Background

In this difficult environment, each regulatory body is releasing relief measures and guidelines for easing out the impact of COVID 19. On the financial and compliance front, announcements have been flowing from the Government authorities in the form of deferment of statutory due dates or relaxation in payment terms to overcome the financial crisis being faced due to lock-down.

Institute of Chartered Accountant of India (ICAI) has come out with its guidelines for care to be taken by the PREPARER and AUDITOR of the financial statements. This guidance from the ICAI addresses the common issues which would be encountered on account of COVID 19 while preparing the financial statements and its audits and how they should be addressed. For better understanding of the quarterly and year-to date financial results, separate disclosure may be presented in financial statement for aggregate loss incurred due to COVID 19 being irregular and not ordinary in nature. We have bifurcated the guidelines for the preparers and auditors into two sections:

I. Guidelines for the PREPARER of the financial  statements

A. Impact of corona virus on financial reporting - Assets & Liabilities

• Inventory

Inventories would have piled up since due to lock-down, supply chain has come to halt. Also fresh production activity is also stopped. This will require entities to examine the need to write down the inventories where the net realisable value is lower than cost price. Also the overhead costs incurred during the lock-down period cannot be loaded to the cost of inventory and will have to be charged off as expense immediately.

• Impairment test for assets

Reassess the need for impairment of non-financial assets like property, plant & equipments, intangibles and goodwill, considering reduced economic activity, change in financial forecast and budgeted cash flows, etc. Management will have to append the explanatory note in financial statements in regard to impairment test carried out along with sensitivity analysis.

• Change in useful life of fixed assets

During lock-down the assets are not functional and kept idle. The management should reassess whether there is any change required in the useful life / residual life of such property, plant and equipment.

• Fair value of financial assets / instruments

Current market sentiments are not the correct representative for the market prices as at year-end. Accordingly, additional care to be taken in case of the financial assets and financial instruments which are mark-to-market price at the period end.

• Trade receivables – Expected Credit Loss

Year-end outstanding trade receivables would certainly rise due to liquidity constraint being faced by the customers in releasing the over-due payments. In such scenarios, management need to estimate and provide for bad debts and expected doubtful debts.

• Leased assets

In case of modification in lease arrangements like waiver or concession in rental payouts, financial effect needs to be factored in financial statement. Further, in case of non-cancellable lease arrangement which are onerous in nature, provision for impairment of leased assets also to be considered.

• Capitalization of borrowing cost

During this lock-down period, the construction projects have come to halt. In such scenario, borrowing cost incurred during such period does not form part of the cost of qualifying asset and will be charged off as expense immediately.

• Provision for onerous contract

There is overall disruption in supply chain baring essential items & logistic services which resulted into hike in procurement prices. Provision should be made of onerous contracts like expected loss which will be incurred to fulfill the commitment give to customer to supply the products at contract prices which are lower than the procurement prices.

• Going concern assumption need to be reassessed by management

The management will have to assess the impact of COVID 19 on the going concern assumption and accordingly measure its assets and liabilities. Management should include appropriate explanatory note for its impact on the financial statement as on balance sheet date and next 12 months.

• Impact of COVID 19 on significant uncertainties

Financial statement should include disclosure of significant recognition and measurement uncertainties that might have been emerged by the outbreak of the COVID -19 in measuring various assets and liabilities. Management should also disclose how they have dealt with the impact of COVID -19 on the financial positon and financial performance of the entity. 

B. Impact of coronavirus on financial reporting- Revenue & Expenses

• Revenue recognition

Measurement of revenue need to be reassessed considering the impact of COVID 19 on expected increase in sales return, primary and secondary discounts to liquidated the inventories, etc. Additionally, disclosure is required for revenue not recognized due to uncertainty of cash flows.

• Recognition of insurance claims filed due to loss on account of COVID 19

Business interruption insurance claim to be recognized as income in books only if the recovery is virtually certainty else it would be in nature of contingent nature. Disclosure of such contingent assets would be required in financial statement prepared under Indian Accounting Standard.

• Re-measurement of deferred taxes

Management should reassess the recognition of deferred taxes like deferred tax asset recognized on carry-forward business losses, impairment losses, deferred tax liability on distributable profits from subsidiaries, etc.

II. Guidelines for the AUDITORS of the financial  statements

Impact of corona virus on audit of financial statements

• Revision in risk assessment and materiality

Evaluation of additional risks on account of operational disruption, contractual non-compliance, liquidity & working capital issues, possibility of fraud, etc. will require revision in risk assessment and in calculation of materiality.

• Year-end physical verification

Considering the lock-down, it will not be possible for the entities to conduct physical verification of inventory and cash balances as on the cutoff date of 31^st March 2020. The auditor shall perform alternate audit procedures to ensure the appropriateness of the stock levels / cash balances as on the reporting date.

• External confirmations

Auditor shall perform alternate audit procedures if inadequate / no responses are received from external parties for balance confirmation.

• Assessment of significant accounting estimates and assumptions

Considering the fact that lot of estimation and assumptions will be involved for factors such as impairment of assets, provision for onerous contract, contractual penalties, etc., auditor shall be skeptical in assessment of such estimates and assumptions made by management or its expert. The auditor shall obtain written representation from the management.

• Assessment of Going concern

In the current pandemic of prolonged operational disruption, the financial position of the entities would have been unfavorable. Auditors’ should evaluate its impact on the going concern of the entity and discuss this with those charged with governance.

• Group audit

In case of audit of consolidated financial statements where the component(s) auditors are located in severely affected places, the principal auditor may perform alternative methods like video conferencing, filing detailed questionnaire, etc. for conducting the audit. It shall consider the impact of COVID 19 on the financial statement of its components.

• Other reporting requirements in the audit report

• The auditor shall evaluate that whether the impact of disruption could be a Key Audit Matter (KAM).
• In regards to its responsibilities relating to other information, the auditor shall consider the disclosures made by the Company for COVID-19 risks in its financials / annual report.
• In case of reporting under Internal Financial Controls (IFC), additional considerations might be required to be considered before drawing an opinion.

In our view,

• auditors should prepare a separate set of questionnaire for management to identify such risks involved in each of the critical areas and measures taken to mitigate such risks and revisit the level of materiality.
• auditors will have to assess the risk involved in each client based on the size, volume and classification of inventory at year end. Auditors should formally communicate to the management about the alternate steps which would be taken during the course of audit and auditor’s representative will not be present during the year end physical count.
• auditor shall examine subsequent receipts / payments, underlying documents for transactions during lock-down period. Confirmations from related parties should be insisted.
• additional precaution should be taken by the auditors and emphasis may be added in the audit report.
• audit steps should include assessment of risk and ability of the management to fulfill its obligations / current liabilities in next 12 months.
• early warning should be given by the component auditor to principal auditor for matter like deadlines which cannot be fulfilled, any material adjustments, etc.

Conclusion

The impact of COVID-19 on economy, financial markets and entities in particular continues to evolve.  In the current phase, the management of the respective entities are taking all the precautionary steps for their ‘business continuity’ and assessing the impact and risk of COVID-19 on the financial position of their entity. These guidelines from ICAI would certainly assist the CFO’s and management to take adequate care in closing the year end accounts and be prepared for audit.

Further, considering the fact that role of auditors at times like this is under increased scrutiny, the auditor shall exercise a very high degree of skepticism and work in accordance with professional standards and ethics requirements. The auditor may need to significantly alter its audit procedures to address the challenges and uncertainties arising out of impact of COVID-19. However; irrespective of the challenges and uncertainties, there should not be any dilution or non-compliance with the auditing standards in carrying out the audits and they may modify the audit report if the situation demands.