Financial Statements, Audits and committees in times of Crisis
by Monique Bachner
This article stems from the fourth web “Coffee Chat” organised by, the Luxembourg Institute of Directors (ILA), on 24 April 2020, and hosted by Monique Bachner, ILA Board member and a governance professional involved in various Boards.
Monique was joined this week by Katrin Wehr-Seiter and Justin Griffiths. Katrin is Chair of the Audit and Risk Committee at SES SA and Managing Director at BIP Investment Partners.   Justin is an audit partner at Deloitte, Luxembourg, as well as being Chair of ILA’s Investment Fund Committee. 

The future is uncertain:  Board should enhance reporting and scenario testing 

Various recurrent themes are evident as in all our coffee chats so far:  Boards must be vigilent regarding safety, business continuity and liquidity issues.  In a crisis, Boards and management teams also need to communicate more than usual.  

Scenario Testing
Board should also perform scenario testing, where they envisage different scenarios unfolding, and therefore can consider how they may need to react if faced with such scenarios.   Such “worst-case” scenarios are critical for Boards to asses liquidity, including whether current facility agreements would be adequate or even accessible.  Boards and Management should also ensure they remain aware of conditions precedent to draw downs (e.g. leverage ratios).  

If a drawdown is to facilitate business continuity, such as, say, to purchase protective equipment for employees and customers or for payment of ongoing bills, then lenders have been treating such requests more favourably.  If, however, a facility is required to service other loans, lenders will be more hesitant.  

More frequent Board reporting 
Boards should receive more frequent reports on liquidity, cash flow and business continuity, as well as overviews on key upcoming expenses and receivables.   Audit committees are liaising more and involving the full Board more than usual, whilst still leading.  This increased immediacy and transparency stems from the importance of all Board members needing to be fully informed as    things are changing so quickly.  

Discretionary payments – to pay or not to pay.  That is the question… 
The challenging area discretionary payments such as shareholder distributions and bonuses is especially important in times of crisis.  In the banking and insurance sectors, and where a company has accessed government support too these may be prohibited.  

Dividends declared but not yet paid are a difficult area, the legal situation for those who fail to pay once declaring distributions will only become clear in due course.  Boards must remain very cautious about amounts and timing of any new distributions.   Where dividends have been cancelled, effects on post-year accounts must be considered.   Cancelling or reducing distributions may cause issues for some investors, including pension funds, which may depend on dividends as part of their income.  

Board oversight of the year-end audit process and financial statements? 

As always, reporting should be true, fair and represent an accurate financial position of the company.  Increased scrutiny is inevitable given the uncertainties of the Covid-19 situation, making it new disclosures unavoidable.  Management will usually present the accounts and reports, and Directors must carefully and diligently review these to ensure they have confidence in them.  Ultimately it is the Board’s liability which may be engaged.  

Going concern evaluations: twelve months through the looking glass 
Can your Board confidently say the company will continue for “foreseeable future”?  Generally considered to be at least twelve months, going concern status is a fundamental accounting principle, requiring Boards to carefully consider the nature of the business and degree of impact from the crisis.  The greater the impacts and uncertainties, the more scrutiny required by the auditors.  Business sectors related to air travel, shopping and HORECA are set to be harder hit than others. 

Governments and regulators have extended reporting deadlines in order to provide Boards more time to consider the potential impacts, and the extent to which these may impact the financial reports and/or accounts, and to provide auditors with additional time to challenge assumptions made.  

Management should prepare going concern projections for the Board, providing various scenario analyses, including extreme scenarios.  Aspects to consider include items such as liquidity risk, impairments of tangible and intangible assets including goodwill, the extent of potential operational disruption, diminished demand for products or services, access to capital and recovery of receivables and bad debt.  Will major customers be lost? Will revenues be depressed, and by how much and for how long?  With economic forecasts erratic and fluctuation, material uncertainty, exists.  Boards should not be afraid to disclose these uncertainties as appropriate.  

In general, we have seen Boards tending to be more optimistic and auditors more pessimistic, but usually although these discussions are often lengthy, in the end there is a meeting of minds and a balance is found. 

Boards must be mindful that should the auditor’s opinion be qualified, this could trigger defaults on loans as well as other practical, legal and commercial implications.

Disclosures – Covid-19 as subsequent, but non-adjusting event
In accounting terminology, a “subsequent event” is an event happening after the year end date for the balance sheet, which has an impact on company’s financials.   

“Adjusting events ” are where a company has made provision (say) at financial year end but later on it transpires that the provision was not required; for example, a provision for bad debts where the debtor did in fact subsequently pay the company: the provision is therefore “adjusted”. 

“Non-adjusting events”, by contrast, are where the company need not make any change in the accounts, however investors should still be informed given their impact on the business.  

For entities with a 31 December year end,  Covid-19 is generally considered a non-adjusting event, with the focus on disclosures.  The content of such disclosures must be carefully considered.  Boards must carefully consider and challenge disclosures proposed to them by Management, requesting the rationale and bases of their content.  

Covid-19 effects on representation letters issued by Boards
Auditors will re-assess the risk, and consider adapting the representations they require.  Boards themselves look for comfort from their providers, and need to be satisfied regarding information submitted to them by Management and key service providers.  Boards should not hesitate to probe the information provided.  This also ties in ultimately with directors’ duties and responsibilities.  

Boards must ensure internal controls remain rigorous, enforced and effective.  Given the current working-from-home (WFH) environments, increased risks of fraud, cybersecurity and data breaches, coupled with a dependence on electronic data versus inspection of original documents. Boards are also revisiting procedures like signing logics and internal controls. 

The challenge of valuations in uncertain times 

As Covid-19 is a subsequent event, it does not impact prior valuations, such as those made in December 2019.  For financial year ends since March 20120, however, Covid-19 will have significant impact on valuations, and additionally make these difficult to quantify.  Boards will require robust assessments, and be able to understand and justify how valuations hae been made.  For example, real estate funds that may usually only preform annual valuations may require refreshed valuations as at key moments, which will be challenging.  The less liquid the asset, the greater the valuation challenges.  It may be prudent for Boards to reassess valuation policies and controls, and ensure they have confidence in them given this unprecedented situation.  

AGMs and investor communications faced with Covid-19? 
As mentioned in previous coffee chats, the crisis laws in Luxembourg allow AGMs to be held purely remotely by way of written proxies.  Many are hoping more flexibility for remote shareholder meetings will remain post-crisis – an example of Covid-19 pushing businesses to evolve.  Both our experts agreed that this will have a global effect in that the future paradigm for all meetings will change.

Investor communications
Boards should consider how, when and what to communicate with their investors and other stakeholders regarding changes in circumstances since the Covid-19 crisis.  Depending in the impact to their business as well as other factors such as trading in the shares, Boards may consider communicating either ad hoc or in-cycle. 

Boards should be open and transparent with regard to the challenges faced by the company, their impact and actions taken.  Boards should be open to admitting the uncertainty ahead.  

Participant Polls
From our online polls taken during the coffee chat, most people confirmed their Boards have been receiving enhanced reporting during Covid-19, including scenario testing.  Most were confident about access to capital and banking facilities.  A near-majority too have been sharing scenario testing with Boards. 

By Monique Bachner, ILA Board member and a governance professional involved in various Boards.

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