Implications of COVID-19
Going Concern Assumption
The practice of NFRS implementation has been started in Nepal just few years back. Currently, all the listed companies are required to prepare NFRS complied financial statements. NFRS for SMEs will be applicable from financial year 2019-20, unless some relaxation is given by the concerned authorities.
Actions taken in response to the spread of COVID-19 have resulted in significant disruption to business operations and a significant increase in economic uncertainty, with more volatile asset prices and currency exchange rates, and a marked decline in long-term interest rates in developed economies. The COVID-19 pandemic crisis and its economic effects mean that there will be significant reporting implications in time to come. We will discuss here about the significant implication of Going Concern Assumption.
Going Concern Assumption
Nepal Accounting Standard (NAS) 1 Presentation of Financial Statements states that:
When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. Financial statements shall be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions which may cast significant doubt upon the entity’s ability to continue as a going concern, those uncertainties shall be disclosed. When financial statements are not prepared on a going concern basis, that fact shall be disclosed, together with the basis on which the financial statements are prepared and the reason why the entity is not considered as a going concern.
NAS 1 requires the management of an entity to assess the entity’s ability to continue as a going concern. The going concern assessment needs to be performed up to the date on which the financial statements are issued. The assessment relates to at least the first twelve months after the balance sheet date, or after the date the financial statements will be signed, but depending on the overall impact of the COVID-19, the timeframe might need to be extended.
Financial statements are prepared on a going concern basis unless management intends either to liquidate the entity or to cease business, or has no realistic alternative but to do so. The assessment as to whether the going concern basis is appropriate takes into account events after the end of the reporting period also. When management is aware of material uncertainties that cast a significant doubt on the entity’s ability to continue as a going concern, the entity should disclose those material uncertainties in its financial statements.
When management assesses the entity’s ability to continue as a going concern, it shall consider the current economic uncertainty and market volatility caused by the lockdown resulting from COVID-19 outbreak. In assessing whether the going concern assumption is appropriate, management shall assess all available information of current period and the possibilities of the future consequences (which is at least, but not limited to, 12 months from the reporting date)
Requirement of budget/forecast revision
In case of some entities, budgets and forecast of 2019-20, 2020-21 prepared in 2019 may now be of very limited significance in this changed scenario. These forecasts may require significant revision due to overall business environment being severely impacted by the lockdown, resulting in decrease in sales and suspension of business. It will be critical for management to assess what impacts the current events and conditions will have on the entity’s future operations and cash flows, and whether the entity will have sufficient liquidity to continue its business and meet its obligations as they fall due.
Then entity may need to consider whether:
• it is capable of running its business/operation once the lockdown environment eases;
• it has sufficient cash and unused credit lines/borrowing facilities to meet its short-term needs;
• any further actions needed by the management to enable the entity to generate sufficient cash flows to meet its obligations when they fall due;
• it needs to negotiate with banks and financial institutions to restructure and/or increase borrowing facilities;
• it needs to restructure/redesign operations to reduce operating costs;
• it needs to defer capital expenditure and any other avoidable expenditures;
• it needs to seek financial support from directors/shareholders and/or government programs designed to support businesses.
• the entity is eligible for any government assistance declared by the government to support the organizations impacted by COVID – 19 .
Managing financing challenges
Management should reassess the requirement of fund and the source of fund to meet those requirements in the changed business environment. Lenders may be less willing to renew/increase loan to borrowers with weak credit history and they may demand additional collateral. Borrowers with foreign currency-denominated debt may find that debt servicing costs increase significantly due to the depreciation of their local currency. The cost of financing may be higher in the current circumstances. Shareholders may be reluctant to induce further money.
If management concludes that the consequences of the COVID-19 will result in a deterioration in operating results and financial position that is so severe that the going concern assumption is no longer appropriate, then the financial statements would need to be adjusted accordingly.
Management should disclose all those significant assumptions and judgments applied in making going concern assessments in the COVID-19 environment. In particulars, following disclosures shall be made:
• Assessment of the current situation with anticipated effects of COVID-19 ;
• Management’s evaluation of the significance of the COVID-19 impact in relation to the entity’s ability to meet its obligations;
• Management’s plans that mitigate the effect of these events or Conditions;
• Significant judgments made by management as part of its assessment of the entity’s ability to continue as a going concern.
Possible course of action by the management
Sectors like aviation, travel and tourism, entertainment, retail, construction, manufacturing, insurance and education have been significantly impacted by the COVID -19 in Nepal. As the reporting date is still under 3 months away, new scenario may develop during this time period and the possible course of action as recommended below may vary accordingly.
Management should assess the existing and anticipated effects of COVID-19 on the entity’s activities and the appropriateness of the use of the going concern basis. If it decides to either liquidate or to cease trading, or the entity has no realistic alternative but to do so it is no longer a going concern and the financial statements may have to be prepared on another basis, such as a liquidation basis.
When assessing an entity’s ability to continue as a going concern, management may need to update its budget/forecasts and sensitivities, as considered appropriate, taking into account the risk factors identified and the different possible outcomes amid COVID -19 environment.
Management may assess its plans to mitigate events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. In particular, management would be expected to reassess the availability of finance. The management needs to assess whether its plans are achievable and realistic.
Possible Course of Action by the Auditors
The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern (NSA 570).
Actions taken in response to the spread of COVID-19 have resulted in significant disruption to business operations and a significant increase in economic uncertainty. This situation may limit the availability of finance for the entity which may create a significant doubt on the entity’s ability to continue as a going concern.
The significance of such events or conditions often can be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counter-balanced by management’s plans to maintain adequate cash flows by alternative means, such as by disposing of assets, rescheduling loan repayments, or obtaining additional capital.
Additional Audit Procedures to be followed
Following additional audit procedures may be followed:
• Analyzing and discussing the entity’s latest available interim financial statements. The operating results, cash flow, ratios, working capital situation must be analyzed carefully.
• Analyzing and discussing cash flow, profit and other relevant forecasts with management. The auditor need to check whether the next year’s budget / forecasts have been suitably revised incorporating the impact of COVID -19.
• Reading the terms of debentures and loan agreements and determining whether any have been breached.
• Reading minutes of the meetings of shareholders, those charged with governance and relevant committees for reference to financing difficulties.
• Inquiring of the entity’s legal counsel regarding the existence of litigation and claims and the reasonableness of management’s assessments of their outcome and the estimate of their financial implications.
• Confirming the existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such parties to provide additional funds.
• Performing audit procedures regarding subsequent events to identify those that either mitigate or otherwise affect the entity’s ability to continue as a going concern.
• Confirming the existence, terms and adequacy of borrowing facilities.
• Obtaining and reviewing reports of regulatory actions.
• Determining the adequacy of support for any planned disposals of assets.
Evaluating Management’s Plans for Future Actions
Evaluating management’s plans for future actions may include inquiries of management as to its plans for future action, including, for example, its plans to liquidate assets, borrow money or restructure debt, reduce or delay expenditures, or increase capital.
Deciding on Audit Opinion
If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the financial statements is inappropriate, the auditor shall express an adverse opinion regardless of whether or not the financial statements include disclosure of the inappropriateness of management’s use of the going concern basis of accounting.
When the use of the going concern basis of accounting is not appropriate in the circumstances, management may be required, or may elect, to prepare the financial statements on another basis (e.g., liquidation basis). The auditor may be able to perform an audit of those financial statements provided that the auditor determines that the other basis of accounting is acceptable in the circumstances. The auditor may be able to express an unmodified opinion on those financial statements, provided there is adequate disclosure therein about the basis of accounting on which the financial statements are prepared, but may consider it appropriate or necessary to include an Emphasis of Matter paragraph in accordance with NSA 706 in the auditor’s report to draw the user’s attention to that alternative basis of accounting and the reasons for its use.
When the auditor of a regulated entity considers that it may be necessary to include a reference to going concern matters in the auditor’s report, the auditor may have a duty to communicate with the applicable regulatory, enforcement or supervisory authorities.