficulties range from accessing client information to the additional time needed to assess the impact of COVID-19 on asset impairments, uncertainties related to going concerned and subsequent events disclosures.
In such testing times, auditors are looking to develop and leverage alternative procedures to audit clients’ financial statements. By harnessing available technology, auditors may be able to better fulfil their audit obligations, mandatory isolation notwithstanding.
Auditors are already using various information and communication technologies (ICTs) – spreadsheets for checking samples, macros for running analyses and emails to engage with clients. However, these only allow them to work remotely to a limited extent. To fully transition to remote work, existing ICTs need to be enhanced with additional technological solutions that facilitate remote communication within the audit team, information gathering, reconciliation of transactions, and financial analysis and interpretation.
Fieldwork could pose a particular problem for auditors. The concern is that auditors may have difficulty gaining access to the evidence and people they need to support their audit opinion.
The following areas are envisaged to be of high importance for the performance of ongoing audits:
Professional Skepticism. Auditors should plan and perform any audit and or assurance engagement with professional scepticism. In the prevailing environment where many auditors are working remotely, firms are encouraged to remind everyone, from partners to less experienced auditors, about the importance of staying alert to the quality of evidence and whether that evidence is sufficient and appropriate to reduce audit risk to an acceptable low level.
Obtaining sufficient and appropriate audit evidence.
ISA 500 underscores that it is the auditor’s responsibility to obtain sufficient and appropriate evidence before issuing their audit report. It is acknowledged that access and travel restrictions, as well as the limited availability of personnel due to health considerations, may impair the auditor’s ability to obtain sufficient and appropriate audit evidence. For group audits, both the group engagement partner and component auditors should adapt their audit approach to the current circumstances. Auditors are advised to explore alternative means, including technology, to the extent possible. The completion of high quality audits under the current circumstances may require additional time, which may impact reporting deadlines. As a consequence, auditors may need to postpone the issuance of their audit report, and where this is not possible or not likely to resolve the issue, auditors may need to modify their audit report to reflect that they have not been able to obtain the necessary audit evidence.
Financial Statement Issuance Delays.
With many businesses faced with unexpected closures and demand uncertainties, completion of procedures necessary to issue historical financial statements may be a low priority. Management and auditors of private companies may consider delaying financial statement issuance, if possible until circumstances improve. In the interim, management of private companies could choose to communicate with users by means other than issued historical financial statements (such as drafts or projections). However, such an approach should be carefully considered. If there is a delay in the issuance of the financial statements, auditors will need to consider extending subsequent events and other auditing procedures as necessary.
Physical Inventory Observation.
ISA 500, Audit evidence requires that, if inventory is material to the financial statements, auditors should obtain sufficient and appropriate audit evidence regarding the existence and condition of inventory by attending physical inventory counting, unless impracticable and perform audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results.
For audits of entities with fiscal year-ends that fall in the midst of the COVID-19 pandemic, auditors may encounter cases where retail locations and warehouses are closed or are open with very limited staff, or auditors are unable to travel to the inventory observations due to travel restrictions. In those cases, obvious challenges arise in performing physical inventory observations.
If clients are unable to perform physical inventory counts at year-end due to the unforeseen circumstances, they might decide to perform those physical counts on an alternative date. Auditors may be able to observe the rescheduled counts and perform additional audit procedures on intervening transactions. If the physical inventory counts are to take place at a later date than originally scheduled, auditors will have to perform additional procedures such as reviewing and testing inventory rollbacks.
Auditors might need to perform procedures to obtain assurance that client inventory locations have in fact been locked down for a period of time. This might include obtaining live feeds or security camera footage taken of the retail locations and warehouses during that time and reviewing shipping and receiving records during that time to ensure movement was minimal.
In some cases, clients may be able to perform the usual physical inventory counts, but auditors are unable to attend due to travel restrictions. In those cases, auditors may want to take advantage of technologies including camera systems with live video feeds, to observe inventory counts. In such instances, auditors may need to obtain some level of comfort that the videos are live feeds of client inventory locations, perhaps by confirming visually with key staff and using voice technology to have cameras moved to specified locations on command and direct certain boxes to be opened.
Of course, auditors should be aware that procedures that can be performed virtually might be a bit more limited and may pose additional audit risks that will need to be addressed. When there are multiple inventory locations, how will auditors control inventory counts to be certain inventory was not moved from one location to another? If the audit risks cannot be reduced to an acceptable level, this will pose a scope limitation.
Where inventory balances are material but are not pervasive, this will result in qualified audit opinions. Some alternatives auditors might discuss with clients include issuing qualified opinions now and, then, performing agreed-upon procedures engagements on inventory after travel restrictions ease. Alternatively, clients may be encouraged to discuss with financial statement users as to whether review engagements would be sufficient for the year-end, supplemented with agreed-upon procedures on inventory after year-end when counts can be taken.
Valuation of inventories is subject to IAS 2 Inventories, and inventories are measured at the lower of their cost and net realizable value (NRV). In the current environment, the NRV calculation will likely require more detailed methods or assumptions. Inventory impairment losses should be reflected in the period in which they occur, with subsequent recoveries recognized as gains in future periods. IAS 2 Inventoriesrequires that declines in inventory net realizable value be expensed in the period in which they occur. A loss to the net realizable value may result from damage, contamination, spoilage, physical deterioration, obsolescence, fluctuations in price levels and reduced demand among other causes. Seasonally dependent items should also be assessed for potential loss. Unplanned work stoppages, labour or material shortages, or production bottlenecks could cause production levels to drop below normal capacity levels. If this happens, management will need to consider the effects on its inventory costing.
Access to client records.
During the pandemic, accessing client books and records may present hurdles for some auditors, especially in cases where clients still maintain mostly paper records. Auditors may be able to obtain client-prepared copies or scans of key records, but auditors need to consider the authenticity of those records and perhaps perform additional audit procedures to be satisfied that those records are complete, accurate, and authentic.
In cases where auditors are unable to access client books and records, auditors may have to inform clients that audits cannot be completed until books and records can be accessed. In cases where clients are required to have audited financial statements before specific dates, perhaps due to bank covenant or regulatory requirements, auditors may want to encourage clients to contact users of the financial statements, such as lenders or regulators, as soon as possible to see if waivers can be obtained.
Design, Implementation, and Testing of Internal Control.
If client sites are closed and auditors are unable to perform audits on-site, performing walkthroughs and tests of internal control will be challenging. In this case, auditors may not be able to rely on controls and may have to increase substantive testing.
As noted in ISA 505, External Confirmations, depending on the circumstances of the audit, audit evidence in the form of external confirmations received directly by auditors from confirming parties may be more reliable than evidence generated internally by the entity. In cases where a client site has been shut down or key staff are no longer on-site, obtaining external confirmations could be another alternative way to obtain audit evidence. Due to increasing business closures and movement to telecommuting models, auditors may consider sending electronic confirmations rather than paper ones. Asking clients to first contact their vendors and suppliers in advance may be prudent, to understand the best way to contact these parties in the current environment. In addition, although verbal confirmations are not the best source of audit evidence, perhaps during these times it might be the fastest and most effective way to obtain confirmation of account balances. In considering procedures, firms also should consider that, given sensitivity to cash flow in certain parts of the economy, more accounts receivable may remain outstanding when audit procedures are performed than in prior audits.
The first standard of fieldwork indicates that “the auditor must adequately plan the work and must properly supervise any assistants.” Auditors should take note that remote working does not excuse having required audit planning meetings. Auditors should ensure they still are holding these discussions as needed and having substantive discussions on engagement risks with the engagement team prior to commencing audit fieldwork.
Fraud Brainstorming and Interviews.
ISA 240, the auditor’s responsibility relating to fraud in an audit of financial statements, lays out a number of requirements and procedures that may be more challenging in a remote audit. For example, auditors still will need to carry out an appropriate discussion among the engagement team in order to understand what fraud risk factors may be affecting the entity in this environment. According to ISA 240, inquiries of management and others within the entity are generally most effective when they involve an in-person discussion. However, due to the current circumstances related to the pandemic, these inquiries could be done via video conferencing technology.
Auditors must pay close attention to the entity’s assessment regarding its ability to continue as a going concern. Given the current circumstances, uncertainty around the economic forecasts as well as increased uncertainty around the outlook for many entities may pose a challenge to the auditors’ assessment. Auditors should also consider and report on their evaluation of management’s assessment of the entity’s ability to continue as going concerned and communicate appropriately with those charged with governance.
However, auditors should keep in mind that management’s assumptions are just that and, although making some of these evaluations or forecasts might be difficult to do in our current environment, in many cases, management’s best estimate would be acceptable and would not result in a scope limitation.
For most entities, the crisis emerged after the end of their financial year. Auditors will need to assess whether the disclosures provided by the entity on the impact, both qualitatively and quantitatively, is appropriate in view of the applicable financial reporting framework. Auditors may also need to include an emphasis of matter paragraph in their audit report regarding the impact of the Covid-19 outbreak on entity’s activities, financial situation and future economic performance. Where disclosures provided by the entity are not appropriate, auditors may need to modify their audit reports accordingly.
During this pandemic, additional representations could be added to the management representation letter, depending upon the particular circumstances of an engagement. The additional representations may relate to the going concern assumption, subsequent events, risks and uncertainties, fraud, and significant estimates, among others.
Depending on what is omitted from management’s representation letter, the failure to obtain all representations does not necessarily result in a scope limitation. If management does not provide one or more of the requested written representations, auditors should:
- Discuss the matter with management;
- Re-evaluate the integrity of management and evaluate the effect this may have on the reliability of representations (verbal or written) and audit evidence in general; and
- Take appropriate actions, including determining the possible effect on the opinion in the auditor’s report in accordance with ISA 705, Modifications to the Opinion in the Independent Auditor’s Report
Using electronic means to obtain signed management representation letters is acceptable if auditors can obtain management’s receipt and acknowledgement of the letters. ISA 580 does not require the use of letterhead. However, as a matter of best practice, it might be prudent for companies to note the company name and address at the top of the letter.
Auditors should be on higher alert for fraud risks given these uncertain times. For companies that have laid off key personnel and with workforces moving out of the typical office environment, there could be a breakdown in internal control. Auditors may need to adjust audit procedures as necessary to help reduce any potential fraud risks that could have a material effect on the financial statements.
Reporting and Communication.
Auditors are reminded to pay appropriate attention to assessing whether the description of the entity’s financial position, the principal risks and uncertainties that it faces and its likely future development is consistent with the knowledge they have obtained as part of their audit work. Auditors are reminded that it is important that they communicate timely and appropriately with the entity’s management and those charged with governance about the impact of the Covid-19 outbreak on their audit work as well as on the entity and its financial statements. Where appropriate, auditors may decide to include a key audit matter in their audit report.
Changes in how, and where, auditors are undertaking their work may necessitate firms to respond to the changing environment, for example by considering quality control policies and procedures relating to direction and supervision of engagement teams and the review of their work. At the engagement level, auditors should have heightened awareness of the possibility of fraud or error, including fraudulent financial reporting, with the importance of the exercise of professional scepticism being top of mind in performing audit procedures.
During the pandemic, challenges never before faced by auditors in performing audits are emerging. In response, auditors need to be more agile and creative in performing audits and complying with the auditing standards. The key is remembering that, while the auditing standards outline the performance requirements for obtaining reasonable assurance that the financial statements are free from material misstatement, the auditing standards do not set specific requirements on how auditors might obtain that assurance. Auditors must therefore astutely apply their own professional judgement, maintain compliance with the ethical requirements and continue to achieve a high level of audit quality.
By: Robert Dhuule, Quality Assurance Officer ICPAU