Mar 31, 2020

Financial Statement Audit Requirements and the Impact of COVID-19

By Allison M. Henry, CPA, CGMA, vice president – professional and technical standards

Businesses around the globe are facing the tumultuous coronavirus (COVID-19) crisis which is challenging their sustainability. While some companies are stepping up to serve public needs in the chaos and emerging with new products and services that could change their business models, many more – especially businesses catering to the travel industry, retail, restaurants, hair and nail salons, movie theaters among others – have had to scale back or cease operations, furloughing or laying off employees. This disruption is having a ripple effect on other businesses: real estate management, for example, will have tenants who can no longer pay rent, at least temporarily. Others are surviving by moving to completely remote operations.

Further adding to the challenges are changes to tax deadlines, new regulations impacting everything from employee benefits and other human resource compliance requirements to a temporary suspension of import duties, a $2 trillion emergency spending bill that includes significant tax law changes and financial incentives for employers and employees, and even a deferral of the Financial Accounting Standards Board’s new Current Expected Credit Losses standard for banks until the national health emergency has ended or Dec. 31, 2020, whichever is earlier.

Worker on 3 electronic devices at the same time.All of this will affect CPAs performing financial statement audits. CPA firms are testing their remote work capabilities as they struggle to keep up with all the new laws and regulations and continue to meet their clients’ needs during this crisis. CPAs will also face the business impact of all of this on clients’ financial statements. The impact on the financial statements and the related attestation work depends on the year-end of the financial statement engagement. For Dec. 31, 2019, year-end engagements, the impact could simply be adding a subsequent events footnote to the financial statements and considering the need to add an emphasis of a matter paragraph. For businesses with a March 31, 2020, year-end, the impact on the financial statements and the attest work could be pervasive. Financial statement presentation and disclosure challenges could include inventory valuation; accounts receivable and collectability; handling variable consideration under FASB ASC 606, Revenue from Contracts with Customer; impairment considerations and valuation of intangible assets, debt and equity securities, and equity method investments, fixed assets, contract assets, and deferred tax assets; accounting for and disclosing insurance proceeds; accounting for lease or debt modifications; disclosures of debt covenant compliance violations and waivers; assessing going concern, loss contingencies, risks and uncertainties, and vulnerability due to certain concentrations; as well as evaluating subsequent events in an incredibly uncertain environment.

The impact on the audit engagement will be driven by the impact on the business, and audit teams will have to address many issues that their clients may have never experienced. Logistics, too, could add to the challenges: the audit team may not be able to be onsite for a physical inventory, and it may be difficult to have effective fraud inquiries over Skype. It is in this environment that auditors should consider going back to the basics – start with questioning the nature and timing of the engagement, as well as the appropriateness of the financial reporting framework. Here are some questions to consider:

  • Does the client need an audit?
  • Can the deadline and the timing of the work shift?
  • Is management taking responsibility for the appropriateness of the financial reporting framework? (e.g., Can they make key ASC 606 implementation decisions, and will they be able to implement the new FASB ASC 842 - Leases?)

Once the fundamental engagement decisions are made, auditors will need to vigorously challenge risk assessment at the assertion level. As the assessment of many audit assertions will likely change from the prior year, and as the AICPA Peer Review Board has noted significant nonconformity on risk assessment (> 47%) in conjunction with its enhanced oversight process, this is the year to focus on this critical audit area. Auditors may need to reevaluate internal controls as they may have changed as result of mandatory remote work arrangements. Also, analytical procedures using last year as an expectation will likely not be effective. This may be a good time to consider enhancing the approach for targeted audit areas using data analytic tools, such as Power BI.

Despite the incredible pressure that many CPAs are under, the profession cannot lose sight of the importance of audit quality. Done correctly, the audit can yield critical business insights, enabling auditors to provide important value to clients who need professionals that clearly understand the current business climate, can make sense of the rapidly changing regulatory environment, and can synthesize the impact of the current crisis on the financial statements. To help practitioners to address these financial statement audit challenges, the PICPA is hosting a webinar, COVID-19: Pandemic Impact on Audits, at 10:30 a.m. on Friday April 3. Please reach out to me at ahenry@picpa.org or at (215) 972-6187 on areas that you believe need to be included in this program.

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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of PICPA officers or members. The information contained in herein does not constitute accounting, legal, or professional advice. For professional advice, please engage or consult a qualified professional.