With the coronavirus outbreak, auditors in most instances will 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. Auditors should evaluate any impact, revise their risk assessments and modify planned audit procedures accordingly in accordance with ASA 315 Identifying and Assessing the Risks of Material Misstatement.

Points for consideration:
• If you are yet to begin your year-end audit procedures, are there any new risks that were not assessed during the planning phase?

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

• As part of your assessment of the client’s internal control framework, has management put in place adequate risk assessment controls to monitor and address issues arising from the COVID-19 pandemic?

Do any changes in the nature and level of risk require alternative responses to these risks (e.g. unable to attend client locations to perform tests of controls, the underlying basis or data used for certain analytical procedures is no longer appropriate, increased levels of risk requiring increased sample sizes when performing tests of details).

Paragraph 13 of ASA 210 Agreeing the Terms of Audit Engagements requires the auditor to assess whether circumstances require the terms of the audit engagement to be revised and whether there is a need to remind the entity of the existing terms of the audit engagement. Auditors should review their existing terms of engagement to evaluate if any changes to the audit engagement letter are required as result of COVID-19.  This may include considering whether there may be certain ‘preconditions’ to the audit (as outlined in Paragraph 6 of ASA 210) which may be difficult or no longer possible to be met by the audit client or auditor as a result of the COVID-19 outbreak. For example, COVID-19 restrictions on movement may result in difficulties for management to provide certain information or unrestricted access to persons within the entity. Where such restrictions are identified the auditor is encouraged to discuss this with management, get an understanding of the restriction issues that COVID-19 has created for the client and how that will impact the preparation of the financial report and the conduct of the audit, and determine how the information and access required for the audit will be gained in the current environment. This may require revision of the engagement terms, or a change to the Audit Strategy or Plan which needs to be communicated to the client.

 
If Auditors or Audit Clients wish to amend the terms of engagement for other reasons, consider whether independent legal advice is necessary.

Auditors need to maintain professional scepticism and be alert to how fraud risks may be higher as a result of COVID-19.  There may be situations where there is a greater risk of fraud and the control environment may be operating differently to usual, for instance impacting on segregation of duties and relaxation of security controls at an entity based on changes to working conditions caused by the COVID-19 restrictions.  The following may also increase the risk of fraud:

• Increased incentive or pressure for fraudulent financial reporting due to management being under pressure, from sources outside or inside the entity, to achieve an expected (and perhaps unrealistic) earnings target or financial outcome.
• Increased incentive to commit fraud due to financial hardships.
• Increased opportunity to commit fraud if internal controls have been weakened.

If a risk of material misstatement due to fraud is identified the auditor should design audit procedures to respond to the assessed risks.  Refer to ASA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of a Financial Report for relevant requirements.  Auditors may also find the following guidance in ASA 240 useful:

• Paragraph A1 which describes the characteristics of fraud
• Appendix 1 Examples of fraud risk factors
• Appendix 2: Examples of Possible Audit Procedures to Address the Assessed Risks of Material Misstatement Due to Fraud;
• Appendix 3: Examples of Circumstances that Indicate the Possibility of Fraud

Please click here to view examples of illustrative of events or conditions that may indicate an increased risk of fraud as a result of the COVID-19 pandemic.

ASA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of a Financial Report includes a number of requirements that may be more challenging to perform if there is limited access to client premises and staff.  For example, ASA 240 Paragraphs
18 – 22 require specific enquiries of management, those charged with governance and others within the entity in relation to fraud.  These requirements can be met through utilising technology (such as video conferencing) if it is not practical or possible to do in person.  If possible, use video conferencing to enable auditors to see the person they are interviewing in order to observe the body language.  Auditors are also reminded to interview others within the entity as appropriate, to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity, and to corroborate discussions with management.  ASA 240 paragraph A15 includes more detail on this matter and may assist.

COVID-19 restrictions may result in changes to client’s systems of internal control.  The following are examples of how COVID-19 may impact an entity’s system of internal control:
• With more people working from home, changes in operating environment may result in a change in processes and controls.
• Incorporating new technology to enable employees to work from home may change the risk associated with the entity’s system of internal control.
• Restructures may be accompanied by staff reductions and changes in supervision and segregation of duties that may change the risk associated with the entity’s system of internal control.
• There may be associated changes to the entity’s processes to monitor the systems of internal controls.
• If an entity has an internal audit function, they may not be able to conduct the planned activities to evaluate or monitor the effectiveness of internal controls. 

Auditors should discuss with management whether there have been any changes to the systems of internal control as a result of changes to the entity’s operations caused by the COVID-19 event.  They should also evaluate how management are monitoring and assessing whether the system of internal control is still achieving the objective of reliable financial reporting.  Auditors should also remain alert to possible changes in controls when performing audit procedures.

Where there have been changes to the systems of internal controls subsequent to the performance of planning and risk assessment procedures, the changes need to be understood and the impact on the audit approach assessed, including (but not limited to):
• The impact on the identified risks of material misstatement.
• The planned level of reliance on internal controls.
• Whether more substantive testing will be required as a result of less reliance on internal controls.
• The timing of the performance of audit procedures i.e. a change in the control environment may mean that performing audit procedures at an interim date is not appropriate and audit procedures should be performed at year end (ASA 330 paragraph A2).

Changes to the systems of internal may also impact increase the risk of fraud.  Refer to FAQ A3. Whilst the revised ASA 315 Identifying and Assessing the Risks of Material Misstatement (February 2020) is not yet effective it has useful guidance in Appendix 3 on evaluating systems of internal controls.

In designing and performing tests of controls, auditors are required, in accordance with ASA 330, to test how the controls were applied throughout the period under audit.  If the auditor has performed procedures to understand the systems of internal control and tested a sample of controls relevant to the audit before changes were made as a result of COVID-19, the auditor will need to understand any associated changes to the entity’s system of internal control and determine whether there are any new or revised controls relevant to the audit.  In this scenario, the auditor will need to perform appropriate procedures to obtain audit evidence about the operating effectiveness on the new or revised relevant controls, including performing additional tests of controls to obtain audit evidence over the period when these new or revised controls are implemented. Auditors should approach changes in internal control systems from COVID-19, as they would when encountering any changes to internal control systems that they were intending to rely upon. This includes similar sampling approaches as those adopted when testing a system of internal controls which has changed, and attention paid to making sure that no additional risks arise associated with the changeover.

If planning on using audit evidence obtained in previous audits about the operating effectiveness of controls, auditors need to consider if this is still appropriate as there may be significant changes to the systems of internal control and the entity’s monitoring controls.  Refer ASA 330 paragraph 13 and 14 for further detail.

Even if there are no plans to rely on the operating effectiveness of controls, ASA 315 still requires auditors to obtain an understanding of internal controls relevant to the audit and evaluate the effectiveness of their design and whether they have been implemented.  ASA 315 also requires that the auditor obtains an understanding of the entity’s controls, including control activities, relevant to all significant risks.  In respect of some audit risks, the auditor may determine that it is not possible or practicable to obtain sufficient appropriate audit evidence only from substantive procedures, so controls testing is required by ASA 330.

If restrictions on travel and visiting client’s sites means that controls testing cannot be performed as planned, auditors will need to reconsider the audit approach.  Auditors need to determine what audit evidence can be obtained remotely that provides comfort that controls are designed in a way that would prevent or detect and correct material misstatements in a timely manner, and that they have been implemented and / or are operating effectively.  It may be possible to employ the use of technology to observe controls being performed or inspect relevant supporting documentation (i.e. reconciliations) through video conferencing, scanned documents, sharing screens etc.  Data analytic procedures may also be utilised when performing controls testing.  Auditors should document how they gathered the evidence and their evaluation of the appropriateness of the evidence.  Auditors should consider the control environment when assessing the appropriateness of the source of audit evidence and the risk of manipulation.

Auditors may also need to re-assess the planned level of reliance on controls and perform more substantive testing to respond to the assessed risk of material misstatement.

If auditors cannot adequately perform procedures required by the Auditing Standards this may result in a limitation of scope that requires a modification to the Auditors Report.

ASA 501 Audit Evidence—Specific Considerations for Inventory and Segment Information requires that, if inventory is material to the financial report, 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.

AICPA Chief Auditor Bob Dohrer, CPA, CGMA, said it is possible for auditors to observe inventory without being on-site, under generally accepted auditing standards issued by the AICPA Auditing Standards Board. Please click on the link below to read his comments.
https://www.journalofaccountancy.com/news/2020/mar/auditing-how-to-observe-inventory-during-coronavirus-pandemic.html

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 ASA 705 Modifications to the Opinion in the Independent Auditor's Report.

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

Paragraphs A18 of ASA 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.

The recently revised ASA 540 Auditing Accounting Estimates and Related Disclosures enables auditors to deal with increasingly complex accounting estimates and related disclosures.  While ASA 540 Revised is only applicable to audits of financial reporting periods beginning on or after 15 December 2019 and many auditors would not yet be operating under the revised standard, the revised ASA 540 establishes robust requirements and provides detailed guidance which is expected to greatly assist auditors in auditing accounting estimates.  Under the revised standard, auditors are prompted to devote greater attention to addressing potential management bias in accounting estimates and applying professional scepticism.

ASA 540 Revised focusses on determining what drives the risk of material misstatement of an accounting estimate, and accordingly the impact of the standard on individual audits may vary based on a number of factors including the complexity, subjectivity and degree of uncertainty of the accounting estimates. 
In these uncertain times, the auditor may find a need for greater focus on:

• changes to regulatory factors that may affect accounting estimates (refer ASA 540 Revised, paragraphs 13, A26)
• the effect of changing inherent risk factors, in particular estimation uncertainty (refer ASA 540 Revised, paragraphs 2-4, 16, A72-A79)
• whether assumptions are appropriate in the circumstances (refer ASA 540 Revised, paragraphs 24, A95-A105)
• whether data being used by the entity is relevant and reliable (refer ASA 540 Revised, paragraphs 25, A106-A108)

The revised ASA 540 provides requirements and guidance to assist auditors in these areas, therefore, even if auditors have not early adopted ASA 540 Revised, you may find reference to this standard extremely beneficial.  For this reason, the FAQ’s outlined in this section are referenced in requirements to both extant ASA 540 and ASA 540 Revised, and in most cases to the more detailed application material in ASA 540 Revised. While the revised standard is lengthy, to get the full benefit, auditors are encouraged to read the full standard holistically.

Both extant ASA 540 paragraph 8, and ASA 540 Revised, paragraph 13, require the auditor to obtain an understanding of the entity and its environment, including the entity’s internal controls, to the extent necessary to provide an appropriate basis for the identification and assessment of risks of material misstatement. However, ASA 540 Revised provides more granular requirements and more expansive application material to assist auditors in this area.  Even if auditors have not early adopted ASA 540 Revised, they may find reference to the revised standard beneficial.  On this basis, the information below is referenced from ASA 540 Revised.

In the current COVID-19 environment, there are elements of the risk assessment process that may require heightened focus by auditors, including, but not limited to, understanding:

• the nature of the accounting estimates, (ASA 540 Revised, paragraph 13(d)) as although ASA 540 Revised applies to all accounting estimates, the degree to which an accounting estimate is subject to estimation uncertainty will vary substantially.  For entities impacted by the current COVID-19 environment, estimates linked to forward-looking information may carry significant estimation uncertainty, including for example:

- Impairment of non-financial assets under AASB 136 Impairment of Assets
- Impairment of inventories under AASB 102 Inventories
- Impairment of financial assets under AASB 9 Financial Instruments - for an entity that has any financial assets that are in the scope of AASB 9’s expected credit loss model (ECL) including loans; trade and other receivables; debt instruments not measured at fair value through profit or loss; contract assets lease receivables; financial guarantees; and loan commitments.
- Fair value measurements under AASB 13 Fair Value Measurement
- Assessments of the entity’s ability to continue as a going concern under AASB 101

•  Regulatory factors relevant to the entity’s accounting estimates (ASA 540 Revised, paragraph 13(c)), for example regulators may impose requirements that are additional to those required by the financial reporting framework or may amend certain requirements.  Auditors may find it beneficial to keep an eye on regulator and government websites (for example:  APRA, ASIC and Treasury). 

For example, in relation to the COVID-19 support packages which have mainly been offered to small business and home loan customers, APRA confirmed that the bank need not treat the period of the repayment holiday as a period of arrears. Similarly, loans that have been granted a repayment deferral as part of a COVID-19 support package need not be regarded as restructured. In both instances, the entity and the auditor need to consider the impact on determination of the estimate of expected credit losses. In this example, entities and auditors may find the following publications beneficial:  Application of IFRS 9 in the light of the Coronavirus uncertainty and Accounting for expected credit losses applying IFRS 9 Financial Instruments in the light of current uncertainty resulting from the covid-19 pandemic.

Additionally, auditors may need to understand government programs such as the announcement and period of operation of the various funding initiatives or business and consumer support packages and how such initiatives may impact future cash flows and in-turn impact accounting estimates noted above,  prompting a focus for auditors on these accounting estimates. 
For example, the circumstances that give rise to rent concessions as a result of COVID-19 are likely to indicate that assets may be impaired. For example, loss of earnings during the period covered by a rent concession may be an indicator of impairment of a cash-generating unit to which a lessee’s right-of-use asset relates; and from a lessor’s perspective, the change in the lessee’s circumstance may cause doubt about the recoverability of its lease receivable. The International Accounting Standards Board has proposed to amend IFRS 16 Leases to make it easier for lessees to account for covid-19-related rent concessions such as rent holidays and temporary rent reductions.

• The entity’s information system as it relates to accounting estimates, including understanding:

- How management selects the assumptions and data to be used (ASA 540 Revised, paragraph 13(h)(ii)(a)), including consideration of alternatives.  It may be necessary for management to select from several different assumptions used by different marketplace participants, for example, government economists, banks economists and firm’s economists may all use different discount rates or growth rates, all with equally valid assumptions. 

- How management understands the degree of estimation uncertainty (ASA 540 Revised, paragraph 13(h)(ii)(b)), including the auditor considering how management identified alternative methods, assumptions or data and how management considered alternative outcomes by, for example, performing sensitivity analysis.  

- How management addresses estimation uncertainty (ASA 540 Revised, paragraph 13(h)(ii)(b)). 

In understanding how management addresses estimation uncertainty, including management’s selection of a point estimate and related disclosures for inclusion in the financial report, the auditor needs to consider the specific disclosures required by the financial reporting framework relating to accounting estimates, including specific disclosures regarding estimation uncertainty.  Additionally, in this environment, some entities may choose to disclose additional information.  The robustness of quantitative and qualitative disclosures is essential to users understanding of financial reporting, and auditors may find a need for greater focus on assumptions made about the future and other major sources of estimation uncertainty.  ASA 540 Revised requires the auditor to determine whether disclosures related to accounting estimates are reasonable in the context of the applicable financial reporting framework.  FAQ C7 below provides further detail in this regard.

Furthermore, as part of the risk assessment process, the auditor reviews the outcome of previous accounting estimates (ASA 540 Revised, paragraph 14).  This may include obtaining information regarding the effectiveness of management’s previous estimation process.  A difference between the outcome of an accounting estimate and the amount recognised in the prior period’s financial report does not necessarily mean that management is not effective in their assessments, particularly if this difference arose due to economic or business impacts resulting from COVID-19. 

The auditor may consider the reasons for the difference and whether the differences arise from information that was available to management when the previous period’s financial report was finalised, or that could reasonably be expected to have been obtained and taken into account.  Conversely, while management may have been effective in their estimation process in the past where conditions were more benign, this may not be reflective of management’s effectiveness in the current period.  Therefore, an appropriate level of professional scepticism over accounting estimates should be exercised.

In the current circumstances, there may be more uncertainty in external factors impacting forward looking information, and it may be more difficult, for example, to make forecasts. Estimation uncertainty may increase and accordingly, management may have identified a greater need for specialised skills or knowledge related to accounting estimates.  

Both extant ASA 540 paragraph 8 and ASA 540 Revised paragraph 13 require the auditor to understand how management makes the accounting estimates, and to gain an understanding of the data on which they are based, including whether management has used an expert.  Where a management’s expert is used, the auditor may find the guidance contained in the recently revised GS 005 Evaluating the Appropriateness of a Management’s Expert’s Work beneficial. 

In particular, paragraph 49 of GS 005 identifies factors that may be relevant to the auditor in evaluating the reasonableness of a management’s expert’s assumptions, including consideration of the degree of estimation uncertainty associated with the management’s expert’s underlying assumptions and the degree of stress testing undertaken. 

Considering the heightened risks around subjectivity and estimation uncertainty impacting adversely on the risk of material misstatement of accounting estimates, the engagement team may also need to consider the need for specialised skills or knowledge (ASA 540 Revised, paragraph 15), including the use of an auditor’s expert.  ASA 620 Using the Work of an Auditor’s Expert contains requirements and guidance when evaluating the work of such an expert.

When evaluating the appropriateness of management or auditor’s expert’s work, the auditor needs to consider the relevance and reliability of that work, including the nature of any restrictions, disclaimers or limitations in the expert’s report.  It is possible that in the current environment and given the possibility of significant concerns around estimation uncertainty, the auditor may find a greater number of restrictions, disclaimers or limitations coming through expert’s reports. 

In these scenarios, it may not necessitate the reports or work undertaken by those experts being completely disregarded as audit evidence, rather the auditor needs to consider the nature and reasoning of such restrictions. This includes considering the consistency of the expert’s work with other evidence obtained by the auditor and the auditor’s understanding of the entity and its environment. 

The underlying work undertaken may still be appropriate for the auditor’s purposes, and may still provide a level of audit evidence, however, the auditor will need to determine the nature and extent of additional audit procedures that may need to be undertaken to support the work undertaken by the particular expert so that holistically the auditor has obtained sufficient appropriate audit evidence on which to base their conclusions.

In identifying and assessing the risk of material misstatement, both extant ASA 540 paragraph 10 and ASA 540 Revised paragraph 16 require the auditor to evaluate the degree of estimation uncertainty associated with an accounting estimate.  In addition to estimation uncertainty, ASA 540 Revised requires the auditor to take into account the degree to which the selection and application of the method, assumptions and data in making the accounting estimate are affected by complexity or subjectivity.  ASA 540 Revised, provides more granular requirements and more expansive application material to assist auditors with the identification and assessment of the risk of material misstatement.  Even if auditors have not early adopted ASA  540, they may find reference to the revised standard beneficial.  On this basis, the information below is referenced from ASA 540 Revised.

In these uncertain times, the auditor may find a need for greater focus on the effect of changing inherent risk factors, in particular estimation uncertainty and subjectivity. 

Estimation Uncertainty
The COVID-19 environment is expected to adversely impact estimation uncertainty for numerous reasons including:

• The financial reporting framework requires the use of assumptions that inherently have a high level of estimation uncertainty, such as assumptions with a long forecast period, assumptions that are based on data that is unobservable and are therefore difficult for management to develop, or the use of various assumptions that are interrelated

• In the current COVID-19 business environment, many entities are transacting in markets that are experiencing significant turmoil, (for example, retail, hospitality and tourism), and there are limitations on the availability of knowledge and data to fully understand the go-forward positions impacting such estimates as impairment forecasts.

• That it may not be possible or practicable for management to:

- make a precise and reliable prediction about the future realisation of a past transaction (for example, the amount that will be paid or received under a contractual term), or about the incidence and impact of future events or conditions (for example, the amount of a future loss); or 

- obtain precise and complete information about a present condition (for example, future growth forecasts and discount rates impacting a discounted cash flow impairment model).

Subjectivity
The COVID-19 environment may give rise to increased subjectivity in making some accounting estimates, including varied economic forecast positions, business impacts and management’s possible use of a weighting of multiple scenarios to arrive at an accounting estimate.  The degree of subjectivity in judgements associated with an accounting estimate may increase the susceptibility of the accounting estimate to misstatement due to management bias or fraud.

The greater the degree to which an accounting estimate is subject to estimation uncertainty, complexity or subjectivity, the more likely the risks of material misstatement will be assessed as higher and accordingly a need for more disclosures to aid users’ understanding.

As a result, the audit evidence needs to be more persuasive to determine whether management’s point estimate and related disclosures about estimation uncertainty are reasonable in the context of the applicable financial reporting framework or are misstated.

As described in FAQ C4, the current environment may lead to an increase in the assessed risk of material misstatement in some areas.  The assessed risk of material misstatement affects the persuasiveness of the audit evidence needed and the need for more disclosures to aid users’ understanding; and influences the auditor’s testing approach to auditing an accounting estimate. 

Both extant ASA 540 paragraph 13 and ASA 540 Revised paragraph 18 require that an auditor’s further audit procedures should be responsive to the assessed risks of material misstatement, considering the reasons for the assessment given to those risks and may include any of the three testing approaches (individually or in combination) as outlined below:
• Obtaining audit evidence from events occurring up to the date of the auditor’s report;
• Testing how management made the accounting estimate; or
• Developing an auditor’s point estimate or range.

Extant ASA 540 includes an additional approach of testing the operating effectiveness of controls over how management made the accounting estimate, together with appropriate substantive procedures.  This approach has been incorporated into other requirements within ASA 540 Revised (refer ASA 540 Revised, paragraph 19) and is no longer a stand-alone approach.  ASA 540 Revised provides more granular requirements and more expansive application material to assist auditors in these testing approaches, therefore, even if auditors have not early adopted ASA 540 Revised, you may find reference to the revised standard extremely beneficial.  On this basis, the application material below is referenced from ASA 540 Revised.

In undertaking further audit procedures, auditors are reminded of the revisions to ASA 540 Revised that seek to emphasise the importance of the appropriate application of professional scepticism.  ASA 540 Revised, paragraph 18, requires that the auditor designs and performs further audit procedures in a manner that is not biased towards obtaining audit evidence that may be corroborative or towards excluding audit evidence that may be contradictory.  In the present environment, we are seeing, for example, economists’ views on various outcomes, including but not limited to economic growth and interest rate predictions may vary.  It is important that the auditor obtains audit evidence in an unbiased manner that may involve obtaining evidence from multiple sources, not just those that corroborate management’s position.

Where the auditor develops a range to assess management’s point estimate, the variation between reasonable outcomes may be greater than that developed in prior periods. Where this range is greater than materiality the auditor’s evaluation of the reasonableness of the disclosures about estimation uncertainty becomes increasingly important, particularly whether such disclosures appropriately convey the high degree of estimation uncertainty and the range of possible outcomes (ASA 540 Revised, paragraph A125).

Rapidly changing circumstances may also mean that management will need to update their data and assumptions between the date they on which they reach their initial conclusions and the date the auditor completes their audit. It is important that auditors carefully consider whether management’s methods, data and assumptions remain appropriate based on information available through to the date of the auditor’s report. For example, where the government is frequently updating economic forecasts as more information on recovery scenarios comes to hand, management will need to consider how this impacts their assumptions surrounding forward looking estimates such as expected credit losses.

Answer Extant ASA 540 paragraph 15 requires the auditor to evaluate whether significant assumptions used by management are reasonable.  While ASA 540 Revised paragraph 24 also requires the auditor to evaluate whether significant assumptions are appropriate, the revised standard provides more granular requirements and more expansive application material to assist auditors in evaluating management’s assumptions.  Even if auditors have not early adopted ASA 540 Revised, they may find reference to the revised standard beneficial.  On this basis, the information below is referenced from ASA 540 Revised.

When testing how management makes an accounting estimate, with respect to significant assumptions, the auditor’s further audit procedures need to address the following. [Click to follow the hyperlink.]

Auditors may find ASIC’s COVID-19 implications for financial reporting and audit:  Frequently asked questions (FAQs), particularly FAQ 2, beneficial in this regard.

Extant ASA 540 requires the auditor to determine whether disclosures in the financial report relating to accounting estimates are adequate while ASA 540 Revised requires the auditor to determine whether such disclosures are reasonable.  While ASA 540 Revised has a greater focus for auditors in relation to disclosures, the revised standard provides more expansive application material to assist auditors in this area.  As such, even if auditors have not early adopted ASA 540, they may find reference to the revised standard beneficial.  On this basis, the information below is referenced from ASA 540 Revised.

In the current environment, it is anticipated there may be a heightened risk for some entities surrounding estimation uncertainty, and accordingly a need for more disclosures to aid users’ understanding.  The greater the degree to which an accounting estimate is subject to estimation uncertainty, the more likely the risks of material misstatement will be assessed as higher and therefore the more persuasive the audit evidence needs to be to determine whether management’s point estimate and related disclosures about estimation uncertainty are reasonable in the context of the applicable financial reporting framework (ASA 540 Revised, paragraph A113).  Accordingly, auditors may expect to spend more time and focus additional audit effort in auditing disclosures around estimation uncertainty.   ASA 540 Revised paragraphs 26(b) and 36(a) require auditors to consider disclosures in the context of financial reporting frameworks and beyond those specifically required by the framework to achieve fair presentation.

Disclosures required by financial reporting frameworks

Auditors are required to address whether in the context of the applicable financial reporting framework, management has taken appropriate steps to address estimation uncertainty by selecting an appropriate point estimate and by developing related disclosures about estimation uncertainty (ASA 540 Revised, paragraph 26(b)).  An example of a matter in this environment that may be relevant to the auditor in addressing this requirement, is whether management’s disclosures appropriately describe the amount as an estimate and explain the nature and limitations of the estimation process, including the variability of the reasonably possible measurement outcomes.  Furthermore, a consideration for the auditor regarding management’s disclosures include the requirements of the financial reporting framework.  For example:

• AASB 101 Presentation of Financial Statements paragraph 125 requires entities to disclose the major sources of estimation uncertainty that have a significant risk of resulting in a material adjustment to the financial statements in a subsequent period;

• AASB 13 Fair Value Measurement paragraph 91 requires disclosure of valuation techniques and inputs used when measuring the fair value of assets and liabilities;
• AASB 136 Impairment of Assets paragraphs 130 and 134 require an entity to disclose key assumptions on which management has based its determination of the recoverable amount of its assets; and
• AASB 137 Provisions, Contingent Liabilities and Contingent Assets paragraph 85(b) requires disclosure of major assumptions made concerning future events that may affect the amounts required to settle an obligation.

Disclosures beyond financial reporting frameworks

AASB 101 paragraph 31, requires an entity to consider whether to provide information not specified by Australian Accounting Standards if that information is necessary for primary users to understand the impact of particular transactions, other events and conditions on the entity’s financial position, financial performance and cash flows. An entity will need to apply judgement to assess whether additional information about the estimations it makes would be required to satisfy this paragraph. The auditor is required to evaluate whether management has included such additional disclosures, beyond those specifically required by the framework, that are necessary to achieve the fair presentation of the financial report as a whole (ASA 540 Revised, paragraph 36(a)).

Professional scepticism

Additionally, in the current environment, we may expect to see a heightened degree of professional scepticism being exercised by auditors in relation to accounting estimates disclosures, particularly disclosures around estimation uncertainty.  ASA 540 Revised includes requirements for the auditor to ‘stand back’ and consider all evidence obtained, whether corroborative or contradictory, when evaluating whether the accounting estimates and related disclosures are reasonable in the context of the applicable financial reporting framework. 

Reporting

Auditors are reminded that if the auditor’s consideration of estimation uncertainty associated with an accounting estimate, and its related disclosure, is a matter that required significant auditor attention, then this may constitute a key audit matter (ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report).  Furthermore, in some cases, the estimation uncertainty relating to an accounting estimate may cast significant doubt about the entity’s ability to continue as a going concern.  ASA 570 Going Concern establishes requirements and provides guidance in such circumstances.  Additionally, there may be circumstances where estimation uncertainty may in the auditor’s judgement, be of such importance that it is fundamental to users’ understanding of the financial report.  In this case the auditor may consider it necessary to draw users’ attention to estimation uncertainty and accordingly this may result in an emphasis of matter paragraph in the auditor’s report. 

In relation to auditing disclosures, auditors may find the following publications useful:

• The Impact of Coronavirus on Financial Reporting and the Auditor’s Considerations AASB−AUASB Joint FAQ March 2020, refer QA 3 and QB 3.

• ASIC’s COVID-19 implications for financial reporting and audit:  Frequently asked questions (FAQs), particularly FAQ 3, 4, 7, 9 and 18.

Both extant ASA 540 and ASA 540 Revised require the auditor to request written representations from management and, when appropriate, those charged with governance.  ASA 540 Revised, provides more granular requirements and more expansive application material to assist auditors in this area.  Even if auditors have not early adopted ASA 540 Revised, they may find reference to the revised standard beneficial.  On this basis, the information below is referenced from ASA 540 Revised.

ASA 540 Revised requires the auditor to request written representations from management and, when appropriate, those charged with governance about whether the methods, significant assumptions and the data used in making the accounting estimates and the related disclosures are appropriate to achieve recognition, measurement or disclosure that is in accordance with the applicable financial reporting framework.  Additionally, the auditor is required to consider the need to obtain representations about specific accounting estimates, including in relation to the methods, assumptions, or data used.

In these potentially uncertain times and dependent on the level of management disclosures in the financial report, written representations about specific accounting estimates may include representations:

• That the significant judgements made in making the accounting estimates have taken into account all relevant information of which management is aware.

• About the consistency and appropriateness in the selection or application of the methods, assumptions and data used by management in making the accounting estimates.

• That the assumptions appropriately reflect management’s intent and ability to carry out specific courses of action on behalf of the entity, when relevant to the accounting estimates and disclosures.

• That disclosures related to accounting estimates, including disclosures describing estimation uncertainty, are complete and are reasonable in the context of the applicable financial reporting framework. 

• That no subsequent event requires adjustment to the accounting estimates and related disclosures included in the financial report.

Auditors are reminded that although written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. Furthermore, the fact that management has provided reliable written representations does not affect the nature or extent of other audit evidence that the auditor obtains about the fulfilment of management’s responsibilities, or about specific assertions.

ASA 540 Revised, provides more granular requirements and more expansive application material than extant ASA 540, to assist auditors in the area of documentation.  Even if auditors have not early adopted ASA 540 Revised, they may find reference to the revised standard beneficial.  On this basis, the application material below is referenced from ASA 540 Revised.

In the current environment, owing to possible significant estimation uncertainty and subjectivity around significant assumptions, with the potential for management bias, it will be important for the auditor to document their determination of significant judgements made and the exercise of professional scepticism. 

For example, in relation to accounting estimates, when the audit evidence obtained includes evidence that both corroborates and contradicts management’s assertions, the documentation may include how the auditor evaluated that evidence, including the professional judgments made in forming a conclusion as to the sufficiency and appropriateness of the audit evidence obtained. 

Examples of areas where the auditor exercises professional scepticism that can be evidenced through documentation include how the auditor:

• applied an understanding of management’s estimate in developing their own estimates;
• obtained audit evidence through performing procedures that is not biased towards corroborative evidence and has proper regard to contradictory evidence;
• addresses indicators of possible management bias; and
• concluded on the sufficiency and appropriateness of all relevant audit evidence obtained, whether corroborative or contradictory audit evidence (the stand-back).

The extent of documentation is often influenced, amongst other factors, by the risks of material misstatement, which in this environment, may increase owing to possible estimation uncertainty.  Preparing sufficient and appropriate audit documentation on a timely basis helps to enhance the quality of the audit and facilitates the effective review and evaluation of the audit evidence obtained and conclusions reached before the auditor’s report is finalised, and may assist auditors when hindsight is applied to estimates and judgements that may be subject to review by others at a later time. Auditors may find ASIC’s COVID-19 implications for financial reporting and audit:  Frequently asked questions (FAQs), particularly FAQ 9, beneficial in this regard.

The documentation requirements of ASA 540 Revised have been expanded to include the auditor’s understanding of the entity and its environment, the assessment and the corresponding response to the risks of material misstatements, indicators of possible management bias, and other judgements relating to the auditor’s determination of whether the accounting estimates and related disclosures are reasonable in the context of the applicable financial reporting framework.

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 Paragraphs 12 – 14 of ASA 570 Going Concern for more details.  Refer to AASB-AUASB joint FAQ for further details.  The AASB and AUASB are also working together to develop additional guidance on Going Concern matters for preparers and auditors which will be released soon.

Regardless of the circumstances, 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 ASA 600 Special Considerations-Audits of a Group Financial Report.

Points for consideration:

• Communicate with component auditors as soon as practicable to discuss potential impacts arising from the coronavirus outbreak.

• Consider any increased risk that financial information for those components may be inaccurate or incomplete due to the coronavirus outbreak.

• Can the group engagement team utilise technology, where not prohibited by laws or regulations, to review the component auditor’s work remotely?

• Can the group engagement team perform work themselves without using component auditors, by working with group management?  The group engagement team may consider financial information that is available from group management, as group management also needs to obtain the component’s financial information in order to prepare the group financial report.

• 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:
o Whether additional reporting is required from the component; and
o 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.

• Consider the possible effects on the group audit opinion, ASA 705 contains requirements and guidance on how to address situations where the group engagement team is unable to obtain sufficient appropriate audit evidence.

Whilst there is no obligation to perform any audit procedures regarding the financial report 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 report is issued, there are specific requirements auditors must perform to ensure the auditor’s report remains appropriate. Refer to paragraphs 10 to 13 of ASA 560 Subsequent Events for more details.

If the impact of the COVID-19 event became known after the financial report has 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 ASA 560 Subsequent Events for more details.

COVID-19 was declared a health emergency on 30 January 2020 and a global pandemic on 11 March 2020.  The impact of COVID-19 has escalated rapidly during this time and beyond, as governments impose restrictions on business activity and travel, and global markets significantly deteriorated.

Entities with reporting periods which have ended but for which financial reports are still to be finalised need to carefully consider the impacts of COVID-19 on their financial report, including whether the impact is an adjusting or non-adjusting event under AASB 110 Events after the Reporting Period.  An adjusting event is one which provides evidence of conditions that existed at reporting date, and a non-adjusting event is one where conditions arose after the reporting date.  Refer to AASB-AUASB joint FAQ for further detail on how to assess whether a subsequent event is an adjusting event or non-adjusting event.

Under ASA 560 Subsequent Events auditors are required to obtain sufficient appropriate audit evidence as to whether subsequent events which require adjustment to, or disclosure in, the financial report, are identified and are appropriately reflected.

For entities with 31 December 2019 and 31 January 2020 reporting periods auditors should discuss the impacts of COVID-19 on the unsigned financial report with their client.  For these reporting dates the impacts of COVID-19 are generally considered non-adjusting events as the conditions that gave rise to the significant impacts on the business and the economy occurred after the reporting date.  However this does not mean entities can ignore the impact of COVID-19 on their financial report:

• If the entity concludes that it is no longer a going concern, it can no longer prepare the financial statements on a going concern basis, even if the event leading to this assessment occurred after the reporting date.  The going concern assessment must consider all available information up to the date of signing the financial statements. 

• If the entity concludes that it remains a going concern, entities must disclose the nature of the events and estimated financial effect of material non-adjusting subsequent events in the notes to the financial statements.  If an estimate cannot be made, the entity must make a statement to that effect.

Therefore, entities must consider whether the impacts of COVID-19 on the entity’s business and operations, and its financial position and financial performance are material and require disclosure in the subsequent events note to enable users to understand the nature of the impact on the entity and provide an estimate of the financial effect (where possible).  Materiality should be assessed using the guidance in APS 2, which means that information about COVID-19 would be material if users reasonably expect it to have an impact on the entity, even if the entity does not expect there to be any quantitative impact, [refer to AASB-AUASB joint FAQ for further detail].

Entities with reporting periods ending after 31 January 2020 must carefully consider the specific facts and circumstances to assess whether the subsequent events provide information about conditions that existed at the end of the reporting period (adjusting event) or information about new conditions that did not exist at the reporting date (non-adjusting event).  For example, there were a number of significant government policy announcements made late March and early April which need to be considered.

Under ASA 560 auditors are required to obtain sufficient appropriate audit evidence as to whether subsequent events are appropriately reflected in the financial report in accordance with AASB 110.  This requires assessing if the disclosures are adequate to enable users to understand the nature and an estimate of the impact on the entity.  ASA 560 also requires auditors to obtain a written representation from management.

Also if the entity has disclosed the impact of COVID-19 in the financial report this may meet the definition of an Emphasis of Matter under ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report.  Emphasis of Matter (EOM) paragraphs alert readers to disclosures in the financial report that in the auditor’s judgement are of such importance to users’ understanding of the financial report.  Refer to ASA 706 for the requirements in relation to EOMs.  The following is example wording for the EOM:

Emphasis of Matter – Subsequent event: The impact of the uncertainty of COVID-19

We draw attention to Note xxx in the Financial Report, which describes events subsequent to year end and specifically the possible effects of the future implications of COVID-19 on ABC Proprietary Limited’s future financial position and performance. In our view this issue is fundamental to users’ understanding of the Financial Report.  Our opinion is not modified in respect of this matter.

COVID-19 does not change the auditor’s responsibility in relation to other information that accompanies the Financial Report (e.g. the Annual Report).  The Operating and Financial Review or Director’s Report which is included in the Annual Report should include disclosure of risks associated with and the business impacts of COVID-19 on the entity (refer to ASIC’s FAQ number 4 and 5). Auditors should review the other information carefully to ensure there is consistency between the information in the Annual Report, the Financial Report and the auditor’s understanding and knowledge of the entity. Auditors should exercise professional scepticism when reviewing the other information. For example, if the entity includes non-IFRS profit measures that purport to show the result had the impact of the COVID-19 pandemic not occurred, this may be misleading and include adjustments not related to the COVID-19 pandemic. Refer to ASIC’s FAQ number 4 and 5 for further guidance on disclosures in the other information and risks associated with including alternative profit measures that remove the impact of the COVID-19 pandemic.  If there are inconsistencies refer to ASA 720 The Auditor's Responsibilities Relating to Other Information for the implications on the auditor’s report.

ASA 580 Written Representations deals with the auditor’s responsibility to obtain written representations from management and, where appropriate, those charged with governance in an audit of a financial report.  Auditors should consider whether it is necessary to obtain additional written representations to support any audit evidence relevant to COVID-19.  The following are some matters to consider.

Paragraph 11(a) of ASA 580 requires the auditor to request management to provide a written representation that the management has provided the auditor with all relevant information and access as agreed in the terms of the audit engagement.  Auditors may consider if it necessary to request a representation that management has provided all relevant information on the impact of COVID-19.  Also, if the COVID-19 impacts the accessibility of information and / or access to the client’s premises or staff, the auditor should consider if it necessary to request additional representations to address this.

Auditors should consider obtaining other written representation from the management on the plans or intentions as a result of COVID-19 that may affect the carrying value or classification of assets and liabilities (i.e. shutting down of shopfronts or subsidiaries).  There are other suggested circumstances which the auditor may consider it necessary to request other written representations about the financial report, refer to paragraph A10 of ASA 580 for more details.

In addition, the auditor may consider it necessary to request management to provide written representations about specific assertions in the financial report; in particular, to support an understanding that the auditor has obtained from other audit evidence of management’s judgement or intent in relation to, or the completeness of, a specific assertion. For example, if the intent of management is important to the valuation basis for investments, it is advisable to obtain a written representation from management about its intentions. 

Apart from ASA 580, para 9 of ASA 560 also requires the auditor to request management and, where appropriate, those charged with governance, to provide a written representation that all events occurring subsequent to the date of the financial report (i.e. such as those relating to the COVID-19 event) that require adjustments or disclosures, have been adjusted or disclosed.

If COVID-19 results in an event of condition that may cast significant doubt on the entity’s ability to continue as a going concern, auditors are required to obtain written representations regarding their plans for future actions and the feasibility of these plans (refer ASA 570 Going Concern, paragraph 16(e)). For more going concern considerations, refer to section C of this FAQ.

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 report.

In accordance with ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report, KAMs are those matters which were of most significance and therefore required significant attention during the audit. Auditors of listed entities (or other entities which 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 AUASB have been monitoring listed company auditor reporting in Australia since the COVID-19 pandemic was announced, and have observed that approximately 67% of auditor’s reports on March 2020 year-end financial reports included KAMs which describe the impact of COVID-19 on specific line items or elements within the financial report, which were determined to be KAMs, and the procedures the auditor conducted to address this.

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

• The matters which are determined to be KAMs may change from those reported in prior years as the auditor focuses on the most significant matters in the current audit. For example, focusing on account balances, classes of transactions or disclosures which are significantly impacted by the greater uncertainty in the current environment, which may require additional auditor attention than in previous audits. The AUASB have observed that approximately 50% of auditor’s reports on listed companies March 2020 year-end financial reports communicate new and different KAMs compared with those communicated in the corresponding prior year’s auditor’s report as a result of COVID-19.

• The description of the KAMs includes the procedures the auditor performs to address the impact of COVID-19 on the matter. For example, audit procedures performed over impairment models and cash flow estimates describe how management have considered COVID-19 in their key assumptions and the procedures the auditor has conducted over these. The AUASB have observed that approximately 32% of the total KAMs communicated in listed company auditor’s reports on March 2020 year-end financial reports, included descriptions of the impact of COVID-19 on the matter and the procedures the auditor has conducted.

• Communicating how COVID-19 has impacted the audit approach. The AUASB have observed two instances in auditor’s reports on March 2020 year-end financial reports where auditors have communicated a KAM describing how they have gathered sufficient appropriate audit evidence in a different manner to previous years as a result of COVID-19 related travel restrictions.

• Including a KAM on going concern when it is a “close call”, if the auditor spends more time on gathering evidence that the going concern basis of accounting is appropriate and that no material uncertainty exists, than in prior years.

As detailed in ASA 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 (ASA 705 Modifications to the Opinion in the Independent Auditor’s Report and ASA 570 Going Concern).

If KAMs are not communicated in the auditor’s report (i.e. not a listed entity), the auditor may elect to communicate how COVID-19 impacted the audit in an Other Matter Paragraph (see FAQ G6).

In certain limited circumstances auditors may consider it appropriate to draw report users’ attention to specific disclosures in the financial report, which they consider are fundamental to users’ understanding of the financial report, by including an EOM paragraph in their auditor’s report (refer to ASA706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report).

What is considered “fundamental to users’ understanding of the financial report” is a matter of auditor’s professional judgement and is specific to the entity’s circumstances. ASA 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. ASA 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 ASA 706. An EOM should refer to the entity’s disclosures about the matters considered fundamental to the users understanding of the financial report.

The AUASB have been monitoring listed company auditor reporting in Australia since the COVID-19 pandemic was announced (ie. Auditor’s reports issued mid-March to mid-June 2020) and have observed that approximately 16% of auditor’s reports issued during this period on December 2019 to 31 March 2020 year-end financial reports, included an EOM in relation to specific COVID-19 disclosures about the implications for the entity that the auditor deemed fundamental to the financial report. The EOMs were to draw users’ attention to a note in the financial report which describes:

• The subsequent event regarding the significant uncertainty of the economic environment as at the date of the signing of the financial statements (mainly December 2019 year ends).

• The impact on operations to date and how the entity has considered the uncertainty in the preparation of the financial report.

 Refer to FAQ G3 for details on KAMs and FAQ G4 for details on EOMs. ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report details that if a matter is determined to be a KAM, whilst it may meet the definition of an EOM, it is communicated as a KAM and the KAM description draws further attention to the importance of the related disclosures, therefore meeting the purpose of an EOM. This is to ensure the auditor’s report is as succinct as possible and to avoid duplication in reporting.

COVID-19 may impact an entity and items in the financial report in a number of ways and the auditor may refer to these impacts in a KAM and an EOM if they meet the requirements in ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report and ASA706. For example, valuation of assets (involving estimated future cash flows) may be determined to be a KAM and this will include a description of how COVID-19 has been addressed and refer to relevant disclosures in the financial report, whilst the financial report may also include other disclosures about the impact on operations to date and how the entity has considered the uncertainty in the preparation of the financial report, which in the auditor’s view are fundamental to users’ understanding of the financial report. It is important that the communication of a KAM and an EOM are drawing attention to different matters and disclosures so as to not be repetitive.

What is considered “fundamental to users’ understanding of the financial report” (i.e. definition of EOM) is a matter of auditor’s professional judgement and ASA 706 cautions that widespread use of EOM paragraphs may diminish the effectiveness of the communication of such matters.

Auditors may consider it necessary to communicate an OMP to draw users’ attention to matters that are relevant to understanding the audit or the auditor’s responsibilities for the financial report. For example, auditors may communicate how they obtained sufficient appropriate audit evidence or changed their audit approach as a result of the COVID-19 matter, particularly in those situations where they are not communicating KAMs. Note that if the auditor has assessed this to be a KAM they do not also include an OMP paragraph (ie. so not to communicate twice).

Refer to ASA 706 for more detail on OMP paragraphs.

As detailed in ASA706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report an EOM is only appropriate to draw attention to items which are adequately disclosed in the financial report. If a matter is not adequately disclosed, the auditor does not include an EOM on this matter and considers the impact on the auditor’s opinion, refer to FAQ G9.

If the auditor identifies a matter which meets the definition of an EOM and has also concluded a modified opinion is required due to a matter which is unrelated to the EOM, the auditor’s report can include the modified opinion and the EOM.

Refer to The Impact of COVID-19 on Going Concern and Related Assessments – Joint Publication by the AASB and AUASB for details on when to include a MURGC paragraph.

The auditor expresses an unmodified audit opinion if they conclude they have sufficient appropriate audit evidence that the financial report is prepared, in all material respects, in accordance with the applicable financial reporting framework. In accordance with ASA 700 Forming an Opinion and Reporting on a Financial Report, the auditor modifies the audit opinion when:

• They conclude, based on the audit evidence obtained, that the financial report is not free from material misstatement; or

• They are unable to obtain sufficient appropriate audit evidence to conclude that the financial report is free from material misstatement.

Adequate and appropriate disclosures in the financial report about the effects of the COVID-19 pandemic on the entity, including key assumptions and judgements made by management on accounting estimates and other areas of uncertainty, are important for users to understand. The Impact of Coronavirus on Financial Reporting and Audit Considerations AASB-AUASB Joint FAQ and ASIC’s COVID-19 Implications for financial reporting and audit: Frequently Asked Questions (ASIC’s FAQs) provides guidance for financial report preparers in relation to disclosures in the current environment.

For financial reports prepared in accordance with a fair presentation framework, auditors are required to consider the overall presentation of the financial report, including disclosures, and whether the report represents the underlying transactions and events in a manner that achieves fair presentation. When forming their opinion, auditors consider whether the material effects of the COVID-19 pandemic on the entity have been accounted for and disclosed adequately in the financial report.

The following may result in auditors concluding that a modified opinion is required:

• Inappropriate recognition and measurement of assets and liabilities due to disagreement on how the impacts of  COVID-19 have been reflected; for example, inputs into accounting estimates are not considered reasonable by the auditor based on credible evidence (material misstatement).

• Inadequate disclosure about relevant risks, key assumptions and judgements applied by management (material misstatement).

• Required procedures and sufficient appropriate alternate procedures cannot be performed due to travel restrictions or lockdowns (unable to obtain sufficient and appropriate audit evidence).

Auditors may also find it more challenging when assessing if there is sufficient appropriate audit evidence in the current COVID-19 environment especially in areas of judgement. Refer to the AUASB’s FAQs C1 – C9 for guidance on how to gather sufficient appropriate audit evidence on Accounting Estimates and Related Disclosures.

An inability to perform a specific procedure does not constitute a limitation on the scope of the audit if the auditor is able to perform alternate procedures to gather sufficient appropriate audit evidence.

Refer to The Impact of COVID-19 on Going Concern and Related Assessments – Joint Publication by the AASB and AUASB for when an auditor may modify their opinion for going concern matters.

Under ASA 705 Modifications to the Opinion in the Independent Auditor’s Report, a modified opinion may be qualified, adverse or a disclaimer (inability to obtain sufficient appropriate audit evidence). The decision regarding which type of modified opinion to issue depends upon:

• The nature of the matter giving rise to the modification, that is, whether the financial report is materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated; and

• The auditor’s judgement about the pervasiveness of the effects or possible effects of the matter on the financial report.

ASA 705 paragraph 5 details that pervasive (related to column 3 in Table below) is when the effects or possible effects on the financial report:

• Cannot be confined to specific elements, accounts or items in the financial report;

• If they can be confined to specific elements, they represent or could represent a substantial proportion of the financial report; or

• If, in relation to disclosures, are fundamental to user’s understanding of the financial report.

This table from ASA 705 A1 includes the type of modified opinion to issue [click here for the table].

Therefore if the effects or possible effects of misstatements on the financial report can be confined to specific elements, accounts or items in the financial report, a qualified opinion is given. Adverse and disclaimers are when this is not possible ie. the effects or possible effects are pervasive. Adverse and disclaimer opinions are rare in practice. Adverse is where the auditor concludes the financial report may be misleading, whilst a disclaimer is when an auditor cannot conclude.

Professional judgement is required in making the assessment as to whether a qualified, adverse or disclaimer opinion is appropriate in the circumstances.

Also refer to:

• Flowchart - What type of opinion? 

• What does the Auditor’s Report Mean? which further explains the different types of opinions and communications communicated in the auditor’s report.

• The AASB-AUASB joint publication Impact of COVID-19 on Going Concern and Related Assessments Joint Publication by the AASB and the AUASB for details on when an auditor may modify their report for going concern matters.

At least annually (and half-yearly for listed entities and disclosing entities), the Corporations Act 2001 requires directors, as part of the financial report, to make a declaration of solvency. This declaration states that in their opinion “there are reasonable grounds to believe that the company, registered scheme or disclosing entity will be able to pay its debts as and when they become due and payable”. This declaration is made as at the date of the declaration on the capacity to pay debts which have been incurred at the time of the declaration.

ASIC’s Regulatory Guide 22 Directors’ Statements as to Solvency (RG 22) and ASIC’s COVID-19 FAQs provides guidance on directors’ solvency declarations including matters that directors and auditors should take into consideration in understanding their respective responsibilities. In accordance with RG 22 the directors’ solvency declaration may be that:

• the directors have reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable (positive);

• there is a material uncertainty as to the ability of the company to pay its debts as and when they become due and payable – for example, the ability to renegotiate loans due for repayment is not certain at the date of the declaration and without this being achieved the company will not be able to pay its debts as and when they become due and payable; or

• The directors do not have reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable (negative declaration).

Negative solvency declarations and solvency declarations which include a material uncertainty have to date been rare in practice. This is because a negative solvency declaration in usual circumstances means that the directors consider on that day that the entity is insolvent and the directors would be breaching the Corporations Act 2001 if they were to continue trading. Refer to ASIC’s COVID-19 FAQ 10 for further detail on this temporary relief.

Recent COVID-19 reforms, which provide temporary relief from personal liability for directors in connection with insolvent trading in certain circumstances, may result in entities continuing in operations whilst they are insolvent. This temporary relief does not change the requirements to provide a solvency declaration in the directors’ declaration.

This temporary relief may increase the instances of negative director solvency declarations or solvency declarations which include material uncertainties. Directors may consider that their entity is temporarily insolvent, but still consider themselves a going concern, as in their view once the current business and social restrictions are lifted they expect to trade their way out of this predicament with the support of their creditors. In this scenario the directors should give a negative solvency declaration.

In the current environment, there may be a heightened risk that entities will be insolvent and continue trading. Directors and auditors should be alert to this when fulfilling their responsibilities under the Corporations Act 2001.

Refer to ASIC’s COVID-19 Implications for financial reporting and audit FAQ number 10 for guidance on director’s responsibilities in relation to solvency declarations. Also refer to The Impact of COVID-19 on Going Concern and Related Assessments – A Joint Publication by AASB and AUASB for further detail on financial reporting and auditing considerations in relation to going concern and solvency assessments.

The auditor is not required to provide a separate and distinct opinion on the directors’ solvency declaration. However, the directors’ solvency declaration is contained in the directors’ declaration which forms part of the financial report on which the auditor provides an opinion. This responsibility has not changed. The auditor, based on audit evidence obtained through conducting the audit, considers whether the financial report as a whole, which includes the directors’ solvency declaration, is free from material misstatement.

There is no specific Auditing Standard in relation to the auditor’s consideration of the directors’ solvency declaration. However, when performing risk assessment procedures in accordance with ASA 315 Identifying and Assessing the Risks of Material Misstatement the auditor considers if there are events or conditions that may cast significant doubt over the entity’s ability to continue as a going concern. In addition, the auditor is required by ASA 570 Going Concern to obtain sufficient appropriate audit evidence to conclude on the appropriateness of the management’s use of the going concern basis of accounting, and whether a material uncertainty exists about the entity’s ability to continue as a going concern. The assessment of going concern and solvency are linked but different and therefore may not be the same. Refer to The Impact of COVID-19 on Going Concern and Related Assessments – A Joint Publication by AASB and AUASB for further detail on the differences between going concern and solvency assessments.

The procedures an auditor performs in accordance with ASA 570 alert the auditor as to whether there a risk that the entity is insolvent. ASA 570 A3 includes examples of events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. Some of these events or conditions are also indicators that an entity may be insolvent, for example negative operating cash flows, adverse key financial ratios (negative working capital and / or net assets), inability to pay creditors on due dates, inability to comply with the terms of loan agreements, changing from credit to cash-on-delivery transactions with suppliers. Generally inadequate cash flow is seen as a primary indicator in determining solvency. If any of these events or conditions are identified, and the auditor considers they, individually or collectively, cast significant doubt on the entity’s ability to continue as a going concern, ASA 570 requires the auditor to do additional procedures including evaluating management’s plans for future action and whether these are likely to improve the situation, and evaluate cash flow forecasts, to conclude if a material uncertainty exists in relation to going concern. These additional procedures are also relevant to the auditor’s solvency assessment.

For many entities there may be no events or conditions that may cast significant doubt over an entity’s ability to continue as a going concern, or indicators that the entity is insolvent. In this scenario the auditor does not need to perform specific procedures and gather evidence regarding the directors’ solvency declaration in addition to the procedures they are required to perform in relation to assessing the appropriateness of the management’s use of the going concern basis of accounting in accordance with ASA 570. However, if the auditor has made an assessment that going concern is a significant risk, and / or any of the events or conditions identified above are present and cast significant doubt on the entity’s ability to continue as a going concern, there may be a heightened risk regarding the entity’s solvency and the auditor may need to gather specific evidence to assess the basis for and the presentation of the directors’ solvency declaration as to misstatement or error.

As detailed in ASIC’s COVID-19 FAQ 11, directors are required to perform reasonable steps to determine there are reasonable grounds on which to base their opinion in their solvency declaration. When assessing the basis for and the presentation of the directors’ solvency declaration, auditors should also consider if the directors have performed reasonable steps to determine there are reasonable grounds on which to base their opinion on their solvency declaration, such as those included in ASIC’s FAQ. As part of this procedure, auditors assess the appropriateness of the work performed by the directors. ASIC’s guidance is also useful for auditors when making their own assessment on the presentation of the solvency declaration. The matters included in this guidance are consistent with procedures auditors would conduct when assessing going concern, however there is an additional focus on liquidity and timing of cash flows when assessing solvency.

The auditor considers the evidence obtained through the audit procedures conducted when assessing the presentation of the directors’ solvency declaration as to misstatement or error.

The directors’ solvency statement is a requirement of the Corporations Act 2001. If in the auditor’s view the directors have not taken reasonable steps to determine there are reasonable grounds the auditor considers their reporting obligations under S 311 of the Corporations Act 2001 (Refer to Regulatory Guide 34 Auditor’s Obligations: Reporting to ASIC) and the impact on the auditor’s report. ASIC’s FAQ number 12 provides guidance on this.

When forming their opinion on the financial report as a whole, the auditor, based on audit evidence obtained while conducting the audit, also considers the presentation of the directors’ solvency declaration for consistency with the evidence. Refer to FAQ H3 for the procedures the auditor performs in relation to the directors’ solvency declaration and making an assessment of solvency.

If the directors’ solvency declaration includes a material uncertainty or is negative, the auditor considers on what basis the directors have made this assessment, including whether they have taken reasonable steps to determine there are reasonable grounds on which to form their opinion. In doing this the auditor considers the audit evidence obtained for consistency with the matters considered by the directors as the basis for their solvency declaration. If the auditor considers the directors’ solvency declaration is free from material misstatement, and the financial report has been prepared, in all material respects, in accordance with the financial reporting framework, the auditor issues an unmodified opinion. If the auditor does not agree with the going concern basis of preparation and / or the adequacy of disclosures in the financial report the auditor issues a modified opinion in accordance with ASA 570 Going Concern and ASA 705 Modifications to the Opinion in the Independent Auditor’s Report. The auditor also considers their reporting responsibilities in accordance with ASA 701 Communicating Key Audit Matters in the Independent Auditor’s Report and ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report.

When forming their opinion on the financial report as a whole, the auditor, based on audit evidence obtained while conducting the audit, considers the presentation of the directors’ solvency declaration for consistency with the evidence. The auditor also considers if the directors have taken reasonable steps to determine there are reasonable grounds when forming their opinion on the solvency declaration. If the auditor identifies inconsistencies in the evidence regarding the directors’ solvency declaration and a misstatement or error is identified, the auditor considers whether this is a material misstatement of the financial report as a whole, and whether there is a need to modify their opinion in accordance with ASA 705 Modifications to the Opinion in the Independent Auditor’s Report.

In the instance that the directors’ solvency declaration is positive, but the auditor does not agree with the directors’ opinion, this is likely to be a material misstatement due to its nature. If the auditor does not agree with the going concern basis of preparation and / or the adequacy of disclosures in the financial report the auditor also modifies their opinion in accordance with ASA 570 Going Concern and ASA 705.

Auditors should also consider their reporting obligations under S 311 of the Corporations Act 2001. Refer to Regulatory Guide 34 Auditor’s Obligations: Reporting to ASIC and ASIC’s COVID-19 FAQs which provides guidance on auditor’s S 311 obligations.

If the auditor considers that the directors have not taken reasonable steps to determine there are reasonable grounds on which to base their solvency declaration and that the directors have not met their obligations under the Corporations Act 2001, the auditor requests the directors to conduct appropriate further assessment steps. If the directors do not conduct appropriate further assessment steps the auditor considers whether to modify their opinion on the financial report as a whole. The auditor also considers their reporting obligations under S 311. (Refer to Regulatory Guide 34 Auditor’s Obligations: Reporting to ASIC and ASIC’s COVID-19 Impact for financial reporting and auditors FAQs).

Auditing standards require the auditor to “…plan and perform an audit with professional scepticism, recognising that circumstances may exist that cause the financial report to be materially misstated”. The impact of COVID-19 pandemic raises a number of unique issues relating to the exercise of professional scepticism by auditors.

Professional scepticism is defined in ASA 200 as “…an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence”. Auditing standards do not apply, nor refer to, a ‘levels’ approach, and envisage professional scepticism as an invariant concept. That is, the level of professional scepticism that is to be exercised does not change with different levels of assurance, nor the circumstances within which that assurance is undertaken. The auditing standards do not, therefore, require a higher level of professional scepticism than would otherwise be expected. 

Whilst auditors must maintain a questioning mind, remain alert for conditions that may indicate a possible misstatement due to fraud or error, and engage in a critical assessment of audit evidence in the current environment, it is not a requirement of the auditing standards for auditors to be more questioning, more alert, or more critical than would be expected at other times.
Auditors should be mindful that an inappropriate level of professional scepticism can arise from auditors being insufficiently sceptical as well as being overly sceptical. While insufficient levels of professional scepticism are not consistent with an audit conducted in accordance with Australian Auditing Standards, nor are audits where excessive amounts of scepticism have been applied.

More importantly, while the level of professional scepticism being exercised does not increase in the current environment, the nature, timing and extent of procedures that auditors judge to be necessary in light of the exercise of professional scepticism may vary (and most likely will), in accordance with a higher assessed risk of material misstatement arising due to the impact of COVID-19. Other Q&As highlight examples of unique COVID-19 circumstances that focus the auditor’s attention, and professional scepticism, on issues that would not normally be a focus of attention.

The impact of COVID-19 may elevate the importance of evidence that would not normally be as relevant to the planning and execution of an audit, and requires auditors to adapt to the changing environment. New innovative and novel procedures may be necessary to obtain sufficient appropriate evidence to support their opinion. Other Q&A’s in this series highlight examples of these new circumstances that auditors, with an attitude of professional scepticism, must respond to. Refer to FAQ A3 where auditors need to maintain professional scepticism and be alert to how fraud risks may be higher as a result of COVID-19. Further, refer to FAQs C1, C5, C7 and C9 for where auditors should apply professional scepticism when auditing accounting estimates.

In addition to the numerous considerations that normally occupy an auditor’s mind when addressing threats to the exercise of professional scepticism, the unique characteristics of the COVID-19 environment give rise to additional circumstances that may impair the auditor’s exercise of professional scepticism. Some of these circumstances are noted below.
In a COVID-19 environment, the auditor’s objectivity may become impaired thereby impacting their ability to exercise professional scepticism. In particular, an advocacy threat may be present. While recognising the unprecedented and heartening way in which society has collectively rallied together to fight the medical, social and economic consequences of COVID-19, auditors must remember that they are not advocates for their clients.
As an attitude, an additional factor potentially impairing the exercise of professional scepticism arises from conscious and subconscious biases. While a detailed listing and discussion of all the judgment biases that may impact the exercise of professional scepticism is well beyond the scope of this FAQ, some biases are especially relevant in the current environment.
Although not authoritative, auditors may find the recently proposed changes to ASA 220 informative in that some of the auditor biases potentially impacting auditors’ exercise of professional scepticism are detailed (refer https://www.auasb.gov.au/admin/file/content102/c3/Combined_ISA220.pdf). The four biases noted (i.e., availability bias, confirmation bias, overconfidence bias and anchoring bias) may all be especially relevant in the current environment as auditors, for example, encounter circumstances that they may not have previously experienced, reflect on how current events may inform future conditions, question their knowledge and ability in the current circumstances, and make judgments based on starting points from which insufficient adjustment is made for changed circumstances. In addition, a representativeness bias (auditors trying to ground their judgments in previous experiences that may be different to the experiences encountered in the COVID-19 environment), optimism bias (auditors placing undue weight on positive cues) and conversely pessimism bias (auditors negatively interpreting cues in predicting future states) may also impair the exercise of professional scepticism.

Also pertinent is research showing that pandemics broadly lead to a reduced openness to experience and greater conservatism, meaning that the breadth of issues canvassed may be constrained and those issues considered by auditors being interpreted in an excessively conservative manner.

Auditors should also be cognisant of new and unique threats to compliance with fundamental principles of ethics that may compromise the exercise of professional scepticism, such as the inability to gather evidence traditionally relied upon in forming the auditor’s opinion (and the employment of less commonly used techniques as an alternative), less engagement with and cooperation from the client (as their focus and attention may be elsewhere), new auditor working arrangements and the necessary changes to the direction, supervision and review of audit work undertaken, as well as fee and reporting deadline pressures.

Being aware of the circumstances that may impair the auditor’s exercise of professional scepticism is the first step in personally addressing the threats and creating an environment in which members of the engagement team may themselves address those threats.

The proposed changes to ASA 220 may also be informative, in that it outlines some possible actions that the engagement partner may undertake to deal with impediments to the exercise of professional scepticism at the engagement level. Possible actions (with reference to the current COVID-19 environment) may include:
• Remaining alert to changes in the nature or circumstances of the audit engagement and the implications this has for the need for additional or different resources.
• Explicitly alerting the engagement team to instances or situations where vulnerability to unconscious and conscious auditor biases may be greater.
• Changing the composition of the engagement team assigned, for example, involving more experienced staff in order to obtain greater skills, knowledge or specific experience.
• Involving more experienced members of the engagement team when dealing with members of management who, for a variety of reasons, may not be responsive to audit requests.
• Modifying the nature, timing and extent of direction and supervision of engagement team members and review of their work in light of current audit engagement team working arrangements.

For some entities the financial effects of the COVID-19 pandemic may first be reflected in the 2020 Interim Financial Report. The IAASB have issued Review Engagements on Interim Financial Information in the Current Evolving Environment Due to COVID-19 to assist auditors in conducting reviews of Interim Financial Reports during this period. Please click here to view IAASB’s publication.

The IAASB’s publication includes examples that indicate areas which may require increased attention by management and where the auditor may focus. These include:

• changes in the accounting estimates (e.g. fair value measurements, allowance for expected credit losses or inventory valuation), and the potential for heightened estimation uncertainty;
• application of new accounting policies as a result of new events or transactions (e.g. restructuring costs, termination benefits, government assistance or discontinued operations);
• accounting for modifications to agreements and contracts, or terms and conditions of service (e.g. modifications to return policies, new or modified contracts with customers or suppliers or new or modified debt arrangements);
• impairment of non-financial assets (including goodwill)
• impacts to hedging relationships;
• tax considerations (e.g. recoverability of deferred tax assets);
• potential breaches of loan covenants, including the impact on the classification of liabilities as current or non-current;
• impacts to management’s going concern assessment;
• consideration of subsequent events, including whether they are adjusting or non-adjusting events;
• new or changes to internal controls;
• disclosure of the impact of COVID-19 on the financial position and performance of the entity; and
• disclosure requirements triggered as a result of COVID-19 (e.g. impairments, financial instruments, discontinued operations or loan breaches).

Refer to the IAASB’s publication for further details on the potential impacts of the COVID-19 pandemic on the auditor’s review procedures.

The AUASB have recently re-issued ASRE 2410 to better align the auditor’s review report with the annual auditor’s report (i.e. re-order the review report and use consistent terminology). As re-issued ASRE 2410 is effective for financial reporting periods commencing on or after 1 July 2020, with early adoption allowed, reviews of interim financial reports as at 30 June 2020 are not required to adopt the new standard. However the AUASB encourage early adoption to avoid confusion to users which may result of inconsistent structure and terminology. For example, extant ASRE 2410 requires a material uncertainty in relation to going concern to be reported in the review report as an emphasis of matter. However, to achieve consistency with the annual auditor’s report, the re-issued ASRE 2410 requires the auditor to report a material uncertainty related to going concern under the heading “Material Uncertainty Related to Going Concern”

For further details on the changes to ASRE 2410 refer to the Basis for Conclusions.