Year-End Stocktakes: COVID-19
In these unprecedented and uncertain times, the preparation of year-end accounts will not be high on many people’s list of things to worry about; but considering some things now, before the year-end, may prove to be invaluable in the future when drawing up your year-end financial statements.
Stock is often a material figure in a set of financial statements, which falls outside the normal double-entry system, and therefore a full year-end stocktake is normally required to establish the quantity, condition and value of stock. If the financial statements are subject to audit the extent of the auditor’s involvement will need to be considered. In the current circumstances, it is vital that the entity engages with its auditors on a timely basis to map out its approach.
It is important to note that there are very few absolutes. Every business needs to consider its own specific circumstances. Some industries and/or some businesses will not be as adversely affected by the current government-imposed restrictions as others and an appropriate approach will vary on a case by case basis.
The following questions should be considered:
- Is stock material (and where)?
- Can the stock be counted at the year-end?
- Is the stock going anywhere?
- Are there continuous stocktaking procedures in place?
- Can the year-end be changed?
- Requirements for auditors
- What is the likely effect on the audit report?
Is stock material (and where)?
It’s an obvious question but the answer may be different from previous years. If you have been able to dispatch stock over the last few weeks but nothing has been coming in (perhaps an export embargo from overseas) the stock levels may be lower, or lower at least at some sites. On the other hand, if the reverse is true and stock has been building up, you may have material levels of stock at sites where previously it was less of a problem. Don’t forget stock held at third party locations. Will the third parties be able to count stock and provide you with similar confirmations as previously?
Can the stock be counted at the year-end?
Given the current situation and the latest government guidance for employers and businesses on coronavirus, it is likely that in many cases, physical stocktake will be impracticable at the balance sheet date.
If you do intend to perform a full year-end stocktake, as auditors under the current virtual lockdown conditions, we certainly will not be able to attend such a stocktake in person (even if you wanted us to). There has been quite a lot of talk in the audit profession of virtual attendance (for example using video call facilities). We will be willing to look at this as a method of gathering audit evidence but we approach it with a high degree of scepticism and there are no guarantees that this would be sufficient.
Is the stock going anywhere?
If there is no stocktake and limited or no activity because of the lockdown, the levels and value of stock (if you hold perishable goods we are sure you will have addressed that problem long before reading this article) will be similar whenever the restrictions are lifted. Even where there is some limited inward and outward movement of stock, if this is carefully recorded it is eminently possible that the year-end values can be attained by conducting a stocktake at a future date with a roll-back to the balance sheet date. Alternatively, you may have carried out an interim stocktake before the year-end and it may be possible to use those results and roll-forward to the balance sheet date.
As auditors, we will be able to work with this. What of course it means is that when you are able to access your stock again, you will need to give priority to counting it (which might not otherwise be your number one priority). Perhaps limited numbers of staff observing strict rules of hygiene could be utilised before trade starts up again in full. If that is the approach, as auditors we will need to know when this is going to happen so that we can also attend.
Are there continuous stocktaking procedures in place?
Of course, this is far less of a problem if you have a well-controlled and reliable continuous stock counting system. You may be able to rely on these records and, subject to our usual testing of the controls (and we are mindful that the operation of controls may have changed in these exceptional times), we would hope to be able to audit stock in this way as we have done so before.
Many businesses have some form of continuous stocktaking system but use the year-end full stocktake as a back-up. Again, as auditors, we will work with whatever is available.
Can the year-end be changed?
It may be worth considering whether it is expedient to change the accounting reference date to later in the year (for example, in accordance with Companies Act 2006 section 392). We can discuss the details of this with you. In so doing, the quantification and valuation of stock will be deferred, and potentially removed. However, this is a big decision; altering the accounting period may have other business implications (both positive and negative) to consider.
Requirements for auditors
The requirements of the auditing standards have not changed as a result of the coronavirus pandemic. If inventory is material to the financial statements, the auditor needs to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by attendance at physical inventory counting, unless impracticable.
There has been a long-standing debate over the years as to what “impracticable” really means but there is little dispute that it has real meaning in the current state of the world. If auditor attendance is impracticable (and of course that includes if a stocktake does not take place), then the auditor is required to perform “alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory”. Where it is not possible to perform these procedures, this will likely result in a modified audit report.
What is the likely effect on the audit report?
By considering the questions above, we as auditor are able to work with management to try to avoid a modified audit opinion over inventory. Should this become necessary, the form of the modification in this circumstance will usually be that of a qualification in respect of a limitation in scope.
In this scenario, we will make specific reference to COVID-19 in the basis for the qualified opinion paragraph.
Whilst no-one wants this outcome, we believe audit reports for year-ends at around this time will be read in context; it is safe to say there will be many more qualified reports than in previous years. Therefore, we hope that users of the financial statements (including the audit report) will apply common sense. Even where that might seem optimistic (for example if credit rating agencies are using a tick-box approach) the volume of qualified opinions will have an effect.
It is also worth noting that, aside from the year-end stocktake issue, it is not yet clear what the broader consequences of COVID-19 will have on financial reporting. No-one can reliably predict what the circumstances will be in the coming weeks and months as companies move toward the finalisation and approval of their financial statements. Commentary from our regulator the FRC indicates that it is highly likely that more extensive disclosures in the financial statements and modifications to audit reports will become increasingly commonplace.
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