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The COVID 19 pandemic has spread around the globe resulting in largest global recession in the history with more than one third of the global population being placed under lockdown. The economic impact of the 2020 coronavirus pandemic in India has been quite disruptive to the industry specifically the supply chain management, logistics, entertainment, hospitality and the service sector which contributes significantly to the economy. Many existing companies are also in the verge of close down due to the pandemic. In such uncertain situation, the appropriateness of management’s use of going concern basis in preparation of the financial statement comes under critical review. It has to be critically analyzed whether there are any uncertainties and whether management has taken appropriate steps to overcome the uncertainties caused due to the existing pandemic of COVID 19
The Board of Directors of every company are required to make a statement in the “Directors Responsibility statement” (as referred in S.134 (5) of Companies Act, 2013) that the Directors had prepared the financial statement on going concern basis. It signifies that Board of Directors has to specify that it has reasonable expectation that the company will be able to continue its operations and meet its liabilities as they fall due during the period of assessment. Thus, the management will need to give significant consideration to the going concern especially in the current environment. As the current situation is changing very rapidly and uncertainties crop up, the assessment by the Board needs to be dynamic and reflect the facts considering the latest conditions and information specifically arising from COVID 19.
As a part of going concern assessment, it is critical for the management to assess what impact the current events and conditions have on entity’s operations and forecasted cash flows, with a focus on whether the entity will have sufficient liquidity to continue to meet its obligations as they fall due. Management will need to consider the existing and anticipated effects of the COVID-19 pandemic on the assumptions in its assessment giving particular attention to significant assumptions that are sensitive or susceptible to change or are inconsistent with historical trends.
The considerations related to COVID 19 pandemic that management should include in their assessment are discussed below:
a. The impact of measures taken by Government (in all countries) where the entity operates
b. Changes to entity’s access to capital impacted by measures taken by the regulators like industry or financial institutions/banks
c. Entity’s ability to meet the regulatory ratios
d. The entity’s ability to prepare timely financial statements or other required information/filings, including delays in receiving financial data from operations in other countries or material investees for consolidated financial statements.
a. General operating considerations may include whether the company is thinking of restructuring of the entity that may be required to generate sufficient cash flow.
b. Cost associated with temporary suspension of operations
c. Restart costs and the remedial steps taken after the lockdown
d. Level of lost revenue and the associated cash flows including the effect of rebates, refund and allowance.
e. Impact of foreign exchange fluctuations.
f. Loss of existing / future contracts due to inability to honor certain terms of contract due to lockdown and invocation of force majeure clauses.
g. Significant increase in the raw material cost and related impact to the gross margin.
a. Risk relating to receivables (delays of failure of counterparties, request for changes in payment terms)
b. Loss is ability to factor trade receivables due to uncertainties over collectability.
c. Impact of trade financing products such as letter of credits, shipping and payment terms etc
d. Adverse movement in bond yields leading to deterioration of value of investments and impact on recoverability due to adverse market movements.
Role of Auditor for assessment of Going Concern
The auditor is required to consider whether management’s assessment includes all relevant information they are aware of at the time of assessment and the auditor compares it with the information that the auditor is aware of as a result of the audit. The auditor should assess how management addressed the considerations listed below and their impact on the entity to help identify and focus on the most sensitive assumptions that are likely to increase the risk of a material uncertainty on a case-by-case basis. This assessment involves judgment and it is auditor’s responsibility to maintain an appropriate level of professional skepticism.
The auditor should also consider the necessity with regard to involvement of an expert to assist in asset valuations, given the current uncertainty in both local and global markets and how the expert has developed his assumptions. Valuations based on projected future cash flows are likely to be more challenging, as developing robust models of cash flows into the future may be more difficult given current volatility and uncertainty.
Key questions which is auditor should consider due to impact of COVID 19
1. Has the management performed a preliminary assessment of the entity’s ability to continue as going concern?
2. Were there interruptions in the supply and production cycle of the entity due to the COVID- 19 outbreak? If so, does management have a feasible recovery plan?
3. Are these disruptions due to COVID 19 expected to continue for a foreseeable future and the action plan of the management to mitigate these risks?
4. Does the events or conditions resulted due to COVID 19 cast significant doubt about entity’s ability to continue as going concern?
5. Are there any financial difficulties, resulting in additional credit risks, higher than usual bad debts and potential impairments and write-offs because of the COVID-19 outbreak?
6. Whether the auditor considered the risk of inadequate disclosures in the financial statements related to the
COVID-19 outbreak and management’s recovery plans?
In evaluating the going concern, period of 12 months has to be considered from the end of the reporting period. However, the auditor should remain alert and consider the known or expected events that will occur soon after 12 months from the end of the reporting period.
SA 570 (Revised) – Going Concern makes necessary for the auditor to maintain the following documentation.
a. Discussion notes regarding the impact of COVID 19 on entities with management and Those Charged with Governance.
b. Obtain sufficient appropriate audit evidence to assess whether the disclosures given by management about COVID 19 events are appropriate
c. Checklist to review the going concern and the related events of the entity