This article was first published in the April 2012 China edition of Accounting and Business magazine.
As the storm clouds of economic turmoil emanating from the eurozone drift menacingly to other parts of the world, including East Asia, regulatory bodies have started warning the profession to remain alert during the current uncertain economic landscape and stay the course in performing their professional duties.
On 28 December last year, the International Auditing and Assurance Standards Board (IAASB) issued a press release highlighting challenges and guidance for auditors in light of the global economic slowdown. The IAASB pointed out that such conditions make it challenging for the management of entities, those charged with governance, and auditors to fulfil their responsibilities, including assessing an entity’s ability to continue as a going concern (see below).
Closer to home, the Malaysian Institute of Accountants (MIA) also issued a similar circular in January to its members, advising auditors to be vigilant. In the circular, MIA executive director Ho Foong Moi said: ‘Auditors in Malaysia similarly should take cognisance of the currently challenging global economy and accordingly must remain alert throughout the audit to identify and critically examine evidence of events or conditions that may exist nationally or globally which may cast significant doubt on an entity’s ability to continue as a going concern.’
Members of the profession who spoke to Accounting and Business highlighted going concern assessment, professional scepticism and talent development as critical factors for auditors as companies today grapple with the trials of coping with internal and external forces that affect business sustainability.
MIA president Datuk Mohd Nasir Ahmad says that although Malaysia has not yet experienced any significant impact as a result of the eurozone crisis, auditors may face challenges when auditing multinational European companies, irrespective of whether these are holding or subsidiary companies, as well as clients that have substantial transactions with European companies.
‘Malaysian auditors may face challenges including test of recoverability if the customers of audit clients are European companies; shortage of important supplies if the suppliers of audit clients are European companies; test of impairment in the value of investment if audit clients’ subsidiaries are in Europe; and loss of financial support if their holding companies are in Europe, among others.’ All of these challenges may potentially be associated with the issues of going concern, Mohd Nasir says. He adds that the going concern assumption should be considered from a group-wide perspective, including audit engagements involving multinational companies, irrespective of whether it is a holding or subsidiary company.
Tang Seng Choon, head of audit at BDO Malaysia, envisages greater challenges once the full brunt of the eurozone crisis hits Malaysian shores. Malaysian auditors may face difficulty in assessing and accepting cashflow and profit projections prepared by management for various purposes, such as going concern assessment, impairment of assets and deferred tax recognition, he says.
The level of uncertainty associated with an economic downturn has made audits more challenging as it can affect company operations, profitability and financial reporting, which in turn have implications on audits of financial statements, says Dr Nordin Mohd Zain, executive director at Deloitte Malaysia.
‘Malaysian auditors are faced with companies that are more likely to experience difficulties in meeting financial commitments or managing cashflows or meeting debt covenants, and there is increased pressure to achieve certain financial results that could lead to biases in management judgments for a particular outcome. It is during these times that there would likely be higher incidents of misstatements, fraud and risks of going concerns,’ he offers.
Need for scepticism
In light of the increasingly complex environment for businesses, auditors have been advised to exercise professional scepticism to weed out potential problem areas. Audit Oversight Board (AOB) executive chairman Nik Mohd Hasyudeen Yusoff says that, for auditors, there is always the need to debate and challenge management assumptions, particularly in areas such as determining fair value, and asset impairment, especially in challenging economic times.
Indication of financial distress, such as negative operating cashflows, adverse key financial ratios, substantial operating losses, capital deficiency position, inability to comply with the terms of loan agreements, shortage of important supplies and the loss of a major market, among others, should raise red flags, says Mohd Nasir.
‘Auditors must continue to exercise professional scepticism and judgment in evaluating financial statement disclosures and the implications for the auditor’s report when a material uncertainty exists relating to events or conditions that individually or collectively may cast significant doubt on the entity’s ability to continue as a going concern,’ he says.
Tang says that it is also important to learn from the past. ‘Fresh lessons learnt from the global financial crisis of 2008 would certainly serve as a reminder for auditors to challenge the management to adjust projections to reflect the dynamics of the present economic conditions,’ he says.
‘There will also be a need to assess reliability of fair value measurement and disclosures arising from elevated historical volatility of asset prices which serve as a major input to valuation models in one way or another,’ he adds.
‘Auditors would do well to consider potential effects of volatility clustering and the degree of reliability of sources of fair values in arriving at an opinion on the reasonableness of the fair values used by management in preparing the financial statements.’
Tang also notes that random and unexpected economic or capital market events are more commonplace now, and auditors would need to quickly consider such events in depth, together with the management, before signing the auditor’s report.
While the technical aspects are central to ensuring high-quality audits, ACCA Malaysia country head Jennifer Lopez raises a pertinent observation on the need for talent attraction and retention in such times.‘The business landscape is constantly changing, especially with fewer global trade barriers and introduction of new regulations,’ she says. ‘All this means that the auditor must make the effort to invest in learning and development to ensure that their capabilities remain relevant and valuable.’
Lopez recommends that auditors train outside of accounting and finance to strengthen their roles as business advisers, and also be sensitive to the needs of their employees in order to motivate them. This approach would tie in with the need for auditors to be more responsible for the direction of the profession by being proactive in ensuring that the quality of their work remains top-notch, she adds.
Audit quality improving
Since the establishment of the AOB in 2010 by the Securities Commission to ensure high-quality audits, particularly on public interest entities (PIEs), there is consensus that it has brought improvements. Lopez believes that the AOB has been stringent in its monitoring, especially for large and medium firms, and the positive effects of the enforcement are apparent.
The AOB’s Nik Hasyudeen says that the auditing framework in Malaysia is comparable to global best practices. ‘Overall, the quality of the financial reporting ecosystem is sound as Malaysian audit firms have generally put in place good control mechanisms, policies, procedures, systems and infrastructure, to implement the standards and embed the principles of quality auditing.’
He says that through the AOB’s yearly exercise of inspecting audit practices, the board is working to build a strong foundation for the enhancement of professionalism among auditors in Malaysia and this has definitely helped to prepare auditors for greater challenges ahead.
Mohd Nasir agrees that audit quality for PIEs may have improved over the last two years, with deficiencies identified through due process and conveyed to the respective top-tier audit firms in Malaysia. Nevertheless, he noted that there is room for Malaysian auditors to improve on their audit quality, especially compliance with the International Standard on Auditing 230, Audit Documentation.
A high-quality audit is one of the essential elements in maintaining credibility of the financial reporting chain and ensuring that the public gets reliable financial information on companies, regardless of the economic climate.
However, the volatile state of the global economy presents amplified challenges for all players within the business landscape and, as noted by the IAASB, if risks are not managed properly, there are wide-ranging financial reporting implications that often extend beyond national borders.
In view of such heightened risks in the present operating environment, auditors must play their roles to the best of their abilities to avert potential financial mishaps.
Auditors reminded of duties
The International Auditing and Assurance Standards Board (IAASB) has reminded auditors of their important responsibilities under the International Standards on Auditing (ISAs).
In a statement last December, professor Arnold Schilder, chairman of the IAASB, said: ‘Difficult economic conditions give rise to many important audit considerations, but none more important than evaluating management’s assessment of an entity’s ability to continue as a going concern and determining the appropriate auditor reporting in the circumstances. Auditors must remain alert throughout the audit for evidence of events or conditions that may cast significant doubt on an entity’s ability to continue as a going concern.’
As guidance, Schilder pointed auditors to the 2009 IAASB Staff Audit Practice Alert, Audit Considerations in Respect of Going Concern in the Current Economic Environment.
The alert addresses factors relevant to the assessment of going concern; the period of time considered in making a going concern assessment; financial statement disclosures; forming an opinion on the financial statements; and the implications for the auditor’s report.
‘While this alert was released in context of the 2008–09 credit crisis, many of the matters addressed in it are equally relevant today,’ Schilder added.
‘For example, an entity may be experiencing a decline in its financial health, or may have material uncertainties arising from direct or indirect exposures to sovereign debt of distressed countries.’
Asha Gopalan, journalist