Last week the UK’s Financial Conduct Authority, Financial Reporting Council and Prudential Regulatory Authority issued emergency guidance intending to help companies and auditors to manage the challenge of providing investors with accurate and timely financial information in the face of Covid-19.
Covid-19 has caused a sudden and sharp reduction in activity with no known end date. Both governments and central banks have put measures in place to support businesses and households, but as yet businesses have no way of knowing exactly how their own business will be affected in the medium term and how far the package of support measures will help them through the disruption.
This leaves auditors in uncharted territory at a time when the profession is still scarred by the blame it has received over a string of high profile corporate failures.
Temporary relaxation to regulatory requirements
To allow businesses time to provide meaningful information, the Financial Conduct Authority has allowed listed companies an extra two months to publish their audited annual financial reports, and asked investors not to draw any conclusions if a company chooses to take advantage of this. They have encouraged companies to defer any tenders for new auditors, even if they are due to change their auditor this year. The FRC has also said that it will look at ways to temporarily scale-back audit quality review work in order to enable companies to focus on urgent issues.
The urgent issues added to the ‘to do’ list include matters that, according to a poll of investors conducted by the Financial Reporting Council’s Financial Reporting Lab are of the most interest to investors: providing information about short term financing; their approach to support for employees; the development of plausible revenue scenarios and the potential mitigating impact of government support programmes.
Boards are asked to focus on how they can ensure that a company still has effective controls in place. Some of the controls that they have depended on in the past may not now be effective: for instance they may rely on financial information from subsidiaries and joint ventures facing equal disruption. They should also be thinking about how they will have sufficient reserves to pay any dividends planned, not just at the time that they propose it, but when the dividend is actually made.
The Financial Reporting Council has also issued guidance to auditors acknowledging that it may no longer be possible to carry out physical meetings with a Board’s audit committee, or certain physical checks. The guidance also highlights that there may be additional work to do, for instance to check that disruption to an entity’s internal controls does not result in fraudulent misstatements.
More detailed guidance needed for auditors
All of these steps are welcome. Crucially, they buy companies and auditors time to avoid the unwelcome 'modified audit opinion' or disclosures which cast doubt on a company's ability to continue as a going concern. These can often become a self-fulfilling prophecy as they cause potential lenders to lose confidence so that a company’s financing dries up overnight.
However, the guidance provided for auditors says they still need to assess the sufficiency and appropriateness of any alternative evidence. Companies are being asked to work with their auditors to find alternative means to complete audit procedures which they would usually do in person.
Inventory checks are an obvious example: while technology has been trialling the use of drones to perform this task it has never been done en masse, and scaling this up quickly will be difficult if not impossible for firms (many without the technology in place). Auditors may very well just need to wait until they can carry out a physical check. If neither delaying nor using technology are feasible, that leaves auditors with the final ‘wild card’ option of finding a completely alternative form of evidence.
To ensure some sort of coherence across all companies and auditors in issuing results, the regulators’ next step may need to be further clear and detailed guidance on what ultimately 'counts' as sufficient and appropriate audit evidence. If not, given the recent scrutiny that auditors have been under, many auditors may seek to avoid future censure by opting for the most conservative audit opinion option possible. That could potentially lead to an even worse bloodbath of corporate failures than the landscape is currently already at risk of.