COVID-19 implications for financial reporting and audit: Frequently asked questions (FAQs)
The FAQs refer to the financial reporting and audit requirements in Chapter 2M of the Corporations Act 2001 (Corporations Act) unless otherwise stated.
The FAQs cover:What was the impact of restrictions in Victoria and changes to JobKeeper on financial reports for periods ended 30 June 2020?
1. What are ASIC’s focus areas for companies, directors and auditors for financial reporting given the impact of the COVID-19 pandemic?
Given the impact on businesses of the COVID-19 pandemic and associated measures (e.g. travel restrictions, remote work and social distancing), key focus areas for financial reports for years ended 31 March 2020 to 30 June 2021 include:
- Recognition and measurement
- values of assets (including intangibles, property, inventories, receivables/loans, investments, other financial assets, contract assets and deferred tax assets)
- liabilities (including provisions for onerous contracts, financial guarantees and restructuring)
- sources of estimation uncertainty
- key assumptions and sensitivity analysis
- operating and financial review (OFR) – underlying drivers of results, business strategies, risks and future prospects
- going concern assessments and solvency
- subsequent events.
Entities should appropriately account for each type of support and assistance from government, lenders, landlords and others. Both the financial report and OFR should prominently disclose significant amounts, the commencement date and expected duration of support or assistance.
Other matters to consider may include hedge effectiveness, sales returns, off-balance sheet exposures, and credit and liquidity risks associated with financial instruments.
Companies, directors and auditors should also be mindful of the requirements of the lease accounting standard that first applied for years commencing on or after 1 January 2019.
See Media Release (20-157MR) Focuses for financial reporting under COVID-19 conditions (7 July 2020), Media Release (20-325MR) ASIC highlights focus areas for 31 December 2020 financial reports under COVID-19 conditions (15 December 2020) and Media Release (21-129MR) ASIC highlights focus areas for 30 June 2021 financial reports under COVID-19 conditions.
Factors to consider in relation to asset values, liabilities and assessments on solvency and going concern may include:
- business and domestic or international economic factors
- industry specific factors
- impact on customers, borrowers and lessees
- impact on supply chains
- exposures to overseas operations, transactions and currencies
- short-term versus long-term conditions
- the availability, distribution and take up of COVID-19 vaccines
- duration of containment measures and business closures
- extent and duration of assistance and support by governments and others
- impact on short-term operating cash flows
- debt refinancing, borrowing covenants, lender forbearances and liquidity support
- modifications of debt and lease contracts
- capital raising
- management plans and response to the pandemic impacts.
This list is not intended to be exhaustive and there may be other factors to consider in the circumstances of individual entities.
These factors may also be relevant in assessing the ability of an entity’s borrowers and debtors to meet their obligations to the entity, and the ability of key suppliers to continue to provide goods and services to the entity.
There are different approaches to uncertainties for different assets and liabilities of the entity. For example, impairment of non-financial assets is based on best estimates of fair value and value in use. The best estimate should have regard to risk factors (e.g. through the discount rate used in a discounted cash flow model). Given uncertainties in the current environment, it may be necessary to use probability weighted scenarios in making estimates of both fair value and value in use.
For loan loss provisioning, a probability weighting of possible scenarios may apply.
Assumptions should be realistic and should not be overly optimistic or pessimistic. However, disclosure on uncertainties, key assumptions and sensitivity analysis will be important for users of financial reports, as well as information and explanations presented in the OFR.
Focus should also be given to the appropriate classification of assets and liabilities between current and non-current categories on the statement of financial position.
The circumstances of companies and the environment in which they operate can change significantly from one reporting period to the next under COVID-19 conditions. This could significantly affect assessments of asset values, liabilities and financial position.
Disclosures of key assumptions, risks, the drivers of results, strategies and future prospects and changes from the previous period will be important for investors and other users of the financial report and OFR. This applies to both full-year and half-year reports. Consideration should also be given to any continuous disclosure obligations.
See also Information Sheet 203 Impairment of non-financial assets: Materials for directors (INFO 203).
2A. What was the impact of restrictions in Victoria and changes to JobKeeper on financial reports for periods ended 30 June 2020?
Key events occurring after 30 June 2020 that may have affected financial reports for full-years and half-years ended 30 June 2020 included:
- the Melbourne-wide Stage 3 restrictions announced on 7 July 2020
- the changes in JobKeeper announced on 23 July 2020 and 7 August 2020
- the Melbourne-wide Stage 4 restrictions and regional Victoria Stage 3 restrictions that took effect from 2 August 2020.
The treatment at 30 June 2020 affects the opening balances for the year ending 30 June 2021 and could affect the result for that year. The discussion in this FAQ might also assist in considering how accounting treatments and estimates might be affected by other events and circumstances at 30 June 2021 or other balance dates.
The impact of the events outlined above on companies depended on their exposures to the Victorian market, such as operations, suppliers and/or customers in Victoria. Companies may also have been affected by the changes to JobKeeper and by general economic impacts flowing from the events.
While these were new events that occurred after 30 June 2020, they may have affected assessments of asset values (such as assessments of impairment of non-financial assets, expected credit losses on loans and receivables, and fair values of investment assets), solvency and going concern.
Other scenarios may also have needed to be considered having regard to the factors listed in FAQ 2 above. Decisions by individuals, companies and governments over time will influence the impact of COVID-19 conditions on a company. Some future decisions and their impact may be more predictable than others having regard to the conditions existing at the balance date (for asset values) or the date of finalising the financial report for release (for solvency and going concern assessments).
Actual events occurring after the balance date may be regarded as more or less predictable at the balance date, and might be correlated to a degree with their proximity to the balance date.
Even in the absence of the events in Victoria in June 2020, the possibility of a ‘second wave’ of COVID-19 cases in Australia may have been factored into assessments and, where applicable, some of the probability weighted scenarios. Some assumed events may have been correlated to a degree with other events – for example, the possibility of a ‘second wave’ may lead to different expectations on the degree of support by governments or others.
In considering asset values at 30 June 2020, regard should have been given to conditions existing at 30 June 2020 and future expectations at that date. Assumptions used should be reasonable and supportable.
By 30 June 2020, with 36 suburbs in 10 Melbourne postcodes already under Stage 3 restrictions and the number of reported infections growing, it could be expected that Stage 3 restrictions for the whole of Melbourne were likely. It might also be expected that Melbourne-wide restrictions could lead to further support from governments and others. The need for, and nature of, possible further restrictions may have been more difficult to predict.
Each company that was significantly affected directly or indirectly by the conditions in Victoria or the changes to JobKeeper could have been expected to take the following approach in assessing discounted future cash flows supporting asset values as at 30 June 2020:
- the expectation of Melbourne-wide Stage 3 restrictions should have been included in a high proportion of probability weighted scenarios and the scenarios should have been given a high weighting
- the expectation of some form of extension of JobKeeper for qualifying companies in many industries may have been considered for a proportion of probability weighted scenarios and given some weight
- the expectation of some form of further restrictions in Victoria would have been lower and may have been factored into a small proportion of probability weighted scenarios and given a low weighting. The specific restrictions applying in Victoria from 2 August 2020 would not have been envisaged at 30 June 2020.
Different companies may have modelled larger or smaller numbers of scenarios or used other methods to achieve a similar outcome.
The extent to which the events in Victoria were factored into the determination of asset values by companies with exposures to the Victorian market may have been key assumptions to be disclosed in the notes to the financial report. The notes may also have needed to disclose the nature and an estimate of the financial effect of these subsequent events to the extent that their impact was not fully reflected in asset and liability carrying amounts in the financial statements at 30 June 2020.
Solvency and going concern assessments
Assessments of solvency and going concern should be based on:
- conditions existing at the date of finalising the financial report for release, including the impact of all events that occurred up to that date
- expectations of future events.
In some cases, uncertainties may lead to a relatively broad range of reasonable and valid assumptions as to future performance and cash flows for an entity’s businesses or assets. This could affect the assessment of asset values or liabilities/provisions, or the assessment as to whether an entity is a going concern.
Directors should have a reasonable basis for each significant estimate in the financial report and any assessment on whether the entity is a going concern. Key assumptions should be appropriately challenged by directors and auditors.
Useful and meaningful disclosure on sources of estimation uncertainty and key assumptions will enable users to understand the basis for the estimates and judgements made. Information should be sufficiently specific to the circumstances affecting the entity and the impact on particular assets, liabilities, revenues and expenses. This includes clearly disclosing changes in key assumptions between reporting periods under COVID-19 conditions as circumstances change or become clearer.
Disclosing the impact under different possible scenarios as part of an entity’s sensitivity analysis on assets and liabilities may also be considered.
Transparency is important to market and investor confidence in financial reports.
Communication should be clear, concise and effective. Key information should not be lost in unnecessary detail.
For listed entities, the OFR should explain the business impacts and underlying drivers of the results and financial position, as well as strategies, risks and future prospects. This is particularly important for entities whose results and financial position have been adversely affected as a result of the COVID-19 pandemic.
The information and explanations in the OFR should tell the story and be specific to the circumstances of the entity and provide all information that members of the listed entity would reasonably require to make an informed assessment of:
- the operations of the entity, including underlying drivers of results that relate to the impact of the COVID-19 pandemic and other factors that are not related to the pandemic
- the financial position of the entity, including how the entity’s financial condition has been affected by the impact of the COVID-19 pandemic
- the business strategies of the entity, including the strategies to address impacts and risks from the COVID-19 pandemic, and prospects for future financial years.
Entities should address the relevant factors outlined in the response to FAQ 2 above.
Changes between reporting periods under COVID-19 conditions due to changed circumstances and assumptions should be clearly disclosed.
Similar disclosures may be required in the directors’ reports of unlisted entities. These reports are required to include a review of operations, as well as details of significant changes in the state of affairs and in the nature of the entity’s principal activities.
The OFR should properly identify all significant causes of adverse performance, including those factors not attributable to the impact of the COVID-19 pandemic.
See Regulatory Guide 247 Effective disclosure in an operating and financial review (RG 247).
Non-IFRS profit measures that purport to show the result had the impact of the COVID-19 pandemic not occurred are likely to be misleading. They will be hypothetical and may not show the actual performance of an entity. It may also not be possible to reliably identify and separately quantify the impact of the COVID-19 pandemic. Any non-IFRS profit measures should be unbiased and not used to avoid presenting ‘bad news’ to the market. Directors should refer to the relevant ASIC guidance (listed below) in presenting non-IFRS financial information.
Presenting a split of profit or loss (or particular revenue and expense items) between pre-COVID-19 and post-COVID-19 periods is problematic and can be potentially misleading because:
- the cut-off point cannot generally be clearly identified
- the pre-COVID-19 period may not be representative of future performance
- the impact of the COVID-19 pandemic is unlikely to be the only factor contributing to changes between pre-COVID-19 and post-COVID-19 results
- the effects of the COVID-19 pandemic are unlikely to be constant or uniform in the post-COVID-19 period.
It is important that the underlying drivers of the result are discussed in the OFR or review of operations. This includes providing an understanding of the impact of the pandemic and all other significant drivers of the result. Any analysis of the result should not be presented in a manner that is potentially misleading.
The result should not be split between pre-COVID-19 and post-COVID-19 periods on the face of the income statement or in the notes to the financial statements. Segment results should cover the entire reporting period. Segment results should not exclude the result for all or part of the post-COVID-19 period.
In some cases, it may be possible to quantify and disclose in the notes to the financial statements specific types of transactions as significant items included in the result that arose solely due to the impact of the COVID-19 pandemic (e.g. government support). It is not appropriate to present all or some ongoing operating costs (including maintenance or similar costs brought forward) as a significant item during a period of reduced revenue.
An explanation should be given as to why an item is described as solely COVID-19 related. Where an item is not solely COVID-19 related, other contributing factors should also be clearly described. It may be misleading to describe a COVID-19 related expense as being non-recurring, particularly where the effects of the COVID-19 pandemic cross over a balance date. It should be clearly disclosed that any significant items attributed in whole or part to the COVID-19 pandemic are not the only affected items. For example, other items of revenue and expense are also likely to be affected.
It may not be possible to attribute some items such as impairment losses or changes in sales revenue solely to the impact of the COVID-19 pandemic and to separately quantify the amounts attributable to different causes.
Where asset impairment losses were excluded from a non-IFRS profit measure in a prior period, any subsequent impairment reversal should also be excluded from that measure for the current period.
See Regulatory Guide 230 Disclosing non-IFRS financial information (RG 230).
The underlying reasons for improved performance or improved elements of performance related to the impact of the COVID-19 pandemic should be described in the OFR (or directors’ report), as well as strategies, risks and future prospects.
For example, an entity that had increased sales to parties who stockpiled the items sold should disclose the cause of the increased sales, and also disclose the possibility of reduced sales if customer stockpiles are reduced in the future.
Some entities may have obligations that give rise to liabilities at balance date in the specific circumstances. For example, the suspension of non-urgent or non-essential elective surgery (or voluntary decisions by insureds, practitioners or hospitals to defer procedures due to COVID-19 conditions) for a period may result in a backlog of surgical procedures that has not been fully cleared by balance date. Private health insurers should recognise a claims liability where an insured person who knows that they have a condition is likely to continue their cover until the surgical procedure has been performed. Community rating and waiting periods may be relevant to the decision by an insured person with a pre-existing condition to retain their cover. The liability estimate should typically have regard to the pattern of claims in prior periods compared to the pattern of claims in the current year. A liability would not be required to the extent that there has been a reduction in the number of injuries in motor vehicle accidents.
See Regulatory Guide 247 Effective disclosure in an operating and financial review (RG 247).
7. What disclosure is required in half-year financial reports and what work should the auditor perform?
While half-year reports of listed entities and other disclosing entities typically have reduced disclosures compared with full-year financial reports, an entity’s half-year report may be either:
- the first financial report where asset values, liabilities and results are significantly affected by the impact of the COVID-19 pandemic (e.g. for the half-year to 30 June 2020), or
- affected by significant developments and continuing impacts of COVID-19 conditions since the last full-year report (e.g for the half-year to 31 December 2020 or the half-year to 30 June 2021).
Half-year reports must explain events and transactions that are significant to an understanding of the changes in financial position and performance since the end of the financial year.
Half-year financial reports and directors’ reports should also provide comprehensive disclosure on relevant matters such as:
- in the financial report – estimation uncertainties, key assumptions and liquidity risk disclosures
- in the OFR – business impacts, underlying drivers of performance, strategies, risks and future prospects.
There is the potential for significant changes in the circumstances of companies and difficult judgements on asset values, liabilities/provisions and assessments of going concern. While auditors may conduct reviews rather than audits, it is likely that matters will come to the auditor’s attention that will require additional inquiries or other procedures in order to conclude in the review report.
Companies must have appropriate processes and records to support the information in their financial reports and OFRs. Management should apply appropriate experience and expertise to produce quality financial information and reports, particularly in more difficult and complex areas, such as accounting estimates (including asset values).
Papers should be prepared for the directors on significant judgements, and should include all relevant facts and the basis for the conclusions reached. Directors should be given sufficient time to consider financial reporting issues and to challenge assumptions, estimates and assessments. There should be adequate time for changes to be made before the financial report and OFR are released.
Information should be produced on a timely basis and be supported by appropriate analysis and documentation. This will support the quality of financial information in the market and the audit process.
Early planning of the reporting process will help to reduce any deadline pressures. This should include the work of external management experts such as asset valuers.
9. How do directors minimise possible liability in connection with accounting estimates and forward-looking information?
In our view, the risk of being found liable for misleading or deceptive accounting estimates or forward-looking information is minimal, provided:
- any statements are properly framed as, for example, being based on the information available at this time
- any estimates, assumptions or statements have a reasonable and supportable basis and have been appropriately challenged, which involves good governance at board level for signing off on that information
- there is ongoing compliance with any continuous disclosure obligations when events or results overtake estimates, assumptions or statements.
Both directors and auditors should ensure that the circumstances in which judgements on accounting estimates and forward-looking information have been made, and the basis for those judgements, are properly documented at the time and disclosed as appropriate. This will minimise the risk that hindsight is applied when estimates, information and judgements are reviewed by others at a later time.
See Regulatory Guide 247 Effective disclosure in an operating and financial review (RG 247).
In the current environment, a mechanistic approach should not be applied in determining expected credit losses for loans or for receivables. Past models and historical experience may not be representative of current expectations. This applies to all loans and receivables, including a bank’s loan assets and a manufacturer’s trade receivables. A probability weighting of possible scenarios may be needed.
It may also be possible to rebut the rebuttable presumptions in the relevant accounting standard about loans in arrears for 30 days or 90 days under current loan repayment deferral arrangements for some borrowers who may have short-term liquidity issues but who are expected to meet their obligations thereafter.
Key assumptions used in determining expected credit losses will be affected by changes in factors such as expected future economic and market conditions, and the impacts on particular industries. Entities should obtain current information about the circumstances and financial condition of borrowers and debtors at the individual and/or portfolio level.
Consideration should be given to both the short-term liquidity issues for borrowers and debtors, and to the financial condition and earning capacity of borrowers and debtors.
It is important to disclose estimation uncertainties and key assumptions used in determining expected credit losses.
The National Cabinet Mandatory Code of Conduct: SME Commercial Leasing Principles (Code) set out good faith leasing principles between landlords and those tenants of commercial properties that were eligible for JobKeeper and had annual turnover up to $50 million. State and Territory legislation has been made that is consistent with the Code.
While these provisions may have only applied to 31 March 2021, the agreements made to waive or defer rent may have been made in the year ending 30 June 2021 and may also have an ongoing effect.
Either the landlord or tenant could start negotiations. Negotiations should have taken into account the impact of the COVID-19 pandemic on the tenant and its revenue and profit. Waivers of no less than 50% of rent should have been given, subject to the landlord’s financial ability to provide waivers. Tenants may have chosen not to seek a waiver or agree to waivers of less than 50%.
The waivers could apply for the same period as JobKeeper. Rent unpaid before the enactment of the legislation (i.e. rent for March and April 2020) may also be covered by the waivers.
The following outline of the accounting approach is specific to the facts and circumstances described.
For accounting purposes, the landlord is likely to have classified the rent agreement as an operating lease. The accounting approach outlined below applies for operating leases of a landlord and where changes to the rent arrangement did not lead to classification as a finance lease.
The State and Territory legislation did not change a rent agreement. Until negotiations were completed and an arrangement agreed between the landlord and tenant, there was no lease modification.
When an agreement was made between the landlord and tenant to waive rent (i.e. with no rent deferral):
- rent waived that related to future occupancy was spread over the remaining lease term and recognised on a straight line basis
- rent waived that related to past occupancy was expensed immediately, except to the extent of a pre-existing provision for expected credit losses relating to unpaid rent.
Rent revenue was recognised by the landlord for occupancy up to the date of a waiver agreement. If there was no agreement at balance date, a provision for expected credit losses should have been recognised against any receivable for unpaid rent for past occupancy.
The provision was recognised with a corresponding expense. The provision should have covered the difference between contractual cash flows that were due and cash flows expected to be received. Accordingly, the provision should have included both that part of the receivable that was likely to be waived and any additional amount relating to credit risk associated with the financial condition of the tenant. Probability weighted scenarios should have been applied in determining expected credit losses.
If the tenant had fully paid rent for the period of occupancy up to balance date, there was no receivable against which to make a provision. Where at balance date it was expected that some of the rent already paid by the tenant would be waived, there was no basis to recognise a liability at balance date. It was important to prominently disclose material expected waivers after year end (including waivers given after balance date but before completion of the financial report).
An agreement made after balance date was a non-adjusting subsequent event and did not affect the recognition of rent revenue up to balance date, but may have provided information about conditions that existed at balance date that were relevant in determining expected credit losses at balance date.
If rent deferrals were given instead of waivers, the Code suggested that the deferred rent should be adjusted against future rent payments over the greater of the remaining lease term or 24 months, unless otherwise agreed. For accounting purposes, the pattern of revenue recognition by the landlord was not affected by the change in the timing of the rent payments.
A lessee is not required to assess whether a rent concession is a lease modification, or account for it as a lease modification, if the concession is a direct consequence of the COVID-19 pandemic and all of the following apply:
- the change in lease payments results in revised consideration substantially the same as, or less than, immediately preceding the change
- any reduction in lease payments affects only payments originally due on or before 30 June 2022
- there is no substantive change to other terms and conditions of the lease.
9D. What are some other areas of focus for companies, directors and auditors for financial reporting?
Other current areas of focus for companies, directors and auditors for financial reporting, irrespective of COVID-19 conditions may include:
Cloud computing arrangements
The IFRS Interpretations Committee published an agenda decision 'Configuration or Customisation Costs in a Cloud Computing Arrangement (IAS 38 Intangible Assets)' on 27 April 2021. The decision confirms that a cloud computing customer should expense the costs of configuring or customising the supplier’s application software in a Software as a Service arrangement.
There should be sufficient time to identify past amounts capitalised that should be derecognised before 30 June 2021 financial reports are completed. Adjustments are treated as relating to a change in accounting policy.
If amounts previously capitalised and now to be adjusted may be material but they cannot be identified for 30 June 2021 reporting, this fact should be prominently disclosed. Adjustments should be made in the next financial report.
Where only some amounts are identified and adjusted at 30 June 2021 as a change in accounting policy, any further amounts identified and adjusted at 31 December 2021 would be treated as errors.
Aged care bed licences
Aged care providers should review the carrying amount of aged care bed licences in view of the announcement in the Federal Budget for 2021–22 and the decision by the Australian Government that the licences will be discontinued from 1 July 2024. The reforms follow the Royal Commission into Aged Care Quality and Safety.
Under the proposed new arrangements, the number of places that can be provided by an aged care provider will be driven by demand from senior Australians with an assigned place. Government funding will be allocated accordingly.
We understand that while the relevant legislation may not be passed before the next Federal election, the reforms are seen to create a better system for residential aged care and have broad industry support.
In September 2021, the Department of Health released a discussion paper Improving Choice in Residential Aged Care – ACAR Discontinuation. The focus of consultation is on the transition to the new arrangements and their implementation; the focus is not on whether the bed licences will be discontinued.
The discussion paper indicates that a large number of new bed licences remain available to be allocated at no charge in the period until 1 July 2024 and that a large number of provisional places will also be available: see page 33. There may also be some trading in licences, or acquisitions of businesses that hold licences, in order to secure market share ahead of 1 July 2024.
The discussion paper, on page 30, says:
Further measures to mitigate the risk of the removal of bed licences may be considered where necessary. However, at this stage there are no plans to provide direct compensation to providers for the removal of licences. This is because licences are provided by the Government at no cost, and businesses providing quality services are expected to continue to attract residents.
Aged care providers should consider how the discontinuation of the current licencing regime may affect any bed licence intangible assets appearing on their statements of financial position in the lead up to 1 July 2024. In particular, aged care providers should consider:
- Whether to change the amortisation period: Given the Australian Government’s announcement and the information provided in the discussion paper, the remaining lives of the bed licences would not be expected to extend beyond 1 July 2024. There appears to be no reason to believe that providers will receive compensation for the licences that can be recognised as an asset and treated as a residual value for licences held until that date.
- Whether to impair the licences: Aged care providers may have impairment indicators and should consider whether any bed licence intangible assets should be impaired given the remaining expected lives of the licences.
The licences will be impaired where the carrying amount exceeds the higher of fair value less costs of disposal (FVLCD) and value in use (VIU). The value at which licences might be transferred and their FVLCD might be reduced given the information provided in the discussion paper about the availability of new licences and provisional licences at no cost before 1 July 2024.
VIU may not be relevant for not-for-profit providers where the future economic benefits are not primarily dependent on the ability of the provider to generate cash inflows.
In the case of for-profit providers, it is necessary to consider impairment of the licences as separate assets rather than as part of a cash generating unit where either:
- the VIU of the bed licences can be estimated to be close to its FVLCD and FVLCD can be measured. These values may become close given the reduced remaining expected lives of the licences; or
- the licences do not generate cash inflows interdependently with other assets, which may be the case where there is an intention to sell the licences.
- Whether there is a basis for any revaluations of licences: There appears to be no evidence that there is an ‘active market’ for licences that could support revaluing the bed licences. Similarly, any approval to provide aged care services is specific to the provider and could not be revalued.
- Other assets: Amounts allocated to bed licences in past business combinations cannot be retrospectively reallocated to goodwill or other assets.
- Whether to disclose judgements and uncertainties: Providers should disclose any significant accounting judgements and any sources of estimation uncertainty.
While the discontinuation of the bed licences may result in a provider reporting an accounting loss, the cash flows of the business and ability to continue as a going concern may not be affected.
10. Did the temporary relief for directors where a company traded while insolvent affect reporting requirements on insolvency and going concern?
The requirements to provide a solvency statement in the directors’ declaration and assess whether an entity is a going concern remain in place. Transparency on the financial condition of entities and on solvency and going concern are important to the confidence of users of financial reports and their ability to make informed decisions. Speculation in the absence of full disclosure can also be more damaging to an entity than having full and frank disclosure.
Measures introduced in March 2020 in response to COVID-19 provided temporary relief for directors from personal liability for insolvent trading in certain circumstances. This safe harbour may assist a company with short-term financial issues to survive the COVID-19 pandemic.
The Coronavirus Economic Response Package Omnibus Act 2020 relieved directors from personal liability under section 588G(2) of the Corporations Act during the period 25 March 2020 to 31 December 2020 where a company traded while insolvent and a debt was incurred:
- in the ordinary course of the company’s business
- before any appointment of an administrator or liquidator.
The temporary safe harbour relief did not apply to section 588G(3), under which it is an offence if a director suspects a company incurs a debt when insolvent, or would be insolvent by incurring the debt, and their failure to prevent the company incurring the debt was dishonest.
The temporary relief did not extend to relief from statutory and common law director’s duties. These include the duty to act in the best interests of the company as a whole (which can involve directors taking into account the interests of stakeholders beyond shareholders including creditors when the company is in financial distress). These duties also involve the duty to act with care, diligence and good faith and not to use a director’s position or information obtained as a director to gain an advantage or cause detriment to the company.
Directors were, and continue to be, encouraged to seek advice early from a suitably qualified and independent adviser about the company’s financial affairs and the options available to manage the disruption caused by the COVID-19 pandemic.
See ‘Directors duties in the context of COVID-19’, article by Commissioner John Price, 16 April 2020.
The uncertainty created by the COVID-19 pandemic may make it more difficult to make assessments on solvency and going concern. Assessments of solvency and going concern are distinct tests that have regard to their own specific criteria:
- any entity is solvent if it will be able to pay its debts as and when they become due and payable
- an entity is a going concern unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so.
It is possible for an entity to be solvent but not a going concern. There was also temporary relief in certain circumstances from parts of the provisions that make insolvent trading an offence (see FAQ 10), and there may have been cases where some entities were insolvent but a going concern. For example, an entity may be facing short-term liquidity issues due to the impact of the COVID-19 pandemic on short-term cash inflows and may be unable to pay suppliers within normal credit terms. The business may be fundamentally sound, has forbearance from its lenders, and is expected to meet its debts in coming months. While the temporary relief is no longer available, directors needed to exercise caution in relying on that temporary relief, be mindful of its limitations, and may have needed to seek appropriate professional legal and financial advice.
The solvency statement in the directors’ declaration concerns the company’s capacity to pay debts as and when they become due and payable, which it has incurred as at the time of that declaration. Directors should also take into account debts which will be incurred in the foreseeable future.
Directors must have reasonable grounds for believing that the company will be able to pay its debts as and when they fall due. In meeting the reasonable grounds requirement, directors should consider information such as:
- cash balances or overdrafts, the amount and timing of operating cash inflows, access to credit lines and undrawn facilities, and the liquidity of non-core investments
- the timing and amount of payment obligations, supplier credit terms, debt repayment dates, and the end date for any loan repayment or rent holidays
- the ability of customers and borrowers (including related parties) to meet their obligations to the company, including meeting credit and repayment terms
- known or likely changes in economic and market conditions, consumer behaviours and demand, inventory turnover, supply chains, production processes, and ability to deliver goods and services
- ability of the company to comply with debt covenants and normal terms of credit, renegotiate debt arrangements, and refinance maturing debt
- the possibility of withdrawal of financial support by major lenders
- the possibility of debt factoring arrangements, customer supply chain financing or financial support by a parent company not continuing
- ability of a parent or shareholders of the company to meet any financial support arrangements
- the solvency of any entities to which the company has given financial guarantees or offers of financial support
- the extent and timing of any government support and travel or other restrictions
- any uncertainties affecting the above.
Directors should appropriately question this information, the reasonableness of any key underlying assumptions, and the reliability of processes used to produce the information. Directors should ensure that the information is consistent with their understanding of the business, the markets in which the company operates and any other relevant matters.
The work undertaken in making an assessment on going concern may not be sufficient to address solvency, given that a company might be a going concern but not solvent. There may be circumstances where a business is fundamentally sound and the company will continue to trade despite any short-term solvency issues. In these circumstances, directors are encouraged to seek advice to help develop a course of action to address the current financial position (refer s588GA).
Depending upon the circumstances of each company, the solvency statement may be that:
- the directors have reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable
- there is a material uncertainty as to whether the company will be able to pay its debts as and when they become due and payable – for example, the ability to renegotiate loans due for repayment, or
- the directors do not have reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable.
The doubt over whether the company can pay its debts as and when they become due and payable may become so great that it is not appropriate for directors to give a positive solvency statement or one stating there is material uncertainty. In these situations, the directors should make a negative statement stating that the directors do not have reasonable grounds to believe that the company is able to pay its debts as and when they fall due.
A statement that refers to material uncertainty or that is a negative statement must be clearly worded and in sufficient detail for the reader to comprehend the statement fully. The statement should identify the item which is the subject of qualification and disclose monetary details where practicable.
In addition to the financial report, the directors’ declaration and solvency statement are within the scope of the auditor’s report. In that context, auditors should perform appropriate audit work in relation to the solvency statement.
While the solvency statement is made at a point in time, the requirements (as amended) concerning solvent trading apply at all times. Directors should review solvency as frequently as is necessitated by the circumstances of a company.
See Regulatory Guide 22 Directors’ statement as to solvency (RG 22).
12. What are the auditor’s obligations on assessing solvency and reporting suspected insolvent trading to ASIC?
The solvency statement is part of the financial report. The auditor must form an opinion about whether the report complies with the requirements of the Corporations Act. Auditing standards require the auditor to obtain reasonable assurance as to whether the financial report as a whole is materially misstated, and whether the company is solvent could be expected to be material in nature.
In this context, the auditor should perform relevant audit work on whether the company will be able to meet its debts as and when they fall due. The auditor plans the nature, timing and extent of audit work based on their understanding of the business and their assessment of risk, and reassesses the planned audit work having regard to relevant matters identified during the audit. Given the impact of the COVID-19 pandemic, it is particularly important that the auditor considers possible indicators of solvency risks, considers information such as that outlined in FAQ 11 and performs appropriate audit work on the reliability of the information. In performing their work, the auditor should apply appropriate professional scepticism.
In the current environment, a business may be fundamentally sound in the long term and continues to trade, but still have short-term solvency issues and not be able to meet its debts as and when they fall due.
For financial reporting purposes, solvency is assessed at the time of the directors’ declaration and auditor’s report. Audit work otherwise performed on the income statement, balance sheet and subsequent events may not be sufficient to cover solvency. Audit work on cash flows in a discounted cash flow model for asset impairment testing may not be sufficient for solvency purposes because, for example, the impairment model is unlikely to include all cash flows of a company and the timing of cash flows in an impairment model may not be sufficiently precise.
Temporary relief for directors from personal liability for debts incurred when a company was, or would become, insolvent was available until 31 December 2020 in certain circumstances (see FAQ 10 above). An auditor of a company who at any time of the year suspects that the insolvent trading provisions (as amended by the Coronavirus Economic Response Package Omnibus Act 2020) or other duties of directors and officers under the Corporations Act have been contravened should report the matter to ASIC under section 311 of the Corporations Act. Given the amendments, a company continuing to trade while insolvent may not always be a contravention. However, an auditor should report if, for example, the failure of a director to prevent the company incurring a debt may have been dishonest or if debts have been incurred outside the ordinary course of the company’s business.
See Regulatory Guide 34 Auditor’s obligations: Reporting to ASIC (RG 34).
ASIC has extended the deadline for both listed and unlisted entities to lodge financial reports under Chapters 2M and 7 of the Corporations Act by one month for certain balance dates up to and including 7 January 2021 and for balance dates between 23 June 2021 and 7 July 2021.
Extended reporting deadlines are only available on a case-by-case basis for balance dates between 8 January 2021 and 22 June 2021. Applications must be made to ASIC for any such extensions.
The extended deadlines for lodgement up to 7 January 2021 balance dates were to assist those entities whose reporting processes took additional time due to remote work arrangements, travel restrictions and other impacts of the COVID-19 pandemic.
The extended deadlines for balance dates between 23 June 2021 and 7 July 2021 may assist with any pressures on resources for the audits of smaller entities and provide adequate time for the completion of the audit process taking into account challenges presented by COVID-19 conditions. Factors that might affect audit firm resources could include restrictions on travel into Australia and increased staff turnover.
The reporting for larger listed entities at 30 June 2021 is unlikely to be affected. However, directors of some smaller and mainly unlisted companies may be asked by their auditors to facilitate the spreading of deadlines for audited full year financial reports.
When deciding whether to depart from the normal statutory deadlines, directors should consider the information needs of shareholders, creditors and other users of their financial reports, as well as meeting borrowing covenants or other obligations.
Unlisted entities are able to take one additional month to lodge financial reports for year ends from 31 December 2019 to 7 January 2021 and from between 23 June 2021 and 7 July 2021. Listed entities are able to take one additional month to lodge full-year and half-year financial reports for 21 February 2020 to 7 January 2021 balance dates and for 23 June 2021 to 7 July 2021 balance dates.
Listed entities are required to inform the market when they rely on the extended period for lodgement. These entities may also find it desirable to explain the reasons for relying on the extended deadlines.
Similar extended deadlines are available for sending reports to members, but some of those deadlines also operate by reference to the date of the next AGM.
For further information about the extended financial reporting deadlines, see Media Release (20-084MR) ASIC to provide additional time for unlisted entity financial reports (9 April 2020), Media Release (20-113MR) ASIC to further extend financial reporting deadlines for listed and unlisted entities and amends ‘no action’ position for AGMs (13 May 2020), Media Release (20-276MR) ASIC to further extend financial reporting deadlines for listed and unlisted entities and amends ‘no action’ position for AGMs (11 November 2020), and Media Release (21-082MR) ASIC to extend deadlines for 30 June 2021 financial reports and amends ‘no action’ position for AGMs (23 April 2021).
For the instruments providing for these extensions, see ASIC Corporations (Extended Reporting and Lodgment Deadlines – Unlisted Entities) Instrument 2020/395, ASIC Corporations (Amendment) Instrument 2020/396, ASIC Corporations (Extended Reporting and Lodgment Deadlines – Listed Entities) Instrument 2020/451, ASIC Corporations (Amendment) Instrument 2020/452, ASIC Corporations (Amendment) Instrument 2020/1080 and ASIC Corporations (Amendment) Instrument 2021/381.
14. Can entities seek more than one additional month to complete their financial reporting obligations?
Timely reporting by entities is important and we envisage that the additional one month to lodge financial reports will be sufficient for the vast majority of those entities that may require more time. However, ASIC will consider applications to further extend the reporting deadline for individual entities in appropriate circumstances. Where possible, any applications should be made at least 14 days before the normal reporting deadline. Applications can be made using the ASIC Regulatory Portal and should include sufficient information for ASIC to assess the impact of market conditions and COVID-19 developments.
See Regulatory Guide 43 Financial reports and audit relief (RG 43).
ASIC adopted a ‘no action’ position for AGMs of public companies with 31 December 2019 to 7 July 2021 year ends. ASIC will not take action if an AGM is held up to seven months after year end. The ‘no action’ position also applies where holding an AGM in January or February 2021 results in the requirement to hold an AGM in the 2020 calendar year not being met.
ASIC Corporations (Extension of Time to Hold AGMs) Instrument 2021/770 now formally gives all public companies with year ends between 21 February 2021 and 7 July 2021 up to 7 months after year end to hold their AGM. The instrument also gives public companies limited by guarantee with year ends between 24 January 2021 and 7 April 2021 up to 9 months to hold their AGM. Directors must comply with their directors’ duties in deciding whether it is appropriate to rely on the relief.
The Treasurer had issued determinations amending the Corporations Act for six months from 6 May 2020 and the six months from 22 September 2020 which facilitated meetings, including AGMs, being held using one or more technologies (virtual technology) that give all persons entitled to attend a reasonable opportunity to participate without being physically present in the same place: see Corporations (Coronavirus Economic Response) Determination (No. 1) 2020 and Corporations (Coronavirus Economic Response) Determination (No. 3) 2020.
To assist companies and responsible entities, ASIC had issued guidance setting out its views on the appropriate approach to calling and holding meetings using virtual technology and the requirements of the determination.
Legislation now covers the holding of virtual meetings until 31 March 2022: see Treasury Laws Amendment (2021 Measures No. 1) Act 2021.
See Media Release (20-068MR) Guidelines for meeting upcoming AGM and financial reporting requirements (20 March 2020), Media Release (20-113MR) ASIC to further extend financial reporting deadlines for listed and unlisted entities and amends ‘no action’ position for AGMs (13 May 2020), Media Release (20-276MR) ASIC to further extend financial reporting deadlines for listed and unlisted entities and amends ‘no action’ position for AGMs (11 November 2020), Media Release (21-061MR) ASIC adopts ‘no-action’ position and re-issues guidelines for virtual meetings (29 March 2021), and Media Release (21-236MR) ASIC extends time for companies to hold annual general meetings.
16. Is an auditor required to report to ASIC where a company uses the ‘no action’ position on its AGM?
Where a public company with a year end from 31 December 2019 to 7 July 2021 holds its AGM between five and seven months after year end, the auditor is not required to report a contravention to ASIC under section 311 of the Corporations Act. Given that ASIC has adopted a ‘no action’ position, the contravention is unlikely to be considered significant for the purposes of section 311 provided the directors hold the AGM within the seven months.
See Regulatory Guide 34 Auditor’s obligations: Reporting to ASIC (RG 34).
17. Will ASIC consider additional time for listed and unlisted entities to report and hold AGMs for periods ending after 7 July 2021?
While we do not envisage making further extensions of time generally available to listed and unlisted entities, ASIC will continue to monitor how market conditions and COVID-19 developments are affecting financial reporting and AGM obligations for entities with balance dates after 7 January 2021. We may make further announcements depending on market developments.
Focus areas for audits of financial reports under COVID-19 conditions include:
- addressing the matters affecting financial reports discussed in these FAQs – particularly the areas, factors and disclosures outlined in FAQs 1, 2 and 3 – and Media Release (20-157MR) Focuses for financial reporting under COVID-19 conditions (7 July 2020), Media Release (20-325MR) ASIC highlights focus areas for 31 December 2020 financial reports under COVID-19 conditions (15 December 2020) and Media Release (21-129MR) ASIC highlights focus areas for 30 June 2021 financial reports under COVID-19 conditions.
- understanding how the businesses of the entity being audited have been, and are likely to be, affected by factors such as those listed in FAQ 2 (including the impact of such factors on suppliers, customers, investees and others)
- identifying the impact of non-COVID-19 changes affecting the businesses of the audited entity, such as new competitors and changes in technology
- identifying and responding to fraud and other risks, including uncertainties and difficult judgements on assets, provisions, solvency, going concern and disclosures
- addressing the impact of remote work arrangements during and since the year end on:
- the ability to effectively conduct audits remotely, including limitations on interactions with officers of the audited entity and accessing records
- the design and effective operation of key company internal controls, and the impact on the nature, timing and extent of audit procedures
- the audit work on stock counts, fixed asset counts, and system walk throughs, and the ability to conduct procedures effectively using virtual technology
- the impact on component audits and restrictions on access to records
- considering reduced performance materiality due to assessed risks and reduced asset values, revenue and/or profit affecting the nature, timing and extent of audit procedures
- applying professional scepticism and appropriately challenging estimates, assumptions, assessments, and the sufficiency and appropriateness of audit evidence
- applying required experience and expertise to the audit given the challenges and judgements involved, including increased partner involvement, appropriate supervision and review, and the use of the auditor’s own experts
- assessing the adequacy of data, assumptions and past approaches in supporting asset values and other estimates, as well as the auditor’s own analytical procedures
- considering the adequacy of disclosures about matters such as estimation uncertainties, key assumptions and government support, which are likely to be material for investors and other users in the context of the overall financial report (including half-year reports)
- reading the OFR for material inconsistencies with the financial report and the auditor’s knowledge, including the matters outlined in FAQ 4, and reporting any suspected contraventions to ASIC in accordance with section 311
- planning and project management to minimise deadline pressures
- documenting audit work and the reasons for judgements made.
18. What is the impact on the audit report and should all audit reports contain a general emphasis of matter paragraph on uncertainties relating to the COVID-19 pandemic?
There may need to be increased numbers of emphasis of matter paragraphs (EOMs) in audit reports, material uncertainty related to going concern (MURGC) paragraphs, and modified audit opinions (qualified, adverse and disclaimers of opinion).
Auditors should also be mindful that any inappropriate overuse of EOMs may diminish the value of EOMs and the ability of users to focus on the required EOMs.
EOMs draw attention to information in a financial report fundamental to users’ understanding of the financial report. Whether an auditor should include an EOM in their audit report referring to information in the financial report about any uncertainties associated with the impact of the COVID-19 pandemic, should be assessed on a case-by-case basis having regard to the specific circumstances of each entity.
Any EOM should refer to the entity’s disclosures about specific uncertainties relating to the circumstances of the audited entity and the matter giving rise to the uncertainty. For example, this may include referring to specific matters affecting estimates for the value of particular assets.
See also the examples of factors that may affect assets, liabilities and going concern assessments in the answer to FAQ 2 above.
Where a matter is covered in a key audit matter or a MURGC paragraph, it is not also covered in an EOM. If there is a MURGC and it is adequately disclosed in the financial report, the audit report should include a MURGC paragraph. An EOM is not a substitute where a modified audit opinion is required.
A modified audit opinion is required if, for example, the auditor has been unable to obtain sufficient appropriate audit evidence about the impacts of the COVID-19 pandemic on the values of particular assets, or concludes that the impact of COVID-19 has not been appropriately reflected in the financial report and therefore it is not free from material misstatement.
An auditor must complete all necessary audit work that it is possible to undertake to support their opinion before issuing the audit report, even if reporting deadlines (including extended reporting deadlines) will not be met.
However, an auditor should not delay their audit report where information needed for the financial report or supporting the audit opinion will not be available to the auditor for a period and the matter is outside the control of both the auditor and the audited entity, particularly where the period is prolonged or uncertain. The auditor should issue a qualified opinion or disclaimer of opinion in respect of any significant limitation on the scope of the audit.
Finalisation of the financial report, directors’ report and the audit report should not be delayed beyond the reporting deadline pending the resolution of matters such as the audited entity’s funding situation or the impact of the COVID-19 pandemic on the business becomes clearer.
The auditor should also consider the need to report a contravention to ASIC if the financial report is not completed within the applicable reporting deadline.
See Regulatory Guide 34 Auditor’s obligations: Reporting to ASIC (RG 34).
A company is required to pay the auditor’s reasonable fees and expenses (section 331 of the Corporations Act). The setting of audit fees is a commercial decision by companies and their auditors. The overall audit fee setting process should be managed by the directors and the audit committee to ensure that fees are not set at a level that could lead to audit quality being compromised.
When companies are under financial pressure, audit fees can be affected in the pursuit of general cost reductions. However, audit fees are usually a small proportion of costs, and reducing them might not have a significant impact on a company’s profit and cash flows.
The impact of the COVID-19 pandemic may significantly increase audit time and the expertise required. Auditors may be faced with some more challenging judgements in areas such as assessing asset values and whether a company is a going concern.
Remote work arrangements of companies and auditors may affect audit effort and time. For example, the company’s internal control environment and processes may change, stocktakes may need to be observed remotely, and remote work may create communication or other inefficiencies in the audit process.
See Information Sheet 196 Audit quality – The role of directors and audit committees (INFO 196).
21. How are ASIC’s regulatory activities in relation to financial reporting and audit changing in response to the COVID-19 pandemic?
ASIC’s financial reporting surveillance and audit inspection activities are continuing given their importance to confident and informed markets and investors through quality financial reports supported by quality audits.
Consultation on possible routine reporting of audit inspection findings to audit committees and some parts of our reviews on culture and talent at the largest audit firms were deferred.
See Changes to regulatory work and priorities in response to COVID-19 for updates on financial reporting and audit activities.