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Auditor’s Report and the Accounting Impact of the Corona Pandemic By: Dr. Muhammad Abdullah Sawan A Member of IASCA Board of Directors
04-Aug-2020
Auditor’s Report and the Accounting Impact of the Corona Pandemic
By: Dr. Muhammad Abdullah Sawan
A Member of IASCA Board of Directors
Societies of certified accountancy are concerned nowadays about the impact of (COVID-19) on both the auditor’s report and the International Accounting Standards (IAS), specifically the impact on subsequent and contingent events that occurred between the end of the financial year and the date of approving the financial statements. Under IAS, COVID-19 has been classified as a contingent event that occurred after the end of the reporting period. This means, for accountants and auditors, that the amendment of the financial statements of 2019 is not required. Auditors shall disclose the results of companies’ potential future business whether positive or negative.
Corona is an unprecedented crisis, therefore; predicting the results and the future of companies after the crisis is not going to be easy. In auditing, this crisis is treated as an emergency, accordingly the major international audit firms have warned and communicated with their clients and offices around the world in order to set a plan to handle the crisis and to have it reflected in the auditor’s report. At the same time, audit firms have also warned that the impact will be direct and indirect on entities, and the financial statements will be affected accordingly, the harm today is not necessarily to be the same as it will be after a month, two months or a year.
It is known that entities were out of work at the beginning of the crisis, most of which are small or medium-sized enterprises that operate with small or limited capital. Some entities couldn’t cope with the crisis, others may withstand for a limited time in light of receiving government subsidy, yet few companies might have not been affected by the crisis at all. The most impacted entities on the global level are companies that work in tourism, transportation, and properties, among which bankruptcies may appear in the future. On the other hand, some entities may get benefit from the crisis such as the ones operating in the fields of ecommerce, telecommunication, delivery, pharmaceuticals, or cleaning companies…etc.
The government of the United Arab Emirates made important decisions to ensure the safety of the public on the first hand, and to prevent the outbreak of the pandemic on the other hand. Moreover, the UAE government pumped funds into banks, to restore normal economic activity, and allocated AED 256 billion to minimize the impact of Corona on the society. The UAE government provided a subsidy schedule for banks of an amount of AED 50 billion with zero interest rate, most of which is allocated to loans and advances to individuals and companies. In Dubai, the government provided a package of facilities that included freezing the market fees and reducing electricity bills. In addition, in every emirate, governments provided various forms of subsidies to entities, individuals, and the economy.
No doubt that the crisis made it more cumbersome for auditors and IAS, as it has overshadowed all IAS. The crisis will have its most profound impact on debts in terms of collection, deferral, or wavering of parts thereof, the impact will also affect the guarantees provided to others and fears of liquidating such guarantees in case entities fail due to cessation of their activities, failure of implementing the works required from them, or failure to supply a contracted good. The crisis will have a clear impact on the impairment of assets and goodwill of entities, in particular for some international brands, along with the impairment of the value of investments in other entities, and the adverse effect on inventory, employee benefits, revenues, taxes, and government assistance. The subject of subsequent events and the concept of continuity (going concern) will be of greater concern to auditors.
On the other hand, and despite the negative impact of the crisis on entities and economies, the crisis should not be addressed as a burden on entities and audit firms, it might be an opportunity that must be seized, the opportunities include, for example, that the owners of entities and audit firms should reconsider their plans regarding how to handle new financial risks such as the risks of pandemics. Moreover, the government internal audit departments should modify their work programs and conduct subsequent and simultaneous revisions for the financial impacts caused by the crisis. Also, financial departments in local governments should prepare their financial reports in a timely basis, particularly if there are separate budget items that were approved in response to the efforts exerted to combat the virus. The financial supervision authorities shall conduct revisions on the transactions of emergency cases without delay, and within the shortest time interval, such authorities shall also assess the benefits received in exchange of the funds spent on emergency and crisis transactions.
The accounting standards relevant to the crisis: all IFRS and IPSAS shall be applied, yet the most relevant four standards that should be referred to by auditors are:
• IAS 1 (presentation of financial statements). The more the prospective variables and assumptions, the more the judgements are subjective, and the more the situation gets complicated. This may require modifying the values of assets and liabilities along with the provision of more disclosures.
• IAS 8 (accounting policies, changes in accounting estimates and errors). Due to the cases of uncertainty, many items of the financial statements won’t be measured reliably and they will only be estimated.
• ISA 10 (events after the reporting period). Entities are required, under IAS 10, to provide disclosures and descriptions of events and their financial impact. Examples of such disclosures include failure by an entity to repay its obligations, cessation of some activities, decision of restructuring, significant changes in the prices of assets, and guarantees provided to others. Some countries responded to addressing the events that occur after the reporting period, for instance, last April, a circular was issued in Jordan considering Covid-19 as an event that occurred after the reporting period, accordingly it doesn’t modify the financial statements.
• IAS 34 (interim financial reporting). Entities are required, under IAS 34, to provide disclosures in their financial statements about the significant events and transactions, such disclosures are needed to enable the users of understanding the changes that occurred in the financial position since the end of the reporting period of 2019. In other words, due to (Covid-19), entities are required to provide additional information to reflect the impact and the measures taken to contain the virus.
If this emergency “the Coronavirus” is an existing fact, what should the auditor write regarding this situation in terms of subsequent events?
There are paragraphs and texts that auditors adhere to:
Text of paragraph (1): The Company believes that this emergency is considered as an event that occurred after the reporting period, accordingly, and at the management’s discretion, the amendment of the financial statements is not required.
Text of paragraph (2): at this early stage of the event, the Company formed a team to evaluate the expected impacts on the Company, and conducted a preliminary study in order to revise and assess the potential risks relevant to some matters.
Text of paragraph (3): in case of the occurrence of any material changes in the current circumstances, additional disclosures shall be provided, or the amendments to financial statements shall be approved.
The above paragraphs indicate the most important sentences and paragraphs accepted by all audit firms to describe the subsequent events. It is worth noting that the annual report, issued by the senior management, shall be relevant to the description of subsequent events, characterized by transparency, and is distributed to shareholders by registered mail. The report contains additional and detailed information about the company and the most prominent events including the Corona crisis. The report of the Board of Directors addresses important topics relevant to the company such as: the company’s achievements, strategies, activities, and financial risks, in addition to future prospects and financial results, and finally the company’s policy regarding the distribution of dividends and remunerations.
The report of the Board of Directors includes the decisions issued by the management in the following wording: (The management acknowledges that the accounting records were prepared appropriately, and the company has a sound financial control system, and the company has no doubts about its ability to continue in its activities). In addition to reports and representations, the management also issues assurances such as: (the management assures that it did not provide any monetary loan to the members of the Board of Directors, and it ensures that it complies with the IAS, and the standards of the financial market as well as other standards. The management also ensures that it won’t make any material change in their accounting records).
That was regarding the annual report and the report of the Board of Directors. Regarding the auditor’s report and the financial statements, they aim at showing the real financial position of the assets and liabilities of the company, the gains or losses, and they provide information about the financial position to users, help the leadership make decisions, in addition to providing the users (shareholders, managements, suppliers, banks, financial markets…etc.) with numbers, data, comparisons, and indicators.
Generally, a company cannot develop its work or compete with others without knowing its financial position. By the financial position we mean the numbers issued through the auditor’s report. This report is a testament by the auditor about the correctness of the financial statements prepared by the management. The auditor’s opinion is as important as the financial statements per se, it is the backbone of the report, and the first page that users read to be assured about the auditor’s opinion regarding the content of the financial statements. The auditor’s opinion about the financial statements includes five important paragraphs as follows:
• Paragraph (1) states that: “We have audited the accompanying financial statements, which include the statement of financial position, the statement of income, the statement of changes in equities, the statement of cash flows, and a summary about the accounting policies and notes.
• Paragraph (2), the Management’s Responsibility about the Financial Statements: “the management is responsible for the preparation of the financial statements; this responsibility includes maintenance of internal control system, the fair presentation of financial statements that are free from material misstatement whether resulting from fraud or error. Finally, the management is responsible for the selection of accounting policies and for making reasonable estimates.
• Paragraph (3) regarding the responsibility of the auditor: “Our opinion about the financial statements was based on the audit work conducted by the auditor and on the ISA, which require compliance with professional ethics, and planning and implementation of audit work, so the auditor would be reasonably satisfied that the financial statements are free from material misstatement.
• Paragraph (4) includes narration of the audit works, which are plenty, such as: obtaining audit evidence and assessing the risks of material misstatements in the financial statements.
• Paragraph (5), which is the most important, the auditor concludes and states that: “we believe that the audit evidence which we obtained is sufficient and appropriate to provide reasonable basis for our opinion”, and the auditor places in a separate line; a single word title “opinion”, under which the auditor states the following:
In our opinion, the accompanying financial statements present fairly the Company’s financial position, financial performance, and cash flows for the year ended on 31/12/2019 in accordance with the international standards, and the requirements of the articles of association and the main system of the Company.
There are four types of opinions: 1. Unqualified opinion-clean report; 2. Qualified opinion (as a result of not accessing some data that has an impact on the financial statements, such as the non-creation of the needed provisions), 3- Adverse opinion (due to material misstatement or fraud in the statements), 4- Disclaimer of opinion (the auditor did not obtain the important necessarily data). Conclusion: the auditor’s opinion may attract attention to an important, yet absent, matter. Such an important matter may change someone’s decision (for example, a user of the financial statements may change his/her mind and decide not buy a share in the company).
The impact of the pandemic on the requirements of some international financial reports and accounting principles that have great importance and a material impact on the financial statements of companies, as follows:
(1) The going concern assumption: the company’s ability to continue, meet its obligations, continue in operation, the adequacy of its working capital, and the liquidity needed to continue working, should be verified.
(2) IFRS (9), (financial instruments), regarding the financial assets and financial liabilities, their presentation, classification, and fair value.
(3) IFRS (7), disclosure of information about the importance of the company’s financial instruments, and the range of risks arising from such instruments and how to manage them.
(4) IFRS (36) related to the impairment of value when the company is unable to recover the book value of its assets.
(5) IAS (20), accounting for government grants and disclosure of government assistance
(6) IFRS (16), (leases), the impact of the pandemic on leases and recognition of any additional liabilities by the company resulting from these contracts during the pandemic shall be verified.
(7) IAS (37), Provisions, Contingent Liabilities and Contingent Assets, regarding the recovery of the insurance value and studying the need of the company to create and recover the needed provisions to meet any liabilities or risks incurred by the company due to the pandemic.
(8) 8. IFRS (15), revenue will be recognized in terms of verification and classification of liabilities of the company and linking them to the maturities of the payments and the impact of that on the classification of such payments into short-term liabilities and long-term liabilities.
(9) IAS (10), events after the reporting period, regarding the verification of the adequacy of the needed disclosures about the events after the reporting period and the date of issuance, specifically the events that may create a potential liability to the company.