By Nazatul Izma
MIA held a panel discussion on the impact of COVID-19 on MPERS financial reporting during the launch of the MPERS* Illustrative Financial Statements e-book. Tan Khoon Yeow, Partner, Learning & Development, BDO highlighted some issues that auditors should note:
No Requirement for KAMs
Auditors are only required to report on key audit matters (KAMs) when performing the audit of a public interest entity (PIE). Preparers applying MPERS will therefore not see KAMs in the auditor report, “unless your auditor wants to give you value-for-money reporting,” quipped Khoon Yeow.
Assess the Entity’s Going Concern or MUGC
Auditors are required to look into the entity’s material uncertainty over going concern (MUGC) that is increasingly critical since COVID-19 has significantly impacted business continuity, especially small medium enterprises (SMEs). “We as auditors would have to really look and challenge in depth the going concern assumptions used by management during this COVID-19 period,” said Khoon Yeow. Rather than being satisfied with a basic understanding of the assumptions and the inputs used by the management, do insist on more information, such as management’s scenario analysis.
He emphasised the importance of exercising judgement and professional skepticism in determining MUGC. The starting point of these discussions could be the following questions: Is your going concern assumption intact? What are your assumptions underlying your going concern? Are you disclosing these assumptions in the financial statements? Could a material uncertainty be detected just by scrutinising the statement of financial position, statement of profit or loss and statement of cash flows?
For better understanding of MUGC, Khoon Yeow advised auditors to refer to the circulars and FAQs issued by MIA.
There is no direct equivalent of IFRS 7 Financial Instruments: Disclosures in MPERS, which eliminates the requirement for exhaustive disclosures on risks, risk management, risk exposures, and other risk-related issues that could take up voluminous pages in the financial statements.
However, Sections 11 and 12 of the MPERS contain paragraphs that deal with the disclosure on risk of defaults and breaches of loans. This is pertinent for auditors as many preparers who are applying MPERS have loans with covenants. “In practice, there is a high chance that due to COVID-19, the loan covenants are breached. And if this happens, it automatically triggers the relevant requirements of Section 12 for which preparers will now need to disclose it,” explained Khoon Yeow.
Disclosures must also be made if the situation has been remedied after the balance sheet date, or if a government-announced moratorium enabled preparers to remedy the situation. “Preparers should also be disclosing how they have actually remedied the situation whether through action of direct renegotiation with the lenders, by intervention of the government, or for example via the CDRC (Corporate Debt Restructuring Committee). This is where as auditors, we will need to exercise our judgement call again.”
Khoon Yeow warned auditors that they should persuade preparers to disclose this information or risk queries from parties to the covenants, such as bankers and creditors who will read the financial statements. In some circumstances, auditors could be fielding calls from bankers and creditors querying the auditors’ report on financial statements that omit disclosures of a loan covenant that was clearly breached.
Physical Stocktake Difficulties
Pandemic lockdowns and movement control orders meant that many auditors were unable to carry out physical stockcounts. In March 2020, when Malaysia was under a strict Movement Control Order (MCO), MIA issued FAQs that included guidance on inventory count. The FAQs clearly state that alternative procedures were allowed in the auditing standards or International Standards on Auditing (ISAs) as auditors were not able to physically go and perform an inventory count as of 31 March 2020, for instance. The FAQs can be accessed here.
An alternative is for auditors to carry out an emergency stocktake immediately upon the lifting of the MCO. Roll back procedures could then be performed, whereby auditors could roll back their samples or items that they had selected in order to derive what would have been the quantity of the stocks as of the balance sheet date.
External auditors are also allowed to obtain assistance from the internal auditors of the company, although SMEs are usually too small to retain their own internal audit department. If the company does not have an internal audit department, external auditors could rely on the internal controls of the company, depending on the system of perpetual stocktake or cyclical stocktake. Such reliance depends on the strength of internal controls that the client has in relation to their stock counts or their stock quantities. “As auditors, we need to obtain an understanding of the client’s systems and see how best we can execute these alternative procedures in accordance with the auditing standards.”
A potential impact on the auditors’ report arising from inability to verify stocks is the risk of issuing a modified audit opinion due to the inability to obtain sufficient appropriate audit evidence (SAAE) over inventories. The MIA has highlighted this as well in the aforementioned FAQs.
“In this situation, there is no hard and fast rule because it depends on the materiality of inventories to the financial statements,” said Khoon Yeow. If the auditor was unable to attend the stocktake and could not perform alternative procedures reliably for which the impact is not pervasive to the financial statements, then based on the MIA FAQs, it is likely that an “except for” opinion would apply.
However, if the stocks are material, which constitutes a significant percentage of the balance sheet items and have a material impact on reported gross profits of the company, then that would result in a major qualification because of its “pervasive impact,” explained Khoon Yeow. “When something is pervasive, the ISAs unfortunately point one way, which is a disclaimer of opinion because we are not able to obtain SAAE.”
“As practitioners, I would be very worried about jumping straight to an audit qualification. I would do my best to look for alternative procedures to be performed,” advised Khoon Yeow. Although alternative procedures such as roll back of stocks could be hard work, do weigh that option against an audit qualification. “When you qualify, obviously there is a big impact to the markets. Although the client might only be an SME, they do have stakeholders such as banks that provide loans to the SMEs. When you qualify your audit opinion, you could trigger one of the loan covenants and it could become an immediate loan default” he concluded.
*MPERS – Malaysian Private Entities Reporting Standard