Covid 19 coronavirus: Tagged audit reports - What investors will need to look for

Investors can expect to see a lot more of "tagged" auditors reports this year as companies try to account for the extraordinary changes in their businesses arising from the Covid-19 pandemic, PwC's chief risk officer Karen Shires says.

The road ahead will be challenging for everyone, including auditors, and some companies will fail, she says.

"Entities are trying to understand what their revenues are going to look like over the next six to 12 months in a situation that we have never been in before," Shires told the Herald.

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"Investors should be alerted to the fact that this cycle will see more auditors tagging their audit opinions than you have ever seen before," she said.

"So we may usually only get five or six "tagged" auditors reports in a year at the top end of town. It could now be as high as two thirds of all those who report."

Whether it's cutting costs, restructuring debt, or raising new capital - there will be a myriad of issues for companieds to deal with - and it's all going to impact on their financial reporting.

"In the circumstances that we find ourselves in now, never have the financial reporting implications been more important," she said.

"It's really important for trust in our capital markets that entities think about how they are going to report in this upcoming reporting season."

The NZX, along with a raft of other measures, has given listed companies a one-month extension to report their results.

It has also temporarily relaxed the rules around capital raisings to enable entities to raise funds quickly - generally from wholesale or institutional investors.

She says the usual caveats apply when retail investors take part in capital raisings.
"As a retail investor - the fundamentals are the same - you need to understand what you are investing in and that you have the funds to enable you to invest," she said.

"While the market may look very attractive at the moment, clearly there are risks in the longer term."

For many companies who may have just finished reporting their half-year results to December 31, the world has suddenly become a different place.

For some it has meant raising capital just a matter of weeks after reporting their "business as usual" first half results.

"Now a number of them are having to do capital raisings because circumstances have changed significantly, so you do have to be very wary."

Shires said investors should think of audit reports as a traffic light system.
A "green" light means a "clean" opinion, but it may come with key audit matters, or KAMs.

Shires says investors should read those because it will help them understand the significant areas of judgment.

"It's a signpost for the future."

An orange light would be where the auditor has found a few areas of importance in the financial statements, usually around matters of "going concern", which investors would "absolutely" need to look at.

Then there's red.

"Unfortunately, we will see a number of those. It could be around what auditors call a limitation of scope.

"That's when the auditor could not get enough information."

Crucial for any audit is stock-taking and unfortunately for those with March 31 balance dates, stock takes were not about to be done during Covid-19 lockdown.

"Because no one was able to do that, it is highly likely that there will be limitation of scope paragraphs, so that's a red light, although I would see that as a technical matter."

Shires said some entitles who will not survive the course of the year.

Her advice to corporates is to make good use of the extra time available to prepare their annual results.

"Clearly there are a number of measures out there to help entities.

"But there were a number of entities that were struggling before Covid-19. Those are the ones who may not make it out the other end," she said.

"A number of them will conduct capital raisings and will restructure debt, but they are not going to be a strong position as they were before," she says.

Then there will be those who take the opportunity of a more relaxed regulations to "push the boundaries" which may pose risks for corprates further down the track.

"It's difficult to try and forecast the future, but the thing that directors and management need to have in mind is that regulators will in the future look back with perfect hindsight, and that's not a place they really want to be - having to defend the shortcuts that they have taken now."

"We are cautioning corporates against rushing and to make sure that they do take time," Shires said.

Companies that have either shut down or are working at reduced levels may have to look at how they account for the impact on property leases, referrred to as "onerous contracts".

"The implications for the accounts means that they will have to increase the disclosure of them.

"Generally there is a lot of reluctance to put in increased disclosure but I think that we are in a rather than a 'less is more' situation where "more" is definitely the way to go," she said.

The implications of an onerous lease provision would sit on a balance sheet as a liability.
"The cost of those premises effectively ends up hitting the profit and loss, and companies will have to take the loss up front."

Shires said a number of businesses were struggling, even in the favourable conditions leading up to Covid-19.

Among them were tech startups that were taking longer to get up and running.
"Some of them are businesses that have grown way too and have a scale that they probably could not afford," she said.

Shires says there will be receiverships arising from Covid-19.

"I think there will be some, but everybody will want to work together to try and effectively help resuscitate - to put some of those entities on a ventilator and see if we can bring some of them back," she says.

"But clearly, everybody needs to make sure that they only do that for businesses that have a sustainable future."

• Covid19.govt.nz: The Government's official Covid-19 advisory website
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