Going Concern - Key Considerations for Auditors amid COVID-19

Going Concern - Key Considerations for Auditors amid COVID-19

The outbreak of COVID-19 has caused a significant deterioration in economic conditions for some companies and an increase in economic uncertainty for others.

The Board of Directors of every company are required to make a statement in the Directors’ responsibility Statement referred to in Section 134(5) of the Companies Act, 2013 that the directors had prepared the annual accounts on a going concern basis i.e. whether the Board has a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due throughout its assessment. 

Some companies have the impression that this issue of evaluation of going concern basis is more concerning the auditor rather than the Board of Directors. 

• This is not true, management will need to give significant consideration to this area, especially in the current environment and early engagement on this topic will be important. 
• As the 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. 

Management would need to assess whether the current events and conditions cast significant doubt on the company’s ability to continue as a going concern, or in severe cases, whether the going concern assumption is still appropriate as a basis for the preparation of the company’s financial statements. In many cases, budgets and forecasts that may have been used to support management’s initial going concern assessment may now be of limited relevance given the rapidly changing economic and business circumstances and may require significant revision to be able to support management’s assessment in the current environment.

Timely and effective communication between the management and the auditor is essential in ensuring that both are able to fulfill their respective responsibilities in relation to going concern aspects during these uncertain times. Various factors impact the ability of an entity to continue as a going concern. Out of such factors, the auditor, as well as the company, needs to essentially consider the impact of COVID-19 on going concern evaluation critically.

To the extent the events and conditions are identified that may cast significant doubt on a company’s ability to continue as a going concern, disclosure would be required if these events constitute material uncertainties or management’s conclusion involved significant judgement (i.e. a ‘close call’ scenario). Additionally, Ind AS 107, Financial Instruments: Disclosures requires disclosure of quantitative data about liquidity risk arising from financial instruments. A company also needs to explain how it is managing this risk, including any changes from the previous period and any concentrations of liquidity risk.

Impact on accounting estimates

Various accounting estimates, which depend on future forecasts, could be impacted by the outbreak. Examples of specific areas that may be impacted include:

Impairment of non-current assets and goodwill: Many companies may be facing the problem of low demand for their products or services or may be affected by the restrictions imposed by the government. Certain companies may be dependent on supply chains or may have production facilities in the states in India and abroad affected by lockdown. This situation could be an impairment trigger, and require an impairment test. However, it could be a challenge for many companies to estimate future cash flows due to the increase in economic uncertainty. Also companies would need to ensure that discount rates used in recent valuations have been updated to reflect the risk environment at the reporting date.

Companies would need to provide disclosures as per Ind AS 36, Impairment of Assets and also help users understand uncertainty associated with management’s assumptions about the future. Therefore, robust disclosures are needed to understand the degree of estimation uncertainty that exists in estimating the recoverable amount and the sensitivity of the recoverable amount to reasonably possible changes to key assumptions.

Onerous contract provisions: Customer contracts may become onerous if, for example, suppliers are unable to fulfil their obligations under the contract as a result of closure or reduced production by manufacturing plants, which would necessitate recognition of a provision. Delay in fulfilment of contractual obligations may also result in penalties to be provided for. Companies should consider providing meaningful disclosures about judgements and estimates applied in recognising and measuring provisions.

Valuation of inventory: There could be a significant impact on the inventory valuation on account of forced plant shutdowns, decline in net realisable value due to reduction in demand and non-fulfillment of sales and purchase contracts.

Expected Credit Losses (ECLs): Certain sectors and regions may be particularly severely affected by the economic effects of COVID-19. Hence, companies would need to consider the impact of COVID-19 appropriately while recognising ECLs. However, the companies may find it challenging to incorporate into their measurement of ECLs the forward-looking information relating to the economic impact of COVID-19 that is available without undue cost or effort at the reporting date. Relevant disclosures should be provided to enable better understanding of credit risk, timing and uncertainty of future cash flows.

Deferred tax assets: The recoverability of deferred tax assets may be impacted by changes to future forecasts.

Insurance claims: The companies may evaluate the terms of their insurance policies and estimate possible compensation surrounding loss of profits and business disruption, etc. including timing of recognition of such claims.