The end of another year is quickly approaching, and auditors are working on plans for 2021 calendar-year audits.
In 2020, auditors were dealing with COVID-19 impacts on the economy, their clients, and firms. They did not imagine a reality then where they would still be dealing with the pandemic a year later. Companies faced substantial changes in 2021; employees still work remotely, maybe permanently; and economic and business risks are heightened.
Richard Jones, chair of the Financial Accounting Standards Board (FASB), discussed the challenges of his first year and how FASB adapted to ongoing effects of the pandemic at the virtual FEI Corporate Financial Reporting Insights Conference in November. He noted FASB staff are just returning to the office, like many other businesses, and resuming in-person board meetings in place of remote ones.
“The past year was an eventful year for FASB, with continuing post-implementation reviews (PIRs) of revenue, leases, and CECL; the Board’s invitation to comment on the agenda consultation process; and a number of agenda projects,” said Hillary Salo, FASB’s technical director, at the FEI conference.
Feedback from PIRs helps the Board identify and prioritize process issues, scope, and transition, and PIRs have led to changes in effective dates for new standards and amendments to existing standards.
“FASB received over 500 responses to the invitation to comment from over 200 stakeholders,” Salo said. There were several recurring themes, including a significant number of comments regarding accounting for digital assets. The responses are being analyzed and are expected to be summarized for the Board in December to get its direction on how to respond and prioritize the items along with projects already on FASB’s agenda.
Although the responses do not directly affect 2021 audits, preparers and auditors should monitor the Board’s actions as future standard-setting will likely come out of this process.
Auditors should be in better position to perform high-quality audits remotely than last year because they have had a year to implement quality controls, modify audit plans, and train staff in response. Firms have continued to invest in technology to facilitate high-quality audits, including use of advanced data analytics.
At the FEI conference, Public Company Accounting Oversight Board (PCAOB) Acting Chair Duane DesParte discussed the need for firms to fully comply with auditing standards and maintain quality control despite the pandemic. COVID-19 control risks and the effectiveness of remote auditing are a focus area of the PCAOB in future inspections—one that audit committees should be looking at now to improve audit quality.
DesParte noted demand for talent is a pervasive issue causing a strain on financial statement preparers and auditors, and he said the PCAOB will be monitoring firms’ quality control processes for assigning staff to engagements.
Risk assessment by management and auditors is again a critical area for 2021 audits. There have been additional changes in business processes and controls, increased economic and business pressures that can heighten the risk of fraud, and more employee departures that impact the design and operation of internal controls. DesParte warned firms of the risk of overrelying on technology and failing to apply professional skepticism and audit judgment.
Implementation of new accounting standards is another focus area for the PCAOB and audit committees. Private companies adopted Accounting Standards Codification Topic 606 on revenue recognition for 2020 reporting; revenue was a frequent area of audit deficiencies in the PCAOB’s 2020 inspections. Topic 842 on leases was effective for public companies last year and applies to private companies for 2022 reporting. Topic 326 on credit losses is still on the horizon for smaller reporting public companies and nonpublic companies, with an effective date delay until January 2023.
Considerations for year-end audits
A number of other topics should be top of mind for auditors and their clients for upcoming audits. Many of these were on last year’s list, with the ongoing pandemic contributing to their inclusion again this year.
Internal controls. Because of employees working remotely and personnel changes, internal controls might not be operating as designed, might be operating differently for different parts of the year, or operating differently than in prior years. There is potential for less segregation of duties and management override of controls, along with greater risk of fraud because controls are not operating. Auditors are required to evaluate the design and operation of controls and might need to revise audit plans and audit programs to place less reliance on controls and perform additional procedures.
Use of estimates. Management might be facing new pressures on financial results and liquidity and have new motivations that can influence the assumptions used in the estimation process. Estimates are involved in many areas of accounting, so management bias in estimates can be pervasive to financial statements. The Center for Audit Quality released a resource on auditors’ responsibilities for auditing estimates that highlights COVID-19 considerations.
Fraud risk. Auditors should assess the risk of fraud during planning and continue to evaluate it throughout the audit. Working remotely can increase the potential for clients to provide fraudulent documents, so auditors might need to add additional procedures to make sure audit evidence is authentic.
Going concern. Businesses continue to face many uncertainties from the pandemic and the state of the economy. Management and auditors share responsibility for assessing a company’s ability to continue as a going concern within one year after the date the financial statements are issued or available to be issued, based on conditions or events that raise substantial doubt. Accounting and auditing standards apply, and companies and auditors are required to document risk areas and management’s mitigation plans. Assumptions about future liquidity, access to capital, and compliance with debt covenants are all important to the analysis.
Impairment of tangible and intangible assets. If there are indicators of potential impairment, both tangible and intangible assets are required to be evaluated and may need to be written down. The indicators and triggering events can be different than last year’s, vary from company to company, and can change during the audit period.
Indicators of a potential triggering event include equity and credit market conditions, industry and market considerations, increased costs of materials and labor, declines in revenue or cash flows, and changes in management or customers. All of these can be present as a result of the pandemic. Companies must use forecasted cash flows to perform their impairment analysis, and forecasting can be difficult in a changing economic environment. Auditors need to apply professional skepticism and not only rely on management’s judgments.
Fair value. Establishing and assessing fair values of assets and liabilities is a fundamental part of many standards. Changes in the economy and operations from the pandemic might have caused declines in the values of financial and other assets. Management must apply the appropriate accounting model to its fair value assessments—this is a significant judgment area. Auditors must audit the data and assumptions management used and document their procedures. Third-party valuation specialists should be considered to provide support to management and auditors.
Government assistance. Paycheck Protection Program (PPP) loans and other forms of government aid provided during the pandemic are new to businesses and auditors. Eligibility and application rules and criteria for using and keeping funds from these programs are complicated, and accounting for them continues to evolve. Companies might not have established internal controls in this area. There can be new risks of material misstatement because of error or fraud relating to these funds, and other audit areas, like going concern, can be impacted.
Disclosures. Financial statement disclosures should be clear and include current information about changes in the business because of the economy and the pandemic, including a discussion of risks and uncertainties and all material information about subsequent events known through the date of the audit report. For public companies, the expected impact of recently issued accounting standards that have not yet been adopted is required to be disclosed and updated each reporting period.
Although environmental, social, and governance reporting is not yet a separate requirement in audited financial statements, there are many existing GAAP standards that apply to ESG issues and require companies to evaluate related risks and include them in their financial reporting.
Jones was asked at the FEI conference about FASB’s role in ESG reporting. He reminded participants that the organization in March issued an educational paper on the connection between existing accounting and disclosure requirements and ESG matters.
He also noted the invitation to comment included ESG matters and requested input on the need for additional accounting guidance in this area.
The Securities and Exchange Commission (SEC) has been very clear about its expectations that companies provide climate-related disclosures. There is the potential for SEC rulemaking to mandate certain ESG disclosures in the near term. Companies should consider the SEC’s public comments about future changes in ESG disclosures in their evaluation of risks, uncertainties, and estimates used in accounting and financial reporting and related disclosures for this year-end.
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