AR: Going concern considerations arising from COVID-19 and recent corporate failures
Lecturer and Assurance & Reporting Subject Controller, Alix Gemmill, considers the impact COVID-19 and corporate failures have had on going concern assessments for both company directors and auditors.
Most sets of financial statements are prepared on the “Going Concern” basis, ie. on the assumption that the company is going to continue in business for the foreseeable future. In the Assurance and Reporting course, we consider the responsibilities of both the directors and the auditors in relation to Going Concern.
It is the responsibility of company directors to make an assessment on the ability of their company to continue as a going concern, for a period of at least 12 months from the date the accounts are signed, and to prepare the financial statements accordingly. The auditor then has a responsibility to ensure they obtain sufficient, appropriate audit evidence to conclude on management’s use of the going concern basis. As part of this, they must consider whether any material uncertainty exists, in other words, whether there are any future actions or events not under the direct control of the entity that could affect or cast significant doubt over the entity’s going concern. If this is the case, this material uncertainly should be disclosed in the financial statements.
New requirements for auditors
Auditors’ processes around going concern have been thrust into the spotlight in recent years following the high-profile corporate failures of companies such as BHS, Carillion and Thomas Cook. The collapse of each of these companies led to calls for more stringent requirements for auditors regarding the work they do to assess going concern on their clients. This led to changes to ISA (UK) 570 – Going Concern which will come into effect for audits of periods beginning on or after 15 December 2019. These changes impact all stages of the audit process, and include enhanced requirements for auditors to evaluate the client’s method for assessing going concern, consider the relevance and reliability of data used and any assumptions made, consider future actions that the client has planned and obtain written representations regarding going concern. While early adoption was possible, we are now entering the period where we will start to see these coming into effect more widely for audits performed in 2020 and 2021.
The impact of COVID-19
Going concern remains a hot topic in 2020 due to the COVID-19 pandemic, as these changes to ISA (UK) 570 coincide with a period of significant uncertainly for most businesses. As such, viable projections become even more difficult to make. Global lockdowns and the resultant economic downturn have called into question the ability of many companies to continue in business. In addition, the forecasting required for a going concern assessment has become significantly more difficult, with no clear picture of how the UK and the World is going to emerge from the crisis.
Directors must rise to the challenge of preparing detailed assessments and disclosures. It is likely that they will be expected to carry out more detailed analysis, perhaps using sensitivity analysis to consider multiple outcomes, or reverse stress testing to determine what would have to occur for their business to fail. We can expect to see more detail in the Directors’ Reports in financial statements to explain the extent of their analysis, and to justify their going concern assessment. In turn, auditors must ensure that they provide appropriate challenge to meet their requirements relating to going concern.
So how have audit firms and professional bodies reacted? In May 2020, ICAS published guidance for directors of large companies, and, alongside ICAEW, small and medium sized entities, on how to assess their going concern in light of COVID-19. It is hoped that by following such guidance, directors will be more prepared for the necessary robust discussions they can expect to have with their auditors.
The FRC has also been actively reviewing the going concern policies and procedures of audit firms. Their recent findings demonstrate that audit firms are reacting appropriately by enhancing their consultations, communications and reviews in this area. The FRC review noted that there is an expectation that COVID-19 will result in more references to going concern in an auditor’s report (either as a material uncertainly or key audit matter), and that firms should continue to develop their policies to consider this.
Going forward, we can expect to see robust procedures and more detailed disclosures from both directors and auditors to ensure that going concern is appropriately considered during an audit.