Covid-19 could change your financial statements and audit

Jun 25, 2020 | Business

Among the many far-reaching effects of the pandemic is the immediate effect it is having on financial statements and the way accountants need to audit them.

The AICPA recently issued two Special Reports about these matters to help management and their accountants react to some of the special challenges presented by today’s challenging business environment. Here is a summary of the comments.

Financial statements

Businesses may be experiencing temporary closures, uncertainty in regulatory control over future operations, business and production disruptions, supply-chain interruptions, negative impacts on customers, volatility in the equity and debt markets, reduced revenue and cash flows, and other consequences. Here are just some of the ways these might affect financial reporting-

  • Subsequent events and loss contingencies- Entities may need to evaluate whether the consequences of COVID-19 represent subsequent events that should be either reported or disclosed.
  • Accounting estimates- The assumptions and data supporting certain accounting estimates maybe affected by the consequences of COVID-19.
  • Asset impairment- The consequences of COVID-19 may cause asset impairments for some entities pertaining to accounts receivable, inventory, contract assets, investments, property and equipment, intangibles, and deferred tax assets.
  • Going concern- The ability of an entity to continue as a going concern is affected by many factors, including the industry and geographic area in which the entity operates, the financial health of customers and suppliers of the entity, and the accessibility to financing that is available for the entity. The consequences of COVID-19 may impact those factors and may cause a deterioration in an entity’s operating results and financial position.
  • Leases- A lessor and lessee may decide to modify the terms of a lease agreement as to the result of the consequences of COVID-19 and this could have an effect on accounting for the lease.
  • Variable consideration- Under FASB ASC 606 (the new revenue standard), variable consideration should be estimated and recognized throughout the life of the contract subject to an overall constraint. Entities may need to factor the consequences of COVID-19 into their update of variable consideration based on conditions at the reporting date.
  • Risks and uncertainties- Risks and uncertainties that could significantly affect the amounts reported in the financial statements in the near term should be disclosed. The effects of COVID-19 may negatively impact significant estimates and exacerbate a vulnerability due to certain concentrations (e.g., business concentration in a market severely affected by the effects of COVID-19).
  • Hedging relationships-The consequences of COVID-19 may affect the probability of a hedged forecasted transactions and the amounts involved.

Audits

The extent of social distancing needed to mitigate exposure risk is also creating changes to the way audits are conducted. Here are some of the ways the audit is impacted-

  • Audit evidence quality- When auditors are working remotely, they must stay alert to the quality of evidence and whether that evidence is sufficient appropriate audit evidence to reduce audit risk to an appropriately low level. When not working with original documents, auditors may need to employ additional or alternative procedures.
  • Financial statement issuance delays- With many businesses faced with unexpected closures and demand uncertainties, completion of procedures necessary to issue their historical financial statements may be low in their priorities. In cases where companies are required
    to have audited financial statements before specific dates, they should contact users of their financial statements as soon as possible to see if they can obtain waivers.
  • Access to records- During the pandemic, accessing books and records may present hurdles for some businesses and their auditors, especially in cases where companies use mostly paper records. Auditors may be able to obtain client-prepared copies or scans of key records, but they will 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 the business’ books and records, they may need to delay the audit until they can.
  • Access to staff- 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 may need to be done via video conferencing technology in order to have appropriate visual cues during the conversation. If auditors are unable to complete these procedures, they would need to consider a scope limitation.
  • Changes in internal control structure- Due to the ever-changing and somewhat unstable environment, a business’ system of internal control may have changed dramatically multiple times to accommodate remote workforces and process flows, and both the business and its auditors need to react to these changes during the audit.
  • Fraud risk- Auditors will 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 their audit procedures to respond to increased risks.
  • Management representations- During this pandemic, additional representations could be added to the management representation letter depending upon the particular circumstances of an engagement. Those additional representations may relate to the going concern assumption, subsequent events, risks and uncertainties, fraud, and significant estimates, among others.

In light of all the present uncertainty, a business’s commitment to transparency in financial reporting will be critical as it navigates key relationships with investors, financiers, regulators, and other business partners in the upcoming months. The efficiency of audits during this audit cycle will be greatly impacted by accountants’ and auditors’ ability to embrace change, employ current technology, and find creative responses to the current challenges.

This article contributed by Donna Buzby, CPA, RMA, CGMA

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