“COVID-19”, a term that has brought everyday life all over the world to a standstill. This infectious disease caused by a novel Coronavirus and recognized as a global pandemic by the WHO is exponentially spreading illness and causalities across the globe. To reduce the cataclysmic impact caused by this disease, governments across the world are taking drastic measures, including locking down the entire country. Such disruptions are significantly impacting businesses and further pose several challenges in preparing, reporting and auditing the financial statements.
Now that companies approach their 2019-20 Financial Year End Reporting, Chartered Accountants’ apex body, ICAI has come out with detailed guidance note to ensure that potential impact of COVID-19 is suitably considered in financial statements of the companies.
Let us take a look at the guidance note and discuss aspects to be considered while preparing the financial statements.
1. Going-Concern Assessment: COVID-19 has resulted in substantial deterioration of economic conditions for few companies and an increase in economic uncertainty for others. Necessary disclosures as per ‘Ind AS 1 – Presentation of Financial Statements’ such as material uncertainties that might cast significant doubt upon an entity’s ability to continue as a going concern, need to be made.
2. Revenue Recognition: There will be likely increase in sales returns, decrease in volume discounts, refunds, higher price discounts etc. due to COVID-19. Information about uncertainty of cash flows arising due to such events needs to be disclosed as per ‘Ind AS 115 – Revenue from Contracts with Customers’.
3. Lease Accounting: There will be changes in terms of Lease arrangements, rent- free holidays, and concession given by Lessors due to COVID-19 situation. Such revised terms and concessions should be accounted as Lease Modifications as per ‘Ind AS 116 – Leases’. Note that anticipated revisions should not be considered.
4. Impairment of Non-Financial Assets: These include land, buildings, vehicles, equipment, goodwill, patents and other intellectual properties. Reduced economic activity due to COVID-19 should be considered as a factor while performing impairment testing for the purpose of ‘Ind AS 36 / AS 28 - Impairment of Assets’.
5. Financial Instruments: ‘Ind AS 107 – Financial Instruments: Disclosure’ requires disclosure of quantitative data about liquidity risk arising from financial instruments. Companies need to explain how they are managing the risk posed by default in Trade Loans, Trade Receivables, Investment in Debt Instruments, and Financial Guarantees due to COVID-19 situation. Recognition and measurement of impairment loss should be as per Expected Credit Loss (ECL) model.
The current situation poses challenges not only to Preparation but also to Audit of the Financial Statements. Considering increased restrictions on travel, meetings and access to client locations, this Guidance Note enshrines below areas to be given special attention by auditors.
1. Risk of Fraud: The impact of COVID-19 could put management under pressure to meet market expectations or performance targets. This can raise the likelihood of fraud in the financial statements to a higher level. Hence it is very important for auditors to follow and comply with ‘Standards of Auditing SA 240 – The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements’.
2. Inventory Valuation: It will not be possible for most of the entities to facilitate physical inventory verification as on 31-Mar-20 due to government-imposed shutdowns and un-availability of client personnel. In such case, auditors shall modify the opinion in the audit report in accordance with ‘Standards of Auditing SA 705’. It suggests adopting alternative audit procedures such as inspection of documentation of the subsequent sale of specific inventory items acquired prior to physical inventory count.
3. Validation of Management’s Financial Impact Assessment: Contractual penalties, employment termination benefits, asset impairments, insurance recoveries related to business interruptions and allowance for Expected Credit Losses (ECL) are some of the areas likely to have significant accounting estimates made by management. The auditors should therefore use procedures mentioned in ‘Standards of Auditing SA 540 – Auditing Accounting Estimates’. It needs to be ensured such estimates are reasonable, and related disclosures in the financial statements are adequate.
Considering the current situation, recently The Securities and Exchange Board of India (SEBI) has extended the timelines for filing the results for quarter and year ended 31-Mar-20 up-to 30-Jun-20 by equity listed companies.
Since the Management and Auditors both have a public interest obligation to report financial statements in accordance with high professional standards and ethical requirements, their role will remain quite critical. There should not be any non-compliance in spite of the challenges and uncertainties posed by COVID-19.