Auditing Implications

In applying ISA (NZ) 315 (Revised) Identifying and Assessing the Risks of Material Misstatement auditors should consider the implications of COVID-19 when obtaining an understanding of the entity and its environment, in light of its objectives, strategies and other business risks.  Auditors should also discuss with those charged with governance (TCWG) and management whether the impact of COVID-19 has been incorporated into their risk assessment processes and how they have identified and assessed the significance of the business risks arising.  For example, if the business has trading relationships or components in affected jurisdictions, there may be an impact on the risk assessment.

Evaluate the assessment by TCWG and management as to whether risks from COVID-19 could be material, including whether users reasonably expect COVID-19 to impact the entity, regardless of any quantitative impact.  If TCWG and management have determined that there is no material financial impact (or reasonably expected impact) on their entity, auditors should exercise professional scepticism when considering this assessment.  Also consider if there should be disclosure in the financial statements about the key assumptions made in reaching this conclusion.

If you have revised the risk assessment as a result of the COVID-19 event, your audit materiality may also need to be revised as the audit progresses (refer to ISA (NZ) 320 Materiality in Planning and Performing an Audit, paragraphs 12 and 13).

Auditors may need to reassess the nature and level of risks of material misstatement on their audit, as the information on which the initial risk assessment was based may have changed or new circumstances previously not considered have occurred.

The level of risk associated with certain account balances, classes of transactions or disclosures at the planning stage may need to be elevated, perhaps to the extent that they now become a significant risk. If so, consider what additional audit procedures may be required to address any elevated or new significant risks.

The auditor may consider the impact on their understanding of the entity’s system of internal control, for example:

• internal controls may not be operating as planned
• increased risk of fraud

Consider whether management has put adequate risk assessment controls in place to monitor and address issues arising from the COVID-19 pandemic. Additional audit procedures may be needed.

The impact of Covid-19 on an audited entity may result in non-standard amounts or disclosures being recorded in the financial statements. The auditor may want to consider how to take account of this when setting materiality.

The auditor may also need to consider whether a separate materiality level or levels should be determined and applied to the particular related classes of transactions, account balances or disclosures in accordance with paragraph 10 of ISA (NZ) 320 Materiality in Planning and Performing an Audit.

Auditors may need to consider if there any new risks arising that were not assessed during the planning phase. New or revised risks that may arise because of COVID-19 may impact the planned audit approach, for example:

• Lack of audit staff
• Lack of access to information or client personnel

Consider what alternative work is needed and what alternative procedures can be performed. Refer to the audit evidence section below.

ISA (NZ) 501 Audit Evidence-Specific Considerations for Select Items requires that, if inventory is material to the financial statements, the auditor needs to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by attending a physical inventory count, unless it is impracticable to do so. If you are unable to attend an inventory count due to circumstances associated with the COVID-19 epidemic, alternative procedures you may perform include:

• Inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the planned physical inventory counting date.
• Observing physical inventory counts on an alternative date if the attendance of physical counting cannot be performed at the year-end date, then performing procedures to ‘roll-forward’ or ‘roll-back’ inventory balances.
• Where performed, reviewing the client’s cyclical counting procedures and records
• Utilising technology (such as viewing counts by video link) to assess the existence and condition of inventory should you be unable to attend in person.

If sufficient appropriate audit evidence cannot be obtained through alternative procedures, you may have a limitation on scope. Any impact of a limitation on scope on the Auditor’s Report needs to be evaluated in accordance with the requirements of ISA (NZ) 705 Modifications to the Opinion in the Independent Auditor's Report.

For more information read https://www.journalofaccountancy.com/news/2020/mar/auditing-how-to-observe-inventory-during-coronavirus-pandemic.html

Note that these suggestions for alternative procedures may also apply to any restrictions you may face performing physical examinations of other assets, such as Property, Plant and Equipment.

Paragraph A18 of ISA (NZ) 505 External Confirmations provides some examples of alternative audit procedures the auditor may perform when the use or receipt of external confirmations is no longer a viable audit procedure, for example:

• For accounts receivable balances – examining specific subsequent cash receipts, shipping documentation, and sales near the period-end.
• For accounts payable balances – examining subsequent cash disbursements or correspondence from third parties, and other records, such as goods received notes.

Refer to: https://www.ifac.org/system/files/publications/files/Staff-Alert-Auditing-Accounting-Estimates-final.pdf

Some considerations may include:

• Regulatory factors that affect accounting estimates
• Appropriateness of assumptions
• The effect of inherent risk factors

The auditor should consider if the impact of the COVID-19 event requires adjustment to or disclosure in the financial statements based on NZ IAS 10 Events after the Reporting Period, and whether the event impacts the appropriateness of the going concern basis of accounting.

If there is a material financial impact on your audit client’s business post balance date due to the COVID-19 event where the conditions existed before the balance date, then consider if appropriate adjustments or disclosures in the financial statements have been made and audit these adjustments or disclosures.

If the conditions of COVID-19 event existed after balance date, consider if appropriate disclosures in the financial statements have been identified and audit these disclosures.

Refer to requirements in paragraphs 6 to 9 of ISA (NZ) 560 Subsequent Events for more details.

Whilst there is no obligation to perform any audit procedures regarding the financial statements after the date of the auditor’s report, if matters associated with the COVID-19 event became known after the date of the auditor’s report but before the financial statements are issued, there are specific requirements auditors must perform to ensure the auditor’s report remains appropriate. Refer to paragraphs 10 to 13 of ISA (NZ) 560 for more details.

If the impact of the COVID-19 event became known after the financial statements have been issued and, had it been known at the date of the auditor’s report may have caused an amendment to the auditor’s report, additional consideration by the auditor is required. Refer to paragraphs 14 to 17 of ISA (NZ) 560 for more details.

The auditor needs to consider all available information up to the date of the auditor’s report when concluding on the appropriateness of the audit client’s going concern assessment. Refer to ISA (NZ) 570 (Revised) Going Concern and the matter of going concern below for more detail.

Also refer to: https://www.icaew.com/technical/audit-and-assurance/audit-and-assurance-helpsheets/audit-reports-going-concern

The auditor’s responsibility in relation to going concern is to evaluate and conclude on the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements, and to conclude whether a Material Uncertainty Related to Going Concern (MURGC) exists about the entity’s ability to continue as a going concern.

The auditor should apply professional scepticism when fulfilling this responsibility, including if management have appropriately considered this when making their assessment on the entity’s ability to continue as a going concern, and the adequacy of the disclosures in the financial statements.  For example, have management considered:

• the potential impact on the forecasts of future cash flows;
• banking covenants.

If management determines that the basis of preparation is to be changed from a going concern basis the auditor considers if they agree with this.  If the auditor does not agree with the basis of preparation of the financial statements, or that there are sufficient disclosures in relation to events or conditions which may cast significant doubt on the entity’s ability to continue as a going concern, the auditor issues a modified audit report.

Refer to ISA (NZ) 570 (Revised) for more detail, including when to include a MURGC in the auditor’s report.

The group engagement team is responsible for obtaining sufficient appropriate audit evidence to form the group audit opinion and the group engagement partner is responsible for the direction, supervision and performance of the group audit engagement, as required by ISA (NZ) 600 Special Considerations-Audits of a Group Financial Statements.

Also refer to: https://www.icaew.com/technical/audit-and-assurance/audit/group-audit/coronavirus-guidance

Points for consideration as a result of the coronavirus outbreak:

• Communicate with component auditors as soon as practicable to discuss potential impacts arising.
• Consider any increased risk that financial information for those components may be inaccurate or incomplete.
• Can the group engagement team utilise technology to review the component auditor’s work remotely?
• Where additional reliance is to be placed on component auditors, consider what is necessary to evaluate the adequacy of the component auditors’ work and consider additional work or any scope limitation that may arise, including:
  • Whether additional reporting is required from the component; and
  • More frequent communication (via teleconference and written) between the group auditor and the component auditor.

Communicate with management and those charged with governance on a timely basis with respect to significant matters like difficulties encountered during the audit, potential delays in the auditor’s reporting and expected modifications to the auditor’s report.

The objective of communicating KAMs is to enhance the communicative value of the auditor’s report by providing greater transparency to users about the audit that was performed, and in particular how the auditor has addressed the matters which they believe are of most significance to the audit. The importance of transparent communication is heightened in the current environment to enhance confidence in the audit process and the financial statements. 

In accordance with ISA (NZ) 701, KAMs are those matters which were of most significance and therefore required significant attention during the audit. Auditors of FMC reporting entities considered to have a higher level of public accountability (or other entities for which the auditor communicate KAMs) should consider the changing circumstances and the impact of COVID-19 on their client and the audit process when determining which matters are KAMs and the description of how these have been addressed.

The changing circumstances as a result of COVID-19 may impact the communication of KAMs in the following way:

• New types of KAMs or new responses to previously reported KAMs
• How the change in the risks caused by COVID-19 has impacted the audit approach
• New types of KAMs not previously seen including inventory existence, expected credit losses in assessing doubtful debt provisions due to COVID-19, etc.
• Expanded KAMs around disclosures and particular scenarios and sensitivities
• Re-ordering the KAMs with the most important KAM as the first KAM
• Repositioning where KAMs are included in the auditor’s report.

As detailed in ISA (NZ) 701, if a COVID-19 related issue results in a modified opinion or a Material Uncertainty Related to Going Concern these are by definition a KAM, however they are not described in the KAM section of the Auditor’s Report, but are reported in accordance with the requirements of the relevant standards (ISA (NZ) 705 and ISA (NZ) 570).

If KAMs are not communicated in the auditor’s report, the auditor may elect to communicate how COVID-19 impacted the audit in an Other Matter Paragraph.

In certain limited circumstances auditors may consider it appropriate to draw users’ attention to specific disclosures in the financial statements, which they consider are fundamental to users’ understanding of the financial statements, by including an EOM paragraph in their auditor’s report (refer to ISA (NZ) 706). 

What is considered “fundamental to users’ understanding of the financial statements” is a matter of auditor’s professional judgement and is specific to the entity’s circumstances. ISA (NZ) 706 A5 includes examples of circumstances where the auditor may consider it necessary to include an EOM paragraph, which includes a significant subsequent event, and a major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position. ISA (NZ) 706 also cautions that widespread use of EOM paragraphs may diminish the effectiveness of the communication of such matters. 

When determining whether to report an EOM in relation to disclosures about the impact of COVID-19 on the entity, auditors consider if this disclosure in their view meets the definition of an EOM in ISA (NZ) 706. An EOM should refer to the entity’s disclosures about the matters considered fundamental to the users understanding of the financial statements.

The placement of ‘Emphasis of Matter’ paragraphs in the auditor’s report depends on the nature of the information to be communicated, and the relative significance of the matter.

If KAMs are reported and a matter meets the definition of a KAM and an ‘Emphasis of Matter and/or Other Matter’, it is reported as a KAM only. This allows the auditor to  include additional information in the description of the KAM.

Discuss with those charged with governance and management if other disclosures relating to this issue have been made outside of the financial statements and consider whether there are any material inconsistencies between information provided by the entity in the other information and the financial statements about the impact of developments arising from COVID-19.  Refer to ISA (NZ) 720 (Revised) The Auditor’s Responsibilities Relating to Other Information for more details about the auditor’s responsibilities to review other information and consider whether there is material inconsistency between the other information included in the Annual Report and the financial statements.