FRC revises UK going concern audit standard
In this article, we look at questions surrounding the FRC’s new audit standard on going concern.
Why has the FRC revised its going concern standard now?
Thomas Cook. Carillion. BHS. Patisserie Valerie. All high-profile corporate failures that have shone a spotlight on the work and responsibilities of an auditor in relation to going concern.
In September 2019, the Financial Reporting Council (FRC) published a revised version of ISA (UK) 570 including requirements that differ significantly from both its UK predecessor and the equivalent international version of the standard on which it is based. Although we are still waiting for outcomes from Sir Donald Brydon’s review into the quality and effectiveness of audit, the FRC is clear that any further audit failures in the area of going concern would leave stakeholders demanding to know why the FRC had done nothing to address weaknesses it had already identified if it did nothing now.
“This latest corporate failure has shone a light once again on the use of aggressive accounting methods to aid bumper pay-outs to company executives and the apparent inability of auditors and regulators to curb these practices in the wider interests of shareholders, investors, and the public.”
Rachel Reeves MP, Chair of the Business, Energy and Industrial Strategy (BEIS) Committee launching an inquiry into the collapse of Thomas Cook
When do new requirements apply?
The September 2019 version of ISA (UK) 570 is mandatory for UK audits of financial statements with accounting periods commencing on or after 15 December 2019. It can be adopted early.
Will the new standard represent a significant increase in auditor work-effort?
The FRC impact assessment on these changes suggests that for a non-PIE engagement, the additional cost of compliance is a 0.25% uplift in terms of hours. However, the changes will affect some firms more than others depending on just how robust an approach they are taking – or showing they have taken – under the current set of requirements.
The FRC has stated that it hopes setting out a more robust process in the revised standard will prevent ‘delivery gaps’ as it will be clear what the auditing standards require from an auditor when considering going concern.
What does this more robust process entail?
The standard itself has changed significantly. In many places it sees both more prescriptive requirements and additional application material. Headlines include:
- Linkage to understanding: There are more explicit requirements regarding areas that the auditor must understand when performing risk assessment procedures in connection with satisfying audit objectives relating to going concern. This may act to force the hand of any auditor that is at present only considering clearly visible factors. It might be seen by others as the codification of best practice.
- Challenging the management assessment: Again, the standard is more explicit in its requirements when it comes to the work-effort required to challenge management and obtain sufficient, appropriate evidence required to draw conclusions. There is also, as you would expect, more direct reference to scepticism and management bias.
- Stand-back requirements: In common with some other recent audit standards, an explicit ‘stand-back’ requirement has been added to consider corroborative and contradictory evidence when the auditor is drawing their conclusions on going concern.
When we see good going concern sections of audit files on audit quality reviews at present, they would often already be addressing many of the areas prescribed by ISA (UK) 570 Revised. Do we see good going concern sections of audit files often enough? Probably not. Will a greater degree of prescription help? It depends … the FRC states that the intention of the changes is not to create a checklist mentality. One of the areas that we’ll investigate in more detail in the future is the interaction between the application of a more prescriptive standard and the enforcement of the documentation requirements that sit therein, in other words – how to apply this new standard in an appropriate, yet proportionate fashion without losing sight of the overall objectives.
Initial proposals were to change auditor reporting requirements on going concern. Did these make their way into the final standard?
For most audited entities, the answer is no. Enhancements seen back in 2016 still apply, though.
However, if you are auditing a PIE, other listed entity, UK Corporate Governance Code Adopter, or an entity subject to governance requirements of The Companies (Miscellaneous Reporting) Regulations 2018, additional requirements include having to explain in the audit report how you have evaluated management's assessment of the entity's ability to continue as a going concern and, where relevant, the key observations arising with respect to that evaluation.
Will you be updating the UK Mercia Audit Methodology for this change?
Yes. We intend to issue updated methodology products that reflect these changes in 2020. Our updates will also reflect the requirements of the new ISA 540 on accounting estimates and further revisions to standards due to be published later in 2019 following the FRC’s post implementation review of its 2016 audit and ethical standards. For an overview of all the changes to audit standards taking effect over the next year, we are running a webinar on 9 December called Changes to Audit Standards: Gearing up for 2020.
Where can I find out more about the changes to going concern audit requirements?
Look out for our series of webinars that will look at the detail and practical implementation of changes to audit requirements.