2020/21 Reporting Season: the biggest challenges for auditors
14 December 2020: Auditors are facing a perfect storm of standards and uncertainty this reporting season, from remote auditing to going concern.
A material uncertainty around going concern poses a challenge as it puts auditors in a tricky position, Herbert explains. On the one hand, disclosing material uncertainty about going concern in the audit report may send out negative signals to banks. On the other, auditors have an obligation to review that entity’s financial data in a rigorous and objective manner and signpost relevant financial statements disclosures in the audit report where material uncertainty exists.
“It's their client and they're likely to be a bit conflicted,” says Herbert. “They need to do the right thing by the regulations and put that paragraph in their audit report but at the same time, it might be perceived as being the final nail in the coffin for the client’s business. So auditors are between a rock and a hard place. You've got to try to be what we call ‘professionally sceptical’ and not get too sucked into always doing the right thing by the clients.”
A forensic look at going concern
Auditors should take letters of support from business owners and parent companies with a pinch of salt and challenge these appropriately; don’t assume that the existence of such letters means you do not need to make reference in the audit report to material uncertainty about going concern.
“If you've got a company that's got lots of subsidiaries and they provide letters of support to all these subsidiaries, can they realistically provide that support to all the subsidiaries at the same time? Do you really know that an entrepreneur has got the means to pay that entity’s bills? You might have some awareness through desktop research what that person's assets are, but what about their liabilities? What obligations have they got? In the current climate, more than ever, you're going to have to look at going concern very forensically.”
A revised auditing standard for going concern, ISA (UK) 570, has also come into force for accounting periods beginning on or after 15 December 2019, along with ISA (UK) 540 on the audit of accounting estimates. There is also a change to the standard which deals with the drafting of audit reports, ISA (UK) 700.
In the latter case, auditors need to articulate to what extent the audit was capable of identifying irregularities, including fraud. This was borne out of high-profile cases such as Patisserie Valerie, where the finance director was, it seems, able to secure significant borrowings without detection. There is a disconnect between what the general public thinks auditors do with regards to fraud and what they actually do, Herbert explains. This change is an attempt to start to bridge that gap.
“I think these paragraphs probably will be fairly simple to draft. But you can't make them boilerplate. You can't use standard wording and paste it in; you’ve got to figure out how you're going to frame it audit by audit.”
ICAEW has published a helpsheet to give auditors an idea of how to draft this paragraph. It has also been a requirement for public interest entities for some time, so there are historical examples available within the public domain that auditors can use for guidance.
The ISA (UK) 570 change is in response to similar newsworthy cases, such as BHS and Carillion. It ‘ramps up’ requirements in relation to going concern from an auditor’s point of view. In Herbert’s view, with the pandemic already putting additional emphasis on going concern, the change should be minimal for many auditors.
“The new standard changes the wording in the audit reports around going concern slightly, but it probably will have a limited impact because if auditors are doing things well, they should already be doing a lot of things that the new, updated standard requires.”
The final change, to ISA (UK) 540, requires a more in-depth audit of accounting estimates, such as provisions and depreciation, which involve a lot of subjectivity or uncertainty or are more susceptible to manipulation. Auditors need to be more sceptical of the information presented to them, challenge estimates more stringently and seek contradictory evidence.
For some estimates that are not particularly judgmental or less susceptible to manipulation, auditors can largely assess them as they would currently do. But some estimates will require extra scrutiny.
“Where your client is perhaps relying on an expert to do the valuation, you might need to appoint your own expert to do a valuation and then compare it to the client’s expert’s valuation,” says Herbert. “Think about the estimates that will require that extra time and resource going into next year – this broadly applies for 31 December 2020 year ends – so you can then plan for that. If you need to appoint your own expert to independently audit the client’s expert, it's all going to be cost that must get passed on to the client, at the worst possible time with everything else that’s currently going on.”
Remote auditing considerations
One of the unique challenges of the pandemic (which hopefully will not last much longer) is the need to do remote audits. Auditors need to be mindful of the fact that clients could conceal or withhold information from them because they are not performing the audit on site. You may need to find ways to get access to more information from your clients.
“Maybe you need to be able to get access to and interrogate the client’s accounting systems. Can we get them to screen share? Where we're concerned that perhaps some documentation might be at risk of being fabricated, could they send us a hard copy as well? Is there any third-party evidence that we can rely on to back up documentation or explanations provided by the client?”
Attending a stock count could be particularly difficult. Herbert mentions an audit firm that asked him for advice during the ICAEW webinar. The firm was in tier three and its client was in tier two, and the firm wasn’t able to attend the stock count. This could happen because firms need to make sure that they are being appropriately careful about safeguarding the wellbeing of the client employees and that of their own staff. However, while you can sometimes leave the stock count for a later date, this client had an overseas parent that required the accounts to be completed by early January.
“Again, the auditor might be between a rock and a hard place here. If they couldn't genuinely get the evidence they need, even though it's not the client’s fault, they would potentially need to ‘modify’ their audit opinion and report that they didn’t know if the stock quantities were right”.
Wellbeing in the 2020/21 reporting season
With the 2020/21 reporting season likely to be difficult for many, ICAEW reminds members of the resources available to them and their families from CABA.
The Audit and Assurance Faculty are sharing their webinar on maintaining wellbeing during audit busy season broadcast on 11 January 2021. Watch the recording.