Boards of struggling companies (and their auditors) must navigate choppy waters in terms of finalising their audited accounts in the midst of a global downturn.
The global downturn triggered by the COVID-19 pandemic continues to pose challenges to significant swathes of the worldwide economy. Companies across many industries and geographies have seen a precipitous decline in their operations and turnover.
Irrespective of liquidity positions, directors will also need to focus on whether they are able to publish “going concern” accounts and what their auditors’ opinion on those accounts will be. If directors can conclude a company is a going concern at the time of the audit, but harbour doubts about the future, this must be disclosed in the notes to the financial statements. This in turn can impact the basis on which both the accounts are published and the auditors’ opinion thereon prepared.
In many jurisdictions, governments have relaxed the timing requirements for the filing of accounts during the COVID-19 pandemic, including recently in the United Kingdom where companies are entitled to apply for a three months’ extension to publish their accounts following year end. The FCA has also given UK public companies a two months’ extension. Delaying the publication of accounts may allow more companies to reach a “going concern” conclusion. So, the choice can be whether to:
- Finalise accounts at a time of economic and financial uncertainty
- Delay in the hope of a more positive outlook
However, for many borrowers, a more urgent obligation to deliver accounts will be driven by their finance documents, which will typically not be tied into the regulatory requirements. Any delay past the contractual deadline will constitute a default and may require requesting waivers or forbearance from lenders.
In addition to the obligation to deliver audited accounts, finance documents often stipulate that such accounts are not “qualified”. This stipulation is potentially subject to a materiality qualification, but sometimes delivery of any qualified audited accounts is sufficient to trigger a default. However, in other cases, to be a default, the qualification must have a material adverse effect on the interests of the lenders or the borrower, either objectively or determined by the lenders themselves. Additionally, certain audit qualifications may not trigger a default, for example if the qualification arises due to a financial covenant breach, maturity of debt, and/or local audit practices in a jurisdiction where a group has significant operations abroad.
In considering the potential implications of a company’s decision to proceed or delay the publication of accounts under its financing agreements, it is important to understand the basis on which auditors can deliver their audit opinion.
“Modified” opinions (aka qualified opinions)
A “modified” opinion is given if auditors consider that they were unable to obtain sufficient appropriate evidence or the accounts are not free from “material misstatement”.
In this situation, auditors can issue any of the below:
- A qualified opinion – on either of the grounds above, but if the opinion does not have a pervasive effect on the accounts e. those underlying grounds for modification are confined to specific elements, do not affect a substantial proportion of the accounts, or do not concern fundamental disclosures or, if the auditors are unable to obtain sufficient appropriate audit evidence but conclude that the possible effects of any misstatements, if any, would not be pervasive. For example, a qualified opinion may be given because there is not a satisfactory management plan to resolve the adverse issues a company faces as a result of COVID-19.
- An adverse opinion – because there are material misstatements and their effect is material and pervasive.
- A disclaimer of opinion – when the auditor has insufficient appropriate audit evidence on which to base an opinion, and the possible effects could be both material and pervasive (or, if despite being provided with sufficient appropriate audit evidence, the interaction of the various uncertainties and their possible effect on the accounts means that it is not possible to form an opinion).
An unmodified opinion is made if auditors consider that they were provided with sufficient appropriate audit evidence and the accounts are free from “material misstatement”. There are two forms of unmodified opinions:
- A “clean” opinion, when the accounts give a true and fair view and are prepared in accordance with applicable accounting standards.
- An opinion containing an “emphasis of matter”, which is fundamental to the understanding of the financial statements but not in circumstances that justify a modified opinion (for example if there is material uncertainty regarding the use of the going concern assumption but the uncertainty has been adequately disclosed).
Accordingly, accounts published with an emphasis of matter (which has been a common position to date in the current climate) are unmodified and unqualified and should not trigger a typical qualification of accounts default.
But triggering a default is not necessarily the only concern. Although an emphasis of matter may not trigger a default, very real commercial implications arise as the emphasis of matter raises concerns about the company’s creditworthiness. These concerns often become self-fulfilling: credit insurers will increase their premiums/withdraw coverage; suppliers shorten terms; and trade creditors may withdraw credit lines and other forms of support. All such measures create liquidity pressure and may contribute to an avoidable or premature insolvency.
If directors decide to delay publishing accounts, the decision may only be a temporary remedy. If the economic fallout from COVID-19 is extensive and continuing, auditors may increasingly have no option but to qualify accounts or add an emphasis of matter.
Directors should consider engaging proactively with their auditors to discuss these issues as an imperative. The publication of accounts is a collaborative effort and directors should take every opportunity to understand auditors’ concerns and explain to auditors the measures that they are taking to maintain their business as a going concern and/or to disclose all factors relevant to their going concern evaluation. In doing so, directors will put themselves in the best possible position to influence the manner in which the emphasis of matter is presented to the market, and thereby maintain greater control of events.