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The impact of revised auditing standards on your December 2020 year-ends and beyond

Enhanced auditing standards have now come into effect for periods from 15 December 2019. This guide highlights the key changes for the main revised standards and how they will affect our approach to your audit.

Auditing standards and the transparency of auditor reporting has needed to evolve to respond appropriately to a number of events and challenges that have arisen in recent years. These include:

  • Recent high-profile corporate failures, with criticism levelled at both directors and the work of auditors. which have focused further attention on the robustness of audit work on going concern.
  • Increasing complexity in financial reporting standards with often more pervasive use of estimation and judgement which has required standard setters to strengthen the auditors work on accounting estimates.
  • The desire for greater transparency and communication with stakeholders particularly through the auditor report.

A common thread through all the changes has been addressing audit quality and fostering improved and more consistent exercise of professional scepticism.

Below we summarise the impact on three key areas affected by the revised standards:

  • Accounting estimates
  • Going concern, and
  • The Independent Auditor’s report

1. Accounting estimates

The preparation of financial statements requires the exercise of judgement and the use of estimation. As accounting standards have become more complex, the use of estimates has become more widespread and the judgements implicit in determining future events can potentially create greater risk of material misstatement. For example:

  • The use of fair values is common and well recognised in UK Generally Accepted Accounting Practice (GAAP) and International Financial Reporting Standards (IFRS). However, the determination of fair values can range from simple market comparisons to the use of complex modelling. The selection of discount rates to measure long-term provisions, financial liabilities and lease obligations is often an area of judgment.
  • Reliable estimation of future cash flows is critical to making assessments around impairments and is of particular significance in the current pandemic environment.

All sources of estimates feature varying degrees of complexity, subjectivity, and estimation uncertainty. The range of possible outcomes may differ and may materially affect the reported financial performance and position of a company. Therefore, auditing standards have a specific emphasis on robust work on estimates because of their potential for material misstatement due to error or manipulation.

International Standard on Auditing (UK) 540 ‘Auditing Accounting Estimates and Related Disclosures’ brings a number of enhancements to the work on accounting estimates to reflect their increasing use and complexity. Management, directors and those charged with governance will need to ensure they are prepared to address, with suitably supported evidence, not only the quantum of estimates and the estimation process, but also the related disclosures to ensure a clear understanding can prevail. Early engagement with your appointed auditor is critical to ensure work can be completed in a timely, cost effective and appropriate manner.

The range of possible outcomes may differ and may materially affect the reported financial performance and position of a company.

2. Going concern

In light of well publicised corporate failures of both private and public companies, coupled with the more recent economic effects of the pandemic creating fragility for many businesses, the auditors work on going concern takes on even greater significance and is of heightened regulatory focus.

The responsibility for making the going concern assessment of an entity has, and always will, remain with the directors. However, in certain circumstances directors should be prepared for increased scrutiny and challenge in respect of the assessment of going concern. This may result in more work for the directors when making and supporting the going concern assessment. In particular, the directors will need to ensure that those forward looking aspects of their going concern assessment which are suspectable to significant judgement or can create a materially different outcome if alternate assumptions were applied are fully supported, with sensitivity analysis performed as necessary.

The objective of the UK Financial Reporting Council’s revised International Standard on Auditing (UK) 570 ‘Going Concern’ is for the auditor to obtain sufficient appropriate audit evidence to conclude on whether or not a material uncertainty relating to going concern exists and to conclude on the appropriateness of your use of the going concern basis of accounting.

In certain circumstances directors should be prepared for increased scrutiny and challenge in respect of the assessment of going concern.

3. The Independent Auditor’s Report

The auditor report you are familiar with will include two enhancements as to its transparency:

  • International Standard on Auditing (UK) 700 ‘Forming an opinion and reporting on financial statements’ introduced a requirement for auditors to explain in a tailored paragraph, to what extent the audit was considered capable of detecting irregularities, including fraud. This paragraph will now detail the procedures performed and the enquiries made to assess the company’s compliance with relevant laws and regulations and the procedures performed to identify the existence of material fraud.
  • International Standard on Auditing (UK) 570 ‘Going Concern’ requires, subject to satisfactory conclusion of the audit work:
    • a positive statement from the auditor that we have concluded that the directors’ use of the going concern basis of accounting in the preparation of the financial statements is appropriate, and
    • that based on the work we have performed, we have not identified any material uncertainties relating to events or conditions that, individually or collectively, may cast significant doubt on the company’s ability to continue as a going concern for a period of at least twelve months from when the financial statements are authorised for issue.

Conclusion

It is clear that the enhancements to the three standards above respond to an evolving corporate reporting environment and strengthen audit work on the areas that often exhibit the greatest judgement. The changes contribute significantly to improving audit quality and the reliability of financial statements in those areas of often greater subjectivity. However, these will mean that directors and those charged with governance will need to be adequately prepared for greater scrutiny and early consideration will be necessary, including full engagement with your auditor.

Notably, these revised standards are to be applied during a period of significant challenge in both financial reporting and audit in light of the COVID-19 pandemic which has introduced greater uncertainty into the process of deriving reliable estimates and forecasts.

Would you like to know more?

If you have any questions about the above and how it may affect your year-end, please get in touch with your usual Blick Rothenberg contact or one of the Partners whose details are on this page.