As Julie Matheson blogged last Monday, we are living in uncertain times which are likely to have a huge impact on businesses in all sectors.
The Financial Reporting Council (FRC) announced on Thursday in a joint statement that it is taking a series of actions, along with the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), to ensure investor knowledge and the continued operation of the UK’s capital markets.
This blog looks at what those actions are, and also considers the FRC’s bulletin for auditors, “COVID-19 Bulletin March 2020” (‘The FRC bulletin’) which details the factors auditors should consider when conducting audits during the on-going COVID-19 pandemic.
FCA, FRC and PRA Series of Actions
The FCA, FRC and PRA’s joint statement recognises the importance of timely and accurate information to ensure that successful and sustainable business can support our economy and society during the COVID-19 crisis. It acknowledges, however, that there are certain difficulties given the current environment in ensuring timely reporting to ordinary deadlines.
Because of this, the FCA, FRC and PRA have made a series of announcements providing guidance and updating timeframes for certain actions.
Firstly, the FCA announced that it will extend the deadline by which listed companies are to publish their audited annual financial reports by two months. This will give listed companies six months after the end of the current financial year to produce these reports rather than the ordinary four months. The FCA considers that while some companies will maintain the status quo in terms of their reporting, others may find the extension beneficial to ensure “accurate and carefully prepared disclosure.”
Secondly, Guidance from the FRC to companies has been issued explaining how companies should go about preparing their financial statements in such uncertain times. Further, the PRA has issued guidance to banks, building societies and PRA-designated investment firms on the approach to be taken in assessing expected loss provisions under IFRS9.
Finally, the FRC has also published guidance in its FRC Bulletin, discussed in detail below, for audit firms seeking to overcome the challenges in obtaining audit evidence, particularly when, in many cases, companies are not operating from their normal offices with many staff instead working remotely from home.
FRC Bulletin
The bulletin makes clear at the outset that it is driven by two key factors:
1. In order to be able to give an audit opinion that is not subject to a disclaimer or qualification due to a scope limitation, the auditor must always obtain sufficient, appropriate audit evidence; and
2. Even in challenging times, the flow of high quality, independently assured information to support the functioning of capital markets is of fundamental importance. Reporting on audit engagements should be driven by the information needs of users of audited financial statements.”
We summarise below some of the key problems for audit the bulletin identifies together with the FRC’s solutions to best tackle these.
Acceptance and take-on of new audit engagements
Problem
- Auditors are likely to have to revisit their risk assessment and the proposed response to identified risks for audits underway relating to periods that end after 31 December 2019;
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the planned audit approach may anticipate obtaining audit evidence about internal controls operating around the year end which the auditor may not be able to obtain due to a lack of audit staff or a lack of access to information or personnel at the audited entity.
Solution
- Consider whether alternative work is necessary, and what alternative audit procedures can be carried out to obtain sufficient, appropriate audit evidence in support of the auditors’ opinion;
- consider whether assessments of risks of material misstatement due to fraud or irregularity need to be heightened and additional audit procedures carried out (given the increased pressure entities are facing, and the fact internal controls may not be operating as planned).
Materiality
Problem
- COVID-19 may result in non-standard amounts or disclosures being recorded in the financial statements.
Solution
- Consider taking account of non-standard amounts when setting materiality;
- consider whether a separate materiality level or levels should be determined and applied to the particular related classes or transactions, account balances or disclosures in accordance with paragraph 10 of ISA (UK) 320.
Communication with those charged with Governance
Problem
- Physical meetings of audit committees may now be impossible.
Solution
- Agree with audit committees how to communicate through other means, and how to ensure sufficient time for comprehensive, complete and informed communication with the auditor (allowing sufficient time for potential extended communication to explain any modified audit reports, or to report any higher than expected deficiencies or misstatements arising from the current circumstances);
- engage with Those Charged With Governance (TCWG) if the auditor intends to modify their opinion to explain whether the nature of the modification may be ameliorated by allowing the auditor additional time to undertake their work, and obtain the evidence required.
Audit Evidence, including Audit Confirmations
Problem
- Restrictions on travel, movement and visiting client sites may impact obtaining sufficient, appropriate audit evidence to support audit reports in the deadlines set;
- the provision of independent confirmations as a source of audit evidence may be impacted.
Solution
- Consider alternate ways for obtaining sufficient, appropriate audit evidence (this may include the use of technology to examine evidence – where appropriate);
- where physical verification is required, and time critical, and where physical verification procedures cannot be performed, consider the implications for the audit opinion;
- where independent confirmations are impacted, consider whether available online access to secure systems can be used to obtain the necessary evidence rather than waiting for the provision of a documentary copy;
- consider whether additional time is needed to perform identified procedures to seek to obtain sufficient, appropriate audit evidence and whether such time will be available to the auditor. Where management are able to extend their planned timetable but refuse to do so, consider whether such refusal constitutes a limitation on the scope of the audit imposed by management. If so, communicate with the audit committee and take other appropriate actions to comply with the requirements of paragraphs 11 to 14 of ISA (UK) 705 (Revised June 2016).
Going Concern
Problem
- In the current, highly uncertain environment, going concern assessments will be more difficult for entities to make, and more companies will need to report a material uncertainty.
Solution
- Assess whether the entity has access to sufficient liquidity and can remain solvent through the period of public health restrictions and beyond;
- ensure the assessment of going concern and the evidence needed in support explicitly considers both liquidity and solvency factors which may affect the ability of the directors to assess that the entity is a going concern and to identify any related material uncertainties;
- exercise professional scepticism where management and TCWG have determined that the current circumstances are not reasonably expected to have any material financial impact on the audit entity and that there are no material uncertainties related to going concern for the entity.
Quality Control
Problem
- Auditors need to comply with all of the requirements in respect of quality control in ISQC (UK) 1 and ISA (UK) 220 – however, currently some meetings, discussions and access to files will be virtual and facilitated through technology.
Solution
- Document clearly on the file how the direction, supervision and review process was structured and operated to overcome obstacles, and how communication with team members and in particular: key audit partners; engagement quality control reviewers; and any firm technical reviewers, was maintained.
How do these measures help in the current climate ?
The series of actions and FRC Bulletin are a reassuring response to the challenges and uncertainties COVID-19 has brought. The FRC has also confirmed it is considering how it can adjust quality review work to reduce demands on audit firms, whilst maintaining audit standards, which again is welcome news.
David Rule, Executive Director of Supervision at the FRC, has confirmed that the package of measures now introduced will be updated ‘as and when necessary’ and that they will be withdrawn once circumstances return to normal. Whilst COVID-19 lingers on, this novel guidance will at least help auditors weather the storm.
All regulated entities should take heed of the reporting extension and the guidance being issued to support the market during this time. We can likely expect further guidance over the coming weeks, particularly if the Government imposes further measures to flatten the curve and delay the spread of COVID-19.
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