Covid-19 and the Impact on Auditing and Assurance around the World

1.0 Introduction

Ever since COVID-19 was declared as a global pandemic, mandatory safety measures have been implemented such as wearing a face mask in public places and temperature taking. Other than affecting our lifestyles, how does COVID-19 affect the business demographic around the world and most importantly, the audit quality?

It is common knowledge that businesses in the world today have to adapt to the “New Normal”. Business practices such as working from home and engaging in virtual business dealings are nothing out of the ordinary now. However, that does not mean that the audit scene was anything but calm waters before COVID-19. Moving on, audit quality had already been under scrutiny in the last few years prior to the pandemic, especially after fraud cases such as Patisserie Valarie and Carillion came to light. Audit firms in the UK such as PWC, Grant Thronton, KPMG have faced scrutiny from the public, as only 75% of Britain’s 350 largest listed companies were able to meet the audit quality standards in 2017.

Due to these concerns, ICAEW (UK) , ACCA (UK) and CPA Australia have released bulletins about the changes on three main accounting standards, such as, the Going Concern Assumption, Inventory Valuation and Subsequent Events.

2.0 Going Concern Assumption

Going concern (GC) is an accounting term that describes the financial stability of a company that can meet its current and future obligations for the next 12 months. It is the basis on which financial statements such as profit and loss account, balance sheet and changes of equity are prepared. For instance, the aviation industry took the biggest hit when lockdowns and border restrictions were announced. Air Asia, a well-known low cost carrier prepared its’ 2019 financial statements based on the going concern assumption. However, Air Asia shares price dropped by 55% recently and reported a loss of RM803 million for the last three months ending 31 March 2020. Ultimately, Ernst and Young auditors published an unmodified opinion with additional disclosure on the going concern assumption. In the disclosure, the basis of the GC assumption depends on the recovery of Air Asia’s financial status when it enters the and the share price movement during the 12 months relief given by Bursa Malaysia.

Initially, the GC basis is measured through a preliminary assessment performed by each firm’s management at the start of the financial year. During critical times like now, there are certain indications that raise red flags as to the possibility of inappropriateness of using the GC basis. Examples of indications could be: disrupted cash flow cycle due to delayed payments to suppliers, minimal sales revenue or working capital that is heavily dependent on liabilities instead of assets. Even though most firms in the UK are still using the GC assumption in preparing the financial statements, ICAEW and ACCA have made some changes to the preliminary assessment performed by the management team. For instance, the assessment has to consider any chances of a second wave of outbreaks or closures and also evaluate any loss of valuable key members.

From the auditors’ perspective, they are tasked with the collection of audit evidence, which is used to conclude on the appropriateness of the financial statements prepared by the management. Usually, auditors would look at revenue projections, profit and loss accounts and also cash flow timing to collect substantial evidence. However post COVID-19, the audit procedures must include updated assumptions as well as review changes made to the company’s business model. For example, the expected cash projections that would be received when COVID-19 restrictions are lifted; or the company’s current cash position and access to additional finance during this period. The audit procedures should be modified according to changes in the client’s business model, such as operating fully online or delivery-only service.

According to the World Trade Organisation, global trade will plummet to a range between 13% to 32% during this pandemic season. Many sectors in the economy were significantly impacted by plummeting share prices, high staff retrenchment numbers and some even finally falling into bankruptcy. Particularly, sectors such as airline, travel and oil and gas took a turn for the worse during the economic recession as their operations were largely restricted. Therefore, there are higher chances for the publication of a modified audit opinion or an unmodified opinion with an emphasis of matter paragraph disclosing going concern doubts. Undoubtedly, a going-concern opinion may lower stockholders’ and creditors’ confidence in the company, ratings agencies may then downgrade the debt, leading to an inability to obtain new capital and an increase in the cost of existing capital. For instance, the modified opinion published on Multi-Usage Holdings Berhad, a Malaysian construction materials company, plummeted the share price from RM0.40 to RM0.30, and worsened the net loss position to RM898k as of the quarter ending 31 March 2020 .

Given that the financial statements may be published with “less than a stellar mark”, some companies would go to various lengths to avoid this, such as opinion shopping, internal frauds and also manipulation of figures. Opinion shopping refers to the practice of searching for another external auditor to provide a favorable opinion on the company’s financial statements. The company may pressure the current auditors or suddenly change audit firms in search of a favorable audit opinion. For example, Baker Tilly Malaysia sent voluntary resignation for Bina Puri Holdings Bhd in 2019, due to pressures on providing favorable opinion on the financial statements despite having going concern issues that needed to be highlighted. In addition to that, bonus and staff benefits depend on the profitability of the company at each quarter. Hence, management would be more incentivized to commit internal frauds such as manipulation of figures, off-shore payments and cookie jar accounting to hide the actual state of the business. For example, there was a high increase in digital fraud during COVID-19 season. Since most companies went fully online, certain managers used this opportunity to establish an off-shore account to collect receipts from customers . Besides that, fraudsters use fake government websites under the pretense of providing financial assistance to struggling businesses post COVID-19.

3.0 Inventory Valuation 

Valuations and estimates are often used in the preparation of financial statements such as inventory valuation, impairment of non-current assets and depreciation rates. Inventory valuation is important as inventory is a massive current asset especially for the manufacturing and retail-based businesses.The objective of inventory valuation is to ascertain the gross profit in the profit and loss account and determine the closing stock that will be included in the balance sheet. Inventory can be valued at historical cost, market value, net realizable value (NRV) or at replacement cost.

Common inventory audit procedures would be attending the physical stocktake , cut-off analysis and reconcile the inventory count to the general ledger. In regards to attending a physical stocktake, a team of auditors would observe the counting procedure completed by the warehouse staff and trace the counts to the amounts recorded in the stock-count sheets. Each category of inventory should also be labelled accordingly with respective tags. Cut-off analysis is the process of pausing receiving and shipping of inventory while the stocktake process is ongoing. Auditors would usually test a sample of last receipts and shipping invoices to see whether the inventory in the warehouse is properly accounted for.

Post COVID-19, Inventory Auditing had evolved over the past 8 months due to movement restrictions and social distancing measures. Since physical stocktake would be impractical at current times, ACCA (UK) have suggested an alternative approach which is having a virtual stocktake. A team of auditors could attend the stocktake virtually through video camera facilities and the use of drone technology. By doing so, drones will be able to give an overall view of the warehouse where inventory is stored.  In Australia,  technology called CaseWare is used as a more accurate method for inventory auditing.  CaseWare supports data transmission in terms of data import, data mapping and data validation. It would capture data in terms of type of stock, the amount of stock in and the amount of stock taken out. Thus, auditors would only need to reconcile the summary from CaseWare, with additional documents such as supplier order forms and shipping invoices, to ascertain the accuracy of inventory ledger

Given inventory auditing now depends on digital methods and paperless evidence, it is important to evaluate the impact to audit quality. Despite having control over the video cameras and drone technology, there is still a possibility that warehouse staff deliberately hide inventory so that stock count numbers reconcile with financial records. Furthermore, the warehouse staff have the responsibility of counting the stocks and also reporting the figures to auditors in virtual stocktaking. Due to no segregation of duties, it increases the risk of theft as the warehouse staff can steal the inventory and manipulate the figures given to the auditor.If the inventory figures aren’t audited properly, there may be misleading picture on the working capital position of the company. Subsequently, it impacts investor decisions to invest in a company as inefficient inventory turnover cycle refers to the slow rate inventory turns to cash hence higher chances for the inventory to become obsolete and old. 

4.0 Subsequent Events

Subsequent events is an accounting term referring to events that occur after a reporting period and before the issuance of the audit report. Subsequent events can be split into adjusting events which would require an adjustment to the figures in the financial statements and also non-adjusting events that only require a disclosure in the financial statements.

The global pandemic would be considered as a subsequent event similar to natural disasters and unprecedented events like outbreak of fire on the firm’s premises. outbreak on the firm’s premises. For companies with year-end 31 December 2019, the global pandemic would be considered as a non-adjusting event. According to the ICAEW and ACCA (UK) bulletin, the global pandemic has yet to occur for the year ending 31 December 2019 hence there would be limited changes to the basis or figures in the financial statement as a result of that.

For companies with year-ends in January and February 2020, there is still staggering doubt whether the pandemic is an adjusting event. As this matter is still being discussed by UK oversight boards, the pandemic would be categorised based on the pervasiveness of the COVID-19 impact on the firm’s long-term survival. 

For companies with year-ends of March 2020, the pandemic would be considered as an adjusting event. Hence, this could alter the basis used to prepare financial statements which could result in a break-up basis used instead of a going concern basis. Using the break-up basis in preparing financial statements is the assumption that the company would be liquidated and later on declaring bankruptcy after the reporting date. Overall, the financial statements will portray the company’s ability to use its assets to pay for all liabilities. 

5.0 Conclusion

Unprecedented times call for unprecedented measures. Prior to COVID-19, there were already a high number of discrepancies affecting the quality of audit reports produced by practitioners worldwide. Given the impact of COVID-19 on businesses today and with recession on the horizon, the chartered accountancy boards had to make changes to the audit standards and procedures to ensure audit quality does not deplete. The changes focused on the three main auditing standards which are Going Concern, Inventory Valuation and Subsequent events. These standards had the biggest impact as the occurrence of COVID-19 could alter the performance of the firms portrayed on the financial statements. Moving forward, COVID-19 has proven to oversight boards and practitioners that the audit world has to welcome digitalisation in order to sustain good audit quality. Practitioners have to be open to using paperless audit evidence to perform work done for the working papers during audit fieldwork.


Researcher: Durga Panirselvam

Editors: Stella, Hui Zhen

Reviewed by: Vikky Beh, Millen Lau

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