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The Pandemic has Changed Auditing. What Do You Need to Know?

by: Smith and Howard

October 6, 2020

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The COVID-19 pandemic has changed the way businesses function in a multitude of ways. A major change was the move to remote operations, which meant financial reporting processes went from in-person to virtual. As a result, any business with a 2020 fiscal year end or that received an Economic Injury Disaster Loan (EIDL) through the Coronavirus Aid, Relief and Economic Security (CARES) Act needs to be aware that preparing for audits will be different than in previous years. As businesses prepare for upcoming audits and the year ahead, owners should start talking to their auditors sooner rather than later about the impact of the pandemic and related legislation on their operations. This will enable auditors to prepare for accessibility issues in terms of obtaining the information they require and speaking with the employees they must interview for the audit.

Below, we focus on three key areas that are shifting for our audit clients: Inventory, Internal Controls and Fraud.

Inventory

Businesses should begin thinking about their plans for inventory counts well in advance, especially with the additional considerations around employee health resulting from COVID-19. Businesses that perform inventory counts on an on-going rather than annual basis are probably already addressing this. To get ahead on inventory observations, businesses that perform traditional year-end inventory counts need to consider the following questions so that they are prepared for their audits:

  • How will they perform the inventory count in the midst of the pandemic?
  • Will their personnel be able to socially distance and adhere to their business’s COVID-19 policies while performing an inventory count?
  • Will they have to use fewer people to do the inventory count because of social distancing and other pandemic-related health protocols?
  • Does using fewer people mean the inventory count will take more time than it has historically?
  • If the count takes longer, what will be the impact on operations/shipping and receiving?

We continue to perform inventory observations on-site. The pandemic has not affected that aspect, but it does mean that our auditors will discuss safety procedures each business has in place so that we can follow them.

Internal Controls

As a result of transitioning to work-from-home operations, businesses need to consider which of their existing control procedures may have been circumvented. Businesses that were already using technology may have experienced little to no change. Others, however, will have some questions to answer:

  • Did moving to an office environment with only a few “essential” personnel in attendance change how checks or cash receipts were received, logged and deposited?
  • Did cash disbursements continue to go through the normal approval process?
  • In general, were there any key control processes that may have been circumvented because a smaller in-office staff made it difficult to maintain segregation of duties?

If a business implemented changes to controls, your auditor must be informed early about alterations that have taken place so they can understand and take them into account when planning the audit. The auditor can also determine if any additional audit procedures are necessary. It is important for businesses to consult with their auditor to ensure that any changes implemented are understood and can be correctly audited.

Fraud

The Association of Certified Fraud Examiners created a model called The Fraud Triangle, which explains the factors that may compel someone to commit fraud in the workplace. The model consists of three components – need, opportunity and rationalization. The financial stress caused by the COVID-19 pandemic may have exponentially increased the probability of these occurring:

  1. Need – individuals whose personal financial situation has been negatively impacted by the recent economic downturn, for example with unexpected expenses compounded by job loss within the family, could be under financial pressure and have increased incentive to steal money or assets from their employer. In the same way, businesses that have experienced a slowdown in demand for their products but have debt may attempt to alter their financial results in order to appear to meet the terms of a loan covenant.
  2. Opportunity – if key controls were circumvented as a result of the pandemic, as discussed in the Internal Controls section, particularly in terms of the business’s normal segregation of duties, this could lead to increased opportunities for fraud through the theft of business assets and misstatement of financials.
  3. Rationalization – financial stress or desperation could cause people who would not commit a crime under normal circumstances to rationalize fraudulent activities as something necessary for survival.

The Paycheck Protection Program, which was part of the CARES Act and was created to provide loans to small businesses, has been linked to dozens of cases of fraud. Applicants have lied about the size of their operations and costs in order to get funding from the Small Business Administration. There were several instances where businesses that did not need the funds nonetheless applied for and received loans. Some even created shell companies, illustrating the elaborate lengths to which fraudsters have gone during the pandemic. It is because of this abuse of the program that the SBA stated anyone who received more than $2 million in funds would be audited.

Other considerations

There are several other matters that need to be considered when preparing for 2020 fiscal year audits. Among them:

  • Noncompliance – the CARES Act was a massive, complex piece of legislation that was rushed through Congress, which means that the marketplace is still working on fully understanding what it contains. As a result, it is possible that some businesses could unintentionally violate parts of the act or related regulations.
  • Allowance for Doubtful Accounts (AFDA) – if your business is involved in an industry that has been significantly impacted by the pandemic, like travel or hospitality, there is a greater risk that monies your customers owe you may not be collected. Looking only at the customer’s historic collection rates and method used to calculate the AFDA may not accurately reflect the AFDA estimate in the current environment.
  • Goodwill or Intangible Assets – If your business has goodwill or intangible assets, you will need to consider whether impairment is necessary. Are future cash flows from those intangible assets equal to, or will they exceed, the book value? Has the economic downturn caused by the pandemic permanently impacted expected cash flows related to those intangible assets?
    It may be necessary to hire an expert valuation firm to determine the value of those assets and whether impairment is needed.

As we said at the beginning of this article, it is important to talk to your auditor early. The pandemic has had a huge impact on many businesses, and legislation like the CARES Act and PPP could lead to more complicated audit processes. If you have any questions or concerns about how to prepare for an upcoming audit, please contact your Smith & Howard assurance advisor or fill out the form below. Additionally, if you have any tax, controls or fraud concerns, we recommend you speak with a professional.

 

Source of information on The Fraud Triangle:
The Association of Certified Fraud Examiners – https://www.acfe.com/fraud-triangle.aspx

 

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