EnglishSelected topic: Consequences of the COVID-19 pandemic on the accounting and audit functions of business, role technology in addressing the consequences, and emerging challenges.
Business’s accounting and audit functions in times of COVID-19 pandemic and the role of technology to address the emerging challenges
The number of studies researching the impacts of COVID-19 still holds a small part and the analysis is mainly based on a broad perspective. This research aims to investigate the consequences of COVID-19 pandemic on accounting and auditing function of a business and identify the role of technology to address the emerging challenges stated before. From a business’s perspective, the research will provide new points of view about the impacts of the pandemic on two specific aspects including accounting and audit. For each aspect, we will provide the significant challenges to give a systematic picture of COVID-19’s impacts. Regarding accounting challenges, it includes going concern assessment from management’s perspective, cash flows forecast, impairment test and physical inventory count. Regarding audit challenges, it includes going concern assessment from external auditors, auditing procedures and internal audit controls. The emerging challenges are partly addressed by analyzing the role of technology. The future research is to conduct an empirical questionnaire to examine the impacts of the COVID-19 on business’s accounting and audit function and the degree of technology application.
1. Introduction
On a global scale, the COVID-19 pandemic has spread out the globe, bringing the tremendous consequences to the economy and society as many countries have enforced the lockdown measures aiming to contain the spread out of the novel pandemic. The cost of nationwide lockdown is not only a sharp decline in government budget but also the increase in wealth inequality (Giovanni Bonaccorsi, et al., 2020). In comparison to other global phenomena such as natural disasters, climate change, global nuclear war, COVID-19 crisis appears to be entirely different because of its direct destructive economic impacts on global scope (Goodell, 2020).
On business scale, most companies are affected by the pandemic since it causes the macroeconomic shocks coupled with market uncertainty and unprecedented risk. The movement restrictions imposed by the governmental authorities in response to COVID-10 outbreak have significantly disrupted the business operations and caused the magnificent uncertainty about the firm’s future outlook combined with the unexpected risks. This special circumstance poses a huge challenge for accounting and audit professionals when evaluating firms’ financial position and the ability to continue as a going concern (KPMG, 2020). Due to the travel restrictions, performing auditing procedures encounters many problems such as counting physical inventory, understanding and accessing the internal control, confirming accounts… (Illuzzi, et al., 2020). Given the constant changes in business operations and plans to adapt to the ongoing challenges, the internal audit faces the challenges to quickly identify the new COVID-19 related-risks and apply the agile and flexible approach to get involved in addressing COVID-19 crisis management (Beldman & Jansen, 2020). When it comes to financial reporting, the uncertainty amidst COVID-19 places a big challenge for preparers of financial statements. Since the financial reports include the forward-looking statements and a wide range of assumptions about the future cash flows, accountants and auditors have to provide adequate information to users of annual reports while not underestimating the firm’s financial position (Armour, et al., 2020).
As the financial statements play a crucial role as they ensure the transparency of the financial market and make investment decisions, the effects of coronavirus outbreak should be reflected on the annual reports and fully explained in the disclosures. The never-experienced-before crisis and its spillover effects such as economic downturn, market volatility, and unforeseen risks mean that investors and other related parties need the high-quality financial statements more than ever (Gould & Arnold, 2020). The investors are the primary users of financial statements (Deloitte, 2020). If a firm fails to ensure its accounting and audit quality, it is supposed to result in lessening the investors’ confidence and trust on reported earnings figures (Shahzad, et al., 2017). As a result, it raises the investment risk and the cost of capital (Gul, et al., 2009). The investor’s fear sentiment caused by the market volatility may also result in negative impacts on the firm’s financial performance (KPMG, 2020).
The application of social distancing measures prevents the implementation of the traditional auditing procedures. Given the important role of auditing procedures in ensuring the quality of financial reports, especially amid COVID-19 pandemic, the Financial Reporting Council (FRC) has issued the specific note in March 2020 providing the guidance for auditors to deal with the practical difficulties (FRC, 2020). Besides applying the appropriate approach to reflect the impacts of COVID-19 on financial statements, the postpone arising from social distancing measures facilitates the application of information and communication technology (ICT) to “for gathering, storing, retrieving, processing, analyzing and transmitting information” (International Accreditation Forum (IAF), 2018). As “face-to-face” methods are not available during the pandemic, the remote auditing is employed to undertake the key steps in the auditing process such as: data collection, recording and sharing, analysis and interpretation (Castka, et al., 2020). Blockchain technology is supposed to become the financial reporting tool and automate the certain processes of accounting and auditing, which results in more trustworthy information (Coyne & McMickle, 2017).
Even though there is a limited number of recent studies deeply identifying the tremendous economic and social impacts of COVID-19, they partly highlight the consequences of this health crisis on a broad perspective. However, only few of them investigates the impacts of the novel pandemic from a business’ perspective on the specific aspect such as accounting and auditing. Also, the role of technology in accounting and auditing dealing with the contemporary challenges is still not thoroughly examined. Therefore, the aims of this paper are to fill those research gaps by researching accounting and audit functions of business in times of COVID-19 pandemic and investigating how technology application can address the emerging challenges. In doing so, we provide the systematic picture of consequences of COVID-19 on accounting and auditing. In this case, our study contributes to the existing literature through identifying the challenges that negatively impact accounting and audit function of a business. Future research is to conduct a questionnaire survey to empirically examine the impacts of the COVID-19 on accounting and auditing and the degree of technology application.
The paper is structured as follows. Section 2 discusses the challenges related to accounting. There are four subsections including going concern assessment, future cash flow forecast, impairment test and physical inventory count. Section 3 relating to the challenges of audit procedures includes three subsections namely going concern assessment, auditing procedures and internal audit controls. In Section 4, we discuss the role of technology in addressing the challenges stated in Section 2 and Section 3. Section 5 is the conclusion.
2. Accounting challenges
2.1 Going concern assessment
To prevent the spread out of COVID-19, many businesses have to suspend their business, which weakens firms’ operating results and financial position. As a result, those consequences raise the question about the continuity of the business as a going concern basis. A going concern is an underlying principle when preparing financial statements, referring to the ability of a company to continue its business within one year after the issuance date of the interim or annual financial reports (Deloitte, 2020).
The constantly changing business environment poses many difficulties for management to make the going-concern assessment since the unprecedented level of uncertainty about the economic prospects, future cash flows, future earnings, and other fundamental inputs of financial reporting. To make the going-concern judgement, there are a variety of factors to take into consideration. In terms of business operation, those factors include but not limited to the extent of business disruption (due to movement restrictions), sluggish demand of products and services (because of economic downturn), digital sales transformation (due to health concerns and social distancing measures) (IFAC, 2020; Kim, 2020). In terms of financial status, it is crucial to take into account the potential liquidity risks, the ability to access different capital sources, financial health of customers and suppliers (IFAC, 2020). Given the complication and uncertainty of the business environment during the COVID-19, it is challenging for management to capture the interactive effects of multiple factors. In times of global crisis, the management should consider the diverse factors that align with internal accounting policies (Zéman Z., 2018). Besides considering different factors, the complication of going-concern assessment also lies in the inclusion of different scenarios with varying assumptions, coupled with the evolving nature of uncertainties.
2.2 Future cash flow forecast
One of the main challenges in preparation of financial reports amidst COVID-19 is the estimates of forward-looking cash flow and earnings. The forward-looking information is also applied to assess the impairment of non-financial assets, the continuity of a business as a going concern.
The complications associated with the preparation of forward-looking information given a difficult economic environment include but not limited to pandemic’s trajectory, the inclusion of many dependent variables and the gap between macro conditions and firm’s specific context (Deloitte, 2020). In terms of the ultimate trajectory of the pandemic, it still remains uncertain since there is no sufficient reliable data on when the novel coronavirus will be contained, and how long the closures will last. The uncertainty leads to many possible outcomes, which means different scenarios with different assumptions are applied to estimate future cash flows and earnings. In addition, estimating cash flows and earnings include many social and economic variables that are difficult to forecast. Those variables are movement restrictions, the degree of citizen’s compliance towards restrictions, and the economic stimulus program. After capturing macro conditions, the management needs to evaluate its own specific circumstance to make adjustments of its future cash flows and earnings.
2.3 Impairment test
International Financial Reporting Standards (IFRS) requires the entities to conduct the impairment test for long-lived assets at the reporting date when there is an indication of impairment. The enormous market volatility caused by the novel coronavirus makes it necessary to reassess the fundamental inputs of financial statements such as non-financial assets. The uncertainty stemming from COVID-19 pandemic coupled with its unprecedented nature poses challenges for management to select the appropriate assumptions and develop reliable estimates. Besides the choice of estimation method, market disruption due to the social distancing measures may create the uncertainty during the estimation process.
In comparison to the recoverable amount, an asset is impaired when its carrying amount is higher. During the COVID-19 crisis, the carrying amount may not be recoverable due to the decrease in demand, business/supply chain disruption, cancellations/delays of orders, concessions to customers, financial difficulties from customers, decline in stock price (Deloitte, 2020). To estimate the recoverable amount of an asset, it turns to forecast expected cash flow because it is the most effective approach to reflect the uncertainties of COVID-19 (Deloitte, 2020). Given the increased challenge of capturing cash flows amidst COVID-19, the management faces even more challenges, as the assets that need to perform impairment assessment include goodwill and intangible assets with an indefinite useful life.
2.4 Physical inventory count
The management of the company is required to develop the procedures to count physical inventory at least once a year as a basis for the preparation of financial statements. Due to significant health and safety concerns, movement restrictions, nationwide lockdown, implementing a physical inventory count is one of the significant accounting challenges. Not conducting an inventory count on the balance sheet date is one of possible scenarios arising due to COVID-19. The restrictions imposed by competent authorities to combat the COVID-19 outbreak prevent management and its employees from traveling and visiting inventory locations to make inventory inspection. This situation requires management to inform the external auditors, internal audit committee, and governance committee. Another scenario is that the inventory count is conducted at a date other than the date of financial reports. Management has to ensure the effectiveness of the inventory control system and reflect any changes in inventory between the count date and the date of financial statements. Additional factors should be taken into consideration including (1) whether the perpetual inventory records are properly adjusted, (2) reliability of perpetual inventory system, (3) reasons for difference between physical count and perpetual inventory records (KPMG, 2020).
Another notable challenge is to revalue inventory due to the potential of price fluctuations during the pandemic. Inventories should be written down to the lower of cost and the net realizable. Given the uncertainties of COVID-19 associated with the current market conditions, management faces challenges to obtain the net realizable value since it requires the adjustments and consideration of all available data on prices before and after the balance sheet date (PWC, 2020).
3. Audit challenges
3.1 Going concern assessment
In response to the spread of COVID-19 pandemic, many companies have closed their business, which could be difficult for auditors to examine whether in current situation, company has enough ability to continue as a going concern, or in extreme cases, whether a going concern is still an appropriate basis for financial reporting (KPMG, 2020). Besides, the closures of physical stores “do not necessarily mean that a material uncertainty automatically exists” since the businesses are able to maintain their revenue stream through shifting their focus to online sales (IFAC, 2020). The significant doubt on the continuity of an entity will rather depend on the nature and specific circumstances of the entity. During global crisis, where there are the higher level of regulatory scrutiny and greater risk of litigation, audit failure, reputation, auditors encounter higher challenges to obtain sufficient and appropriate audit evidence to reduce risk to an acceptably low level (Xu, et al., 2011).
There are numerous challenges for auditors to analyze the going-concern, including but not limited to the extent of liquidity and solvency issues, government assistance, economic forecast, degree of business disruption (IFAC, 2020). Assessing liquidity and solvency is challenging because of the changes in credit ratings, terms and conditions of sales contracts or covenants or government support. Regarding government assistance, the lag between the announcements of government relief programs may result in the variance in going-concern assessment. In particular, when the relief becomes available, it is sufficient to resolve firm’s liquidity issues, which results in significant change in the firm’s continuity assessment. In terms of economic prospect, the uncertainty makes any assumption become sensitive, which causes the huge variance in economic forecast; therefore, it is difficult to estimate firm’s forward-looking cash flow and earnings. Evaluating the degree of business disruption is also complicated to the auditors since the evaluation does not only lie in business itself but also correlate to other aspects such as the supply chain disruption, consumer behavior.
In times of economic and financial crisis, auditors take more time to issue their going-concern opinions. Given the higher level of risk exposure, audit professionals apply the conservative measures on audit reports by not only giving the defensive reactions on financial statements (Sercu, et al., 2006) but also increasing the audit effort (Bell, et al., 2008). Due to the constant changing environment, the auditors still need to review the subsequent events until issuing the audit report (PWC, 2020).
3.2 Auditing procedures
The travel restrictions imposed by the government prevent the auditors from performing the traditional audit. An auditing relying on inspection, observation, site visits employed by human auditors is referred to as a traditional auditing (Byrnes, et al., 2012). The analytical auditing procedures follows a sequence of activities including “selection of a reference point, collection of data, data recording and sharing, and data analysis to determine a firm’s compliance with the selected reference point” (Castka, et al., 2020).
Due to movement restrictions, the auditors are unable to perform onsite audits; therefore, collecting data is challenging. Obtaining “sufficient appropriate audit evidence” regarding the existence and condition of inventory may be difficult since the auditors are not able to conduct physical verification of inventory. In particular, the auditors may encounter cases where warehouses are closed or open with a limited number of employees, or auditors themselves are imposed the travel restrictions. Besides the huge challenge of physical inventory counting, the auditors also face the challenges to access client books and records, as well as conduct tests of internal control.
During the crisis, it tends to increase the number of companies filing for bankruptcy and manipulating their reported earnings (Claessens, et al., 2001; Illuzzi, et al., 2020). The economic turbulence in the crisis also leads to a significant increase in fraud (Suh, et al., 2019; Fligstein & Roehrkasse, 2016). Given the turmoil caused by the COVID-19, the increase of fraudulent activities combined with the high possibility of internal fraud poses challenges for auditors to expand their scope of work to protect client’s benefits while maintaining the high quality of audit reports.
3.3 Internal audit controls
While external auditors ensure high-quality financial statements to maintain the integrity of the financial market, internal audits “enhance and protect organizational value by providing risk –based and objective assurance, advice, and insight” (Institute of Internal Auditors, n.d.). During the crisis, the main roles of internal audit professionals are to involve in crisis management, identify potential risks and evaluate controls.
During the unprecedented changing times like COVID-19 pandemic, it requires organization to adjust operations and business plans in a timely manner. Also, it is challenging for the company to manage employee safety, disrupted supply chain, and cybersecurity at the same time. The internal audit team plays an important role to provide advice and assistance to help management navigate the emerging challenges.
In terms of risk identification, the internal audit not only looks at the existing risks but also the emerging risks and their impacts on an organization’s future and mitigate those dangers. The emerging risks include but not limited to information security risk, reputational risk, outsourcing risk, model risk (Beldman & Jansen, 2020). n particular, information security risk refers to the cybersecurity threats as the result of work-from-home strategy during the lockdown period. Reputational risk relates to the challenge of managing proper communication with clients via online platforms. Outsourcing risk possibly happens amid COVID-19 since the travel restrictions may disrupt the operation of supply chain partners. In addition, the internal attention has to pay attention to risk of fraud as the organization shifts to work online.
Regarding evaluating controls, due to the social distancing measures, the business model and the way of working entirely change. Most companies transition to work remotely, which requires the changes in controls. As a result, the challenges for internal auditors are to ensure the employees are working effectively and internal audit departments have the proper procedures to perform “remote audits”.
4. The role of technology
The technology plays a leading role to facilitate the transition to remote work during COVID-19 crisis. Before COVID-19 outbreak, accountants and auditors have already used multiple information and communication technologies (ICTs) such as spreadsheets for sample examination, macros for graphic and statistical analyses and email to communicate with clients. To fully shift to work remotely, the existing ICTs have been improved with additional technological solutions that facilitate remote communication, information dissemination, information gathering, transaction reconciliation, financial analyses,…
The uses of ICTs to conduct remote auditing include but not limited to “(1) Teleconferencing using video and/or audio; (2) Sharing of data; (3) Assessment of documents through remote sharing, teleconferencing or other means; (4) Video and/or audio streaming from remote locations; (5) Records of video and/or audio and/or video stills and/or screenshots” (Castka, et al., 2020)
Technologies such as screen-sharing, teleconferencing and video conferencing can help to disseminate information without the physical participation of any party. According to Linking Environment and Farming (LEAF), “any technology that can include at least 3 parties can be used in order to enable remote witnessing of audits – for example, WhatsApp Call, BlueJeans, Microsoft Teams, Skype, Zoom”. As such, ICTs can be considered as a means of collecting and verifying audit evidence, which helps auditors substitute on-site fieldwork. For example, auditors are able to verify inventory even when authority imposes the travel restrictions.
Given the context of working remotely in different locations, the application of cloud-based platform keeps team members stay connected and enables them to collaborate with clients effectively. The cloud-based information system integrating the financial data from client accounting systems that can be extracted to analyze. The team members can share the results and request further information from clients efficiently and securely on this platform. Furthermore, clients are able to track the workflow and progress, which enhances the transparency and accountability of auditing professionals.
The going concern assessment was challenging because of checking financial statements manually. The manual checking not only compromises audit quality but also consumes a lot of time. KPMG’s Financial Checker – an Excel add-in can increase the efficiency by automating the internal check of financial statements and significantly reducing the number of time to execute a financial draft (KPMG, 2020).
However, the application of technology also raises concerns about data security, fraudulent activities, and privacy. Therefore, it is crucial to develop the complete remote working procedures and fully understand the technology and related risk. Besides relying on technology advances, the accounting and auditing professionals need to be more agile and creative in performing their duties while still ensuring to comply with accounting and auditing standards. Also, the facilitation of applying ICTs in accounting and auditing procedures amid COVID-19 give the implications of how we work in future. Everything will be done online.
5. Conclusion
The research provides insights into the consequences of COVID-19 on business scope. The paper particularly investigates the emerging challenges of accounting and audit function. We believe that the going concern assessment (from management’s perspective), cash flows and earnings forecast, impairment test and inventory count are the material impacts of COVID-19 on accounting function. Regarding audit challenges, we figure out that the going concern (from external auditor’s perspective), auditing procedures and internal audit controls are the significant challenges that need to be taken into account. Those challenges require both company and external auditors to thoroughly consider multiple factors to reflect the impacts of COVID-19 on financial statements. Given the low confidence of investors during the economic turbulence, it is crucial to ensure the transparency of the financial market through maintaining high-quality financial statements. Furthermore, the paper shows the leading role of ICTs in addressing the current challenges caused by the pandemic.
To date, to the best of our knowledge, there is a limited number of academic studies investigating the consequences of COVID-19 pandemic on business’s accounting and audit functions, especially on business level. Also, the technology application in accounting and auditing has not clarified in any previous research. This study fills those gaps by researching the accounting and audit challenges given the unprecedented nature of COVID-19 crisis, and clarifying the role of technology in dealing with the challenges stated before. This paper not only provides new points of view about the impacts of COVID-19 but also gives the implication of a new working model after COVID-19.
One of research limitations is that the study is undertaken when it is still unclear about COVID-19’s trajectory. Given the constantly changing environment during the pandemic, it may appear new challenges for accounting and audit functions; therefore, we cannot promptly reflect them on this research paper. Secondly, due to lack of technical knowledge, we are unable to fully clarify the role of some technologies such as machine learning, artificial intelligence, blockchain. To reflect them on our research, we will need to do more research to have more understanding related to those terminologies. Thirdly, this study does not provide empirical evidence of the consequences of COVID-19 outbreak on accounting and audit functions. Therefore, we will further develop this study by conducting empirical research about the consequences of COVID-19 on accounting and auditing and the degree of ICTs’ application.
