Introduction

The immediate focus for Britain’s authorities when dealing with the COVID-19 pandemic has been, quite rightly, to secure the best possible health outcome for the greatest number of people.

Subsequently, following a wave of concern regarding the best way of maintaining the financial status-quo for (i) businesses, (ii) employees, and (iii) individuals, the UK government announced an unprecedented series of assistance programmes, designed to counter the impact of previously unknown, and unquantifiable, distress.

Now, a fortnight into the UK’s lockdown, attention is beginning to turn to how best to assuage other commercial concerns, and, as far as possible, keep businesses operating in the new normal. Whilst these issues have, understandably, played a secondary role to the macro-concerns of health and the economy as a whole, it is important that businesses are aware of the new administrative measures (as distinct from other programmes of financial assistance) designed to alleviate the impact of COVID-19 on reporting deadlines, auditing procedures and insolvency processes.

New measures

The Financial Conduct Authority (“FCA”) has announced a series of measures designed to alleviate the pressure on listed companies:

1. As announced on 23 March 2020, all listed companies are to observe a moratorium on the publication of preliminary financial statements, for at least 2 weeks. The FCA considers that this market practice, not a requirement under the Listing Rules, is “adding unnecessarily to the pressure on companies and auditors”¹ Instead, companies should focus on publishing full audited financial statements following year-end, as per the Listing Rules requirements.
2. Additionally, the FCA is permitting listed companies an extra two months to publish their audited financial reports. Instead of audited reports falling due four months from company year-end (as set out in the Transparency Directive), listed companies will have six months from year-end to publish. The FCA has noted that this temporary relief does not extend (currently) to half-yearly financial reports, which should be published within three months of the half-year end.
3. However, in its Joint Statement with the Financial Reporting Council and Prudential Regulatory Authority, the FCA warned companies that “the Market Abuse Regulation remains in force and companies are still required to fulfil their obligations concerning inside information as soon as possible, unless a valid reason to delay disclosure under the regulation exists”. Therefore “companies must continue to assess carefully what information constitutes inside information at this time, recognising that the global pandemic and policy responses may alter the nature of information that is material to a business’s prospects”².

In addition to announcing these new measures, the FCA has made a series of recommendations³ regarding market behaviour, including:

1. market participants, who are requested “not to draw adverse inferences when companies make use of the extra time our temporary relief gives them”; and
2. listed companies, who are “strongly recommended ... to make appropriate use of the time available, within regulatory deadlines, to ensure accurate and carefully prepared disclosures”.

Following the announcement from the FCA, the UK Government has also reviewed the deadlines for certain public bodies to publish their annual accounts and supporting documentation (and make these available for inspection).  Following the passing of the Accounts and Audit (Coronavirus) (Amendment) Regulations 2020 (on 7 April 2020) local authorities’ deadlines have been extended to 30 November 2020, “in anticipation of the potential disruption to relevant authorities caused by the spread of coronavirus”⁴.

In the spirit of temporarily alleviating COVID-19-related pressure, Companies House is also granting an extension to file company accounts to those companies which apply. Companies citing issues relating to COVID-19 will automatically, and immediately, be granted an extension for filing via a fast-track process. Companies House has requested companies act well in advance of their filing deadlines.

On 28 March 2020, the UK Government also announced amendments to UK insolvency law⁵, designed to give companies breathing space and avoiding premature insolvencies. The UK business secretary has said that these measures would allow companies to “emerge intact the other side of the COVID-19 pandemic⁶”.

1. A new temporary moratorium is to be put in place for businesses, giving them breathing space from creditors enforcing their debts for a period of time whilst they seek a rescue or restructure.Similarly a regime is to be introduced which is intended to ensure the continuation of key supplies to a company that becomes subject to an insolvency regime (including the new moratorium procedure mentioned here).
2. Further, a new process to facilitate a restructuring is to be brought in, which enables cross-class cram down via a restructuring plan, binding creditors to that plan.
3. Importantly, wrongful trading laws have been suspended for the duration of the pandemic. Under s.214 of the Insolvency Act 1986, directors may incur potential personal liability from continuing to trade once they conclude (or should have concluded) that the company has no reasonable prospect of avoiding insolvent liquidation. The suspension will be retrospectively applied to 1 March 2020.
4. However, all other duties and obligations of directors will remain in place. Directors should note that s172 of the Companies Act 2006 will continue to apply where a company is close to insolvency. As such, directors are required to consider the interests of creditors and cannot prefer some creditors over others.Further, common law duties of directors are unaffected, as are regimes existing under the insolvency legislation other than wrongful trading.
5. The suspension of wrongful trading provisions is intended to lessen the spectre of potential personal liability for directors and hence give directors confidence in continuing to trade their companies through the current crisis. Such good faith decisions, taken to balance the interests of the company, its staff and its creditors, could include paying employees and suppliers. Inevitably, decisions are fact based and no doubt there will be many challenging situations for directors to navigate notwithstanding this change.

Audit

Clearly, the role of the auditor is important to consider when companies are preparing their annual report and other reporting milestones. The Financial Reporting Council (“FRC”) have been keeping a watchful eye on the ever-expanding footprint of COVID-19.  In February, the FRC was limiting their advice to “whether the virus affects their ability to review component audits in China”⁷. By 26 March 2020, when it became clear that UK businesses would be affected on a more fundamental level, the FRC published guidance for both (i) companies preparing financial statements, and (ii) a bulletin for auditors.

The overall message for auditors, from the FRC, is that whilst they recognise the difficulties, COVID-19 “should not undermine the delivery of high quality audits”⁸. The FRC has stressed that “audits should continue to comply fully with required standards. In current circumstances, additional time may be required to complete audits, and it is important that this is taken, even at the risk of delaying company reporting”.

Nonetheless, the FRC has recognised that certain changes may need to be made. These include:

• Modification and scoping:

  Modified audit opinions may be required where auditors have been unable to gather the necessary audit evidence to complete the audit in full. For example, auditors may look to limit the scope of their opinion, or including more information in the scoping paragraph to reference the particular, unique, circumstances in which the audit was undertaken.

  The FRC’s guidance for auditors also suggests “the auditor should also consider whether their assessment of risks for material misstatement due to fraud or irregularity needs to be heightened”⁹ given that internal controls may not be operating as planned.

  Ultimately, if an auditor cannot obtain sufficient evidence, then “the auditor is required to modify their opinion in that respect”, noting that “whether the possible impact on the financial statements could be both material and pervasive, then the auditor is required to disclaim their opinion or if it is material not pervasive, to express a qualified opinion”¹⁰.

• Greater disclosures regarding going concern:

  An entity is a “going concern” unless management either (i) intends to liquidate the entity or to cease trading, or (ii) has no realistic alternative but to do so¹¹. Management of an entity has to determine whether the company is a going concern, taking into account all available information about the future (at least 12 months from the date financial statements are authorised for issue)¹². Where management is aware that there may be material uncertainties (such as the existing or potential impact of COVID-19) on the entity’s ability to continue as a going concern, these material uncertainties need to be disclosed in the financial statements.  

  The FRC expects there to be a greater number of financial statements that include disclosures that management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern. When auditors report on the current uncertainty and volatility, and its impact on the company, they should “draw on the available facts and circumstances”, and not “generically report on material uncertainties”¹³.

  The FRC expects auditors to review the adequacy of disclosures made by management about the impact of COVID-19 to the company . The FRC’s current view is that “the auditor’s going concern work will be more extensive, require more evidence, and will continue to be performed through to the point of signing the auditor’s report”¹⁴.

  The FRC also notes that auditors should “remain alert to the possibility that, in the current circumstances, misstatements may occur”, for example as a result of the application of going concern accounting when it is not appropriate, or the omission of disclosures regarding material uncertainties relating to going concern. If an auditor concludes that “misstatements are material, [they] are also required to modify their opinion in that respect. When the effect of such misstatements is both material and pervasive, the auditor is required to express an adverse opinion”¹⁵.  

• Changes to the internal processes for audit:

  On 16 March 2020, prior to the publication of formal guidance, the FRC noted that “auditors will need to engage with the entities they audit to ensure that they set clear expectations as to the level of disclosure they expect to see in annual reports to communicate the impact and risk of COVID-19 on the company”. This emphasis on communication pervades the FRC’s formal guidance produced on 26 March 2020.

  The FRC notes that physical meetings of audit committees may not be possible. As such, they suggest that “auditors will need to agree with audit committees how to communicate with them through other means, and how to ensure that sufficient time is set aside by audit committees for comprehensive, complete and informed communication with the auditor”¹⁶. Equally, given restrictions on travel, movement and visiting client sites, auditors “will need to think about whether there are other ways for them to obtain sufficient, appropriate audit evidence”, which may include greater use of technology. However, auditors remain under an obligation to assess both the sufficiency and appropriateness of the audit evidence produced. This assessment should be clearly documented on the audit file (see further information on documentation below).

• Changes to the timetable for publication of financial information:

  As noted above, the FCA has extended the timetable for publication of companies’ audited accounts. The auditor should “consider whether any additional time is required to perform identified audit procedures, and request such time from management. If this time is refused by management, the auditor should consider whether such a refusal constitutes a limitation on the scope of the audit”¹⁷.

• Postponement:
  The FRC have noted that audit tenders may need to be postponed (even when mandatory rotation is due). Similarly, audit partner rotation may need to be postponed. Currently, key audit partners are required to rotate every five years. However, where there are good reasons (for example, to maintain audit quality in the current circumstances), this rotation can be extended to no more than 7 years. This should be agreed with the audit committee, but does not need to be cleared with or approved by the FRC. 

The overall message from the FRC is that, whilst alternative solutions may be pursued, the quality of the audit should not be allowed to fall, as reporting is “driven by the information needs of users of audited financial statements”¹⁸.

Commentary

Whilst the FRC does appreciate that it is difficult, both (i) for companies to make forward-looking assessments and estimates when preparing financial statements, and (ii) for auditors to subsequently assess such statements, and prepare and sign off on published accounts, COVID-19 should not disrupt “the flow of high quality, independently assured information to support the functioning of capital markets”¹⁹. The focus is on protecting the interests of the users of financial statements, both in the immediate aftermath of the pandemic, and in the future.

The FRC’s approach appears to be themed around (i) documenting and (ii) disclosing, as the best two ways to protect companies, auditors, and the market.

Documenting

Auditors, in particular, would be best advised to document (internally) all stages of their 2019-2020 audit and ensure that the audit file is kept up to date with all material information, including “how the direction, supervision and review process was structured and operated to overcome obstacles”²⁰. For COVID-19 audits, material information may include very granular information, not normally required, such as “how communication with team members and in particular key audit partners, engagement quality control reviews, and any firm technical reviewers was maintained”²¹.

Similarly, careful consideration should be given to the audit report itself, and whether its scope should be limited or modified in any way. The FRC notes that “in the current circumstances, auditors will need to consider how they demonstrate and record an appropriate level of professional scepticism to reflect that engagements may be delivered in a different way”²². Companies and auditors should remember that negligence claims can be brought over a long period of time (the minimum statutory period being 6 years, but this can be subject to extension). Therefore, what may seem clear at the time the report is written – when COVID-19 is on the nation’s mind – may not be clear several years down the line. If in doubt, document.

Disclosing

In addition to documenting one’s approach, the FRC has focused on the need for adequate disclosure of company information to the market. At various points throughout guidance for both auditors and companies, the FRC has stressed that boilerplate wording (whether that be for a company’s material uncertainties, or for scoping of an audit report) will not be suitable in the current climate.

For example, regarding the reporting of material uncertainties, the FRC has suggested an approach whereby companies and auditors “explain to investors the effect on their business of the current public health restrictions in different countries, sensitivities in different short term scenarios, for example the length and nature of public health restrictions that are in place or may evolve during the period of assessment”²³. This is a markedly different approach to a disclosure that COVID-19 has resulted in certain generic uncertainties. Companies should be able to disclose material uncertainties “in terms that are as specific to the entity as possible. Users will wish to know how and when the uncertainty might crystallise and its impact on the resources, operational capacity, liquidity and solvency of the company”²⁴. 

The FRC has said that whilst “boards cannot predict the extent and duration of the COVID-19 pandemic nor its consequences for the global economy … it is reasonable for investors to expect companies to be able to articulate their expectations of the possible impacts on their specific business in different scenarios”²⁵.

Ultimately there can be no ‘one size fits all approach’. Boilerplate text should be avoided, and published company accounts and audit reports should reflect the specific facts and circumstances of the business, on a case by case basis, as “at this time, the need for fuller disclosure is paramount”²⁶.  As such, companies and auditors alike would be best advised to make full use of the extension of time permitted by the FCA, as the regulatory bodies will have very little patience for COVID-19 excuses.