There are various factors causing a (re)focus on “accounting records”, “documentation”, and “audit evidence”.
(a) The current economic environment (i.e. COVID-19)
The unfortunate reality is that it is likely that a more than an insignificant number of entities will ultimately succumb to the current and ongoing economic turmoil that has been brought about by COVID-19 (i.e. insolvencies and the like are on the horizon to some degree).
As was the case with the Global Financial Crisis in the late 2000’s through to early 2010’s, when times go bad… people go into “protection mode”, particularly with respect to foreshadowing the subsequent scrutiny that may be placed on an entity by shareholders, financers, in in the worst-case scenario, receivers, liquidators, and/or the Inland Revenue Department.
One of the first areas to get picked over in this process is looking into how the Directors and Management have been running the business, and were they complying with all laws and regulations as they should have been, including their LEGAL requirement to keep complete and accurate accounting records.
Not having adequate accounting records is “low-hanging-fruit” in any case against Directors and Management, and accordingly the current environment is reminding people of the very real need to make sure that their house is in order.
(b) Expectations on Directors
One of the key responsibilities of Directors is to ensure that their entity is complying with all applicable laws and regulations, including those related to financial reporting and the preparation of financial statements.
In this respect, Directors are responsible that:
- The financial statements fairly represent their business and comply with the applicable financial reporting and accounting standards, and
- The financial statements must be supported by appropriate accounting records that correctly record the transactions of the entity (and where applicable, enable the financial statements to be Audited).
The Financial Markets Authority (FMA) in New Zealand has released various publications and guidance to assist Directors in understanding and executing their roles and responsibilities.
While the FMA is predominately concerned with only FMC reporting entities, their publications and guidance related to the roles and responsibilities of Directors are equally applicable to Directors of all entities.
In the FMA’s most recent Audit Quality Director Guide (Nov 2020) (click here), the FMA expands on what (in their opinion) “accounting records” include, noting that:
This includes, for example, papers that set out the accounting treatments chosen by the entity and any assumptions and judgements made by directors.
We also recommend that directors document instances where they determined disclosure not to be material.
Accordingly, such explicit public comments from regulators such as the FMA have Directors sitting up and taking notice to ensure that their entity’s Accounting and Finance Teams are preparing thorough, complete, and accurate as is expected of them.
(c) Auditor requirements
Auditor requirements are obviously not mutually exclusive from the current economic environment discussed above.
It should be no surprise that when the economic environment is challenging:
- Certain judgmental areas of accounting are “triggered” or exacerbated, resulting in
- Higher audit risk and associated Auditor scrutiny.
Naturally, this will lead to further lines of Auditor enquiry as well as increased requests for documented analysis from an entity to support various accounting treatments, as well and Management’s judgements and estimates.
However, in addition to this, there are a couple of audit-industry-specific factors that are driving the push for increased documentation to be provided by entities:
- 1) The ongoing industry expectation for greater Auditor independence
In response to ongoing industry pressure, Audit firms are drawing definitive lines-in-the-sand around the support that they can and cannot provide to their audit clients in order to demonstrate clear Auditor independence and reduced potential for conflicts of interest.
Accordingly, areas that an Auditor may have previously documented internally themselves for their own audit file purposes are instead now being pushed back onto the entity to be produced directly by the entity themselves in the first instance.
- 2) Revision to Audit Standard ISA (NZ) 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures
In the same way that entities have accounting standards that they must comply with, Auditors too have their own audit standards that they must comply with.
One of these audit standards (ISA (NZ) 540) addresses an Auditor’s requirements when auditing areas that involve accounting estimates.
Recently, ISA (NZ) 540 was updated and revised (effective for year-ends 31 December 2020 and beyond), with the key change being a greater level of professional scepticism being required to be applied by Auditors, with terminology such as “challenge”, “question”, “reconsider”, and “stand back” being spread throughout the revised requirements.
Practicably, this translates to a greater documentation burden being pushed on to entities by their Auditors, to ensure that the revised requirements of ISA (NZ) 540 are complied with.
Failure to obtain sufficient audit evidence documentation may lead to Auditors being required to issue qualified (or even disclaimed) audit opinions with respect to a limitation of scope (i.e. lack of support and evidence).