The unprecedented situation caused by the COVID-19 crisis and the mandatory lockdown of businesses across the nation has made this year’s audit preparations unique, challenging and complicated. Preparing for full-year audits includes both the financial statements and internal controls audit. This article will address preparation for financial statements audits in 2020, with FASB updates in connection with certain business processes. ITGC and entity-level-control internal audit procedures will not be covered.
The current economic environment combined with the FASB updates issued throughout the year mean 2020 year-end audit preparation will not be consistent with the prior year. Preparation will also likely take longer than expected. Companies should think ahead during the interim audit prior to year-end. Based on the financial statements’ assertions (management assertions) in compliance with GAAP for individual accounts, a detailed audit plan should be designed and carried out to make FY 2020’s audit smooth and successful.
There are five financial statement assertions including Accuracy and Valuation, Existence, Completeness, Right and Obligations, Presentation and Disclosures. Audit procedures are designed to test the above assertions of the financial statements.
1. Accuracy and Valuation
Accounting Standards Codification (ASC) Topic 350, Intangibles–Goodwill and Other, ASC 360, Long Lived Tangible Assets – Equipment and Real estate, ASC 320, Debt Securities: Available for Sale and Held to Maturity, ASC 321, Equity Securities all provide the impairment indicators from the triggering events and impairment steps to evaluate whether the above related accounts have been impaired.
Worldwide, stock markets have plummeted in certain industries (e.g., retail and commercial real estate, airlines, restaurant, hospitality) with slight recovery. The timing of economic recovery is uncertain, and triggering events may differ for each of the above. However, the overall macroeconomic conditions, industry and market considerations, financial performance and sustained decrease in share prices, etc., are all examples of qualitative factors to consider when determining if the more-likely-than-not threshold is met.
For nonpublic companies, FASB has deferred the effective adoption date. (That said, as a reminder, don’t underestimate the time and resources required for ASC 842 implementation.) Most importantly, with the Federal Reserve slashing and dropping interest rates to near zero, the discount rate will decrease significantly, the ROU and lease liability balances will become larger than before and the debt-to-equity ratio will be higher. If companies have large loan balances, they should think ahead to quantify whether debt covenants have been breached.
Overall, management should make a professional judgment based on FASB updates to determine which financial statement accounts should be re-evaluated and re-measured.
Preparing for full-year audits has changed dramatically due to the impacts of the pandemic. Due to quarantined accounting departments and the shutdown of many businesses, it might be difficult for auditors to conduct a remote audit for certain areas. For example, physical inventory observations and account receivables (AR) confirmations with third parties may be difficult to audit remotely.
To overcome the risk of getting a qualified or disclaimer opinion due to scope limitations, companies should prepare a remote inventory observation video camera or prepare a wealth of accounting information for alternative substantive tests for the auditors.
Here are notable paragraphs from AU-C 501, Audit Evidence:
“.14 If attendance at physical inventory counting is impracticable, the auditor should perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory…”
“.A34 In some cases, attendance at physical inventory counting may be impracticable. This may be due to factors such as the nature and location of the inventory (for example, when inventory is held in a location that may pose threats to the safety of the auditor).”
Additionally, the integrity of video tapes as audit evidence only allows the auditors to conduct alternative substantive tests under the current circumstances, which may pose concerns.
Further, if AR confirmations can’t be conducted due to office closures, the analytical procedures and tests of details will be used as the alternative and as part of the substantive test. So more information should be prepared (e.g., large volumes of sample tests including sales cut-off tests and invoice examinations).
SAS 31 states, “Assertions about completeness deal with whether all transactions and accounts that should be presented in the financial statements are so included.” (CPA Journal)
It’s imperative that everything that should be included in the financial statements has been included. For example, the audit procedures related to search for unrecorded liabilities (SUL) in the subsequent periods represent for the completeness test of the liabilities’ accounts. Companies should consider whether the estimate of the accrual approach currently used is still applicable under the present level of economic uncertainty. Using historical trends from before the pandemic may overestimate liability balances with fewer transactions due to the business shutdown. Another example is the accrual of future losses under the “onerous contracts” under ASC 606.
4. Right and Obligations
ASC 606 has changed revenue recognition criteria from four to five steps. “Delivery to the customer” has been removed and therefore is not a necessity to recognize revenue.
For example, under ASC 606 – 8.5: Bill and Hold Arrangement, buyers might need more time to prepare for the receipt of products. As such, the seller still retains possession of the products, yet must segregate the products from its own inventory. Of course, several criteria should be met in order to recognize revenue when delivery has not occurred.
Rights and obligations require the entity to have legal title or controls of rights to an asset or to have an obligation to repay a liability. The above example highlights this from the inventory perspective. Although the seller still keeps the inventory in the warehouse, the buyer has the risk of loss in the event of a market decline in the value of the goods since the full legal right, title, ownership and interest in the inventory has been transferred to the buyer. Of course, the seller might still bear the risk of loss of product stored within its own premises—which might be covered by the obligation of paying the insurance coverage over the consigned inventory.
5. Presentation and Disclosures
To present and disclose fair and easily understandable information on their financial statements, companies should be on top of all FASB updates, the economic impact to the industry and federal, state or local regulations.
For example, in March 2020, the CARES Act (i.e., the Coronavirus Aid, Relief, and Economic Security Act) was enacted by the U.S. Government. The healthcare industry, including care providers from hospitals, nursing facilities and senior living communities, have been impacted significantly and many providers applied for funds. The federal stimulus funds should be disclosed and presented in different ways on financial statements based on the different purposes, especially in the absence of authoritative US GAAP covering the accounting for the government grants for the healthcare industry. Searching for the IAS (International Accounting Standards) might be an alternative option.
Additionally, some other factors including subsequent event, going concern, MD&A and financial statements footnotes should be in compliance with the latest guidance from the Division of Corporate Finance. (For more detailed information and descriptions, read our article on SEC disclosures to consider due to COVID-19.) There are also likely added cybersecurity risks from an internal control perspective due to much more required remote access.
Get Support for Preparing for Full-Year Audits
The fiscal year-end is approaching, and given this year’s host of economic changes and new circumstances, we expect companies will encounter more difficulties than ever this year when preparing for full-year audits. If you need support, our team of 90+ finance and accounting consultants can deploy in interim or project execution roles remotely as needed. We offer more relevant information on our financial reporting and accounting page.
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About the Author
Yingfei has acquired more than 17 years of experience in accounting and auditing in industries such as Bio-tech, manufacturing finance, private real-estate and public REITs and spent eight years with Deloitte and Ernst & Young LLP’s focusing on Real Estate practice and manufacturing industry. She participated in the consolidation and external reporting for publicly traded companies and REITs and her core competencies include GAAP accounting: full-cycle accounting/auditing and operations for REITs, internal controls and process improvement, SEC reporting, consolidation and elimination, system implementation. Fund accounting: capital call, design distribution waterfall, fair value preparations and analysis, investor statement preparation, basis relief entry and income allocation based on LPA. Yingfei is a Certified Public Accountant and a Chartered Accountant in England and received a Master’s Degree focused in Accounting from University of Michigan.