Following our blog last week about the three new audit standards effective for 31 December 2020 audits, this week we look at the new going concern standard which triggers a new style audit report. Since this standard was revised in October 2019, there is a new added layer of complexity i.e. the uncertainty surrounding the ultimate outcome of the Coronavirus (COVID-19) pandemic and its financial consequences.
Changes in ISA 570 Going Concern
There will be plenty of additional documentation required of management and the auditor, including 29 requirements for auditors versus 23 in the previous standard.
The auditor will be required to:
- ‘Challenge’ the going concern forecasts /projections prepared by management with a greater degree of robustness than heretofore. This challenge needs documentation to prove that the auditor is sufficiently sceptical.
- Evaluate management’s forecast methodology to assess the entity’s ability to continue as a going concern. The auditor will also be required to determine whether the calculations used by management is sufficiently robust and founded on reliable assumptions.
- Verify the relevance/reliability of the underlying data used by management.
- Appraise management’s future strategy for going concern and determine whether the outcome is likely to be successful or not.
- Consider whether any facts / information available since the period end would influence management’s going concern assessment.
- Obtain written representations from management regarding the feasibility of their future going concern strategy plans.
- Assess whether there is any ‘management bias’ (defined as ‘a lack of neutrality by management in the preparation of information’ paragraph 9-2) evident in their assessment of going concern, including whether judgments / decisions made by management during the assessment preparation process could indicate the presence of possible management bias.
- Carry out a ‘stand back’ assessment where the auditor must consider all the evidence obtained, including corroborative / contradictory evidence, when evaluating going concern. This evidence will form part of the auditor’s challenge to management’s assessment of going concern. There is a similar requirement in the new ISA 540 standard, as discussed in last week’s blog.
These changes trigger significant additional documentation requirements for the auditor including paragraph 26-1 which has a list of five specific matters that must be documented on the audit file, not all of which are new, but will require special attention to comply with the standard. Two new Technical Alerts are due shortly from Chartered Accountants Ireland, and expect new audit programmes in the early part of 2021, dealing with the changes in ISA 570 and 540.’
Coincidentally, in the last week the Financial Reporting Council (the UK audit regulator) issued a letter to the heads of audit firms entitled ‘FRC’s review of firms’ audit of going concern assessments’ where they quote examples of good audit practice from a sample of eleven audit reviews carried out since the Coronavirus (COVID-19) struck.
Among the examples was where the auditors’ assessment included a review of management’s evaluation of historical data from the previous financial crisis, to assist in the assessment of the economic impact of Covid on the business in the forecasts and the reasonableness of the scenarios developed. Another good example was where reverse stress testing and scenario testing were used in the assessing whether there was a material uncertainty.
Quoting from the letter ‘ICAEW guidance states that “a reverse stress test is a stress test that starts from the opposite end, with the identification of a pre-defined outcome. This might be the point at which an entity can be considered as failing, or the entity’s business model becomes unviable. Severe, but plausible, scenarios that might result in this outcome are then explored”. More on this in a future blog.
ISA 570 also triggers a new wording for the audit report. More on this next week.
The changes to ISA 570 come into effect for the audit of accounting periods commencing 15 December 2019 which, in practical terms, means audits for periods ending 31 December 2020.
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