Report

by the Comptroller
and Auditor General

Good Practice Guide

Guide for audit and risk committees on financial reporting and management during COVID-19

HC 524 Session 2019–2021 24 June 2020

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Report by the Comptroller and Auditor General

Ordered by the House of Commons
to be printed on 23 June 2020

This guide has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act

Gareth Davies
Comptroller and Auditor General
National Audit Office

22 June 2020

This guide aims to help audit and risk committee members discharge their responsibilities and to examine the impacts on their organisations of the COVID-19 outbreak. It is part of a programme of work undertaken by the NAO to support Parliament in its scrutiny of the UK government’s response to COVID-19.

Good practice guide

We publish good practice guides on important issues to make it easier for others to understand and apply the lessons from our work.

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009156 06/20 NAO

The National Audit Office study team consisted of:
Charlotte Borg and Robert O’Donoghue, under the direction of Siân Jones.

This guide can be found on the
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www.nao.org.uk

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Introduction

Background

1 The scale and nature of the current COVID-19 outbreak and government’s response is unprecedented in recent history. The outbreak has impacted on all public sector bodies, either through delivering the government’s response, or in dealing with challenges for individual organisations.

2 This guide is part of a programme of work to be undertaken by the National Audit Office (NAO) to support Parliament in its scrutiny of the UK government’s response to COVID-19. Our aim is to report in a risk-based way on programmes and activities being undertaken by government departments and other organisations, and also to support organisations’ own internal scrutiny and challenge.

3 Audit and risk committees are integral to the scrutiny and challenge process. They advise boards and accounting officers on matters of financial accountability, assurance and governance, and can support organisations, providing expert challenge, helping organisations focus on what is important, and how best to manage risk.

4 Each organisation will have existing risk management processes in place, but risk appetite may have changed as a result of COVID-19, for the organisation to operate effectively and respond in a timely manner. This may result in a weakening of controls in some areas, increasing the likelihood of other risks occurring. Organisations will need to consider how long this change in risk appetite is sustainable for.

This guide

5 This guide aims to help audit and risk committee members discharge their responsibilities in several different areas, and to examine the impacts on their organisations of the COVID-19 outbreak, including on:

annual reports;

financial reporting;

the control environment; and

regularity of expenditure.

6 In each section of the guide we have set out some questions to help audit and risk committee members to understand and challenge activities. Each section can be used on its own, although we would recommend that audit and risk committee members consider the whole guide, as the questions in other sections may be interrelated. Each individual section has the questions at the end, but for ease of use all the questions are included in Appendix One.

7 The guide may also be used as organisations and audit and risk committees consider reporting in the 2020-21 period when more specific and detailed reporting on the outbreak will be required.

8 While this guide is intended to be a comprehensive consideration of areas that organisations, and audit and risk committees, will need to consider, each organisation will need to take account of its own unique circumstances in considering the impact of COVID-19. The guide is not exhaustive, and we would expect each organisation to familiarise themselves with the underlying guidance where relevant.

Part One

Annual reports

1.1 The annual report is a key mechanism for transparent disclosure of an organisation’s in-year performance and governance matters. Disclosures in the annual report will help to provide information about the impact of COVID-19 on the organisation to users of annual reports and accounts.

1.2 This part sets out HM Treasury’s requirements for annual reports and potential questions for audit and risk committees to ask in the context of COVID-19.1 While the significant impacts of the outbreak only emerged in the UK in mid-March, there are some impacts in 2019-20. Annual report disclosures are expected to consider the period up to when the document is published.

Performance report

1.3 The purpose of the performance section of the annual report is to provide information on the entity, its main objectives and strategies and the principal risks it faces. The report should discuss how the entity has performed in the year, including areas where performance has deteriorated or is below expectations, where money has been spent and the other key risks impacting on the organisation.

1.4 HM Treasury expects that the performance report will detail the impact of COVID-19 on the organisation in 2019-20. While reporting could be more streamlined than in prior years, it should still provide enough information to satisfy parliamentary accountability and provide appropriate transparency. Any planned streamlining should be agreed with the relevant select committee or department before approval of the annual report and accounts.

Accountability report

1.5 The purpose of the accountability section of the annual report is to meet key accountability requirements of Parliament. In the context of COVID-19, the corporate governance report element of the accountability report provides an important mechanism for organisations to outline how COVID-19 has affected governance arrangements, the control environment, changes to their risks and risk appetite, as well as any relevant considerations in relation to the regularity of expenditure.

1 We have summarised HM Treasury’s requirements for annual reports in this part. The full requirements can be found in the Government Financial Reporting Manual here: www.gov.uk/government/publications/government-financial-reporting-manual-2019-20. Specific COVID-19-related updates to this manual can be found here:
www.gov.uk/government/publications/financial-reporting-manual-addendum-2019-20

2 HM Treasury, Managing Public Money is available at: www.gov.uk/government/publications/managing-public-money

Part Two

Financial reporting

2.1 The effects of the COVID-19 outbreak and response could appear in different areas of the financial statements. This part considers key questions for audit and risk committees to consider, including:

valuations, including property, pension scheme and inventory valuations;

completeness of liabilities;

going concern; and

events after the reporting period.

Valuations

2.2 The economic uncertainty caused by COVID-19 has made valuations of assets and liabilities more challenging for 2019-20. We expect the biggest issues for management to be accessing reliable data sources to base valuations on, as well as significantly increased estimation uncertainty. Therefore, management should consider the following areas in preparing valuations for financial statements:

Whether usual sources of information for valuations remain appropriate in the context of COVID-19 uncertainties, and if not, what alternative sources of information are available.

Whether assumptions used in valuation models/estimates require updating because of COVID-19. This should include considerations that underpin credit loss calculations and impairment reviews where COVID-19 has changed the circumstances for creditors and markets.

If there are additional sources of information that should be used for valuation judgements – such as updated customer information to determine expected credit losses or impairments.

Whether there are practical impacts for some organisations where lockdown measures limit the ability for valuers to complete work on physical assets, including stock-takes as noted in the inventory valuations section below.

If there will be more appropriate information that gives an indication of the situation at the year-end available before the finalisation of the financial statements.

2.3 The financial statement disclosures should also be transparent in setting out all sensitive and material assumptions made in determining valuations.

Property valuations

2.4 The impact of COVID-19 on the economy and the impact of government restrictions has led to a significant slowing of the property market. As of April 2020, property sales in the UK were 46% lower than in March.3 This makes it more difficult for management, and its experts, to value significant property portfolios. In addition to the general valuation considerations set out above, we expect there could be specific challenges in the following areas of property valuation:

Where management uses an expert to value property, the expert may include material uncertainty clauses in valuation reports, given the uncertain environment, which management will need to consider.

Organisations not due to revalue property in 2019-20 may be using an indexation method to uplift prior-year valuations. Due to the lack of reliable and appropriate market data, organisations may find it difficult to identify appropriate indices to use.

There are practical challenges due to the outbreak in relation to the physical verification of assets, impacting valuation judgements.

Pension scheme valuations

2.5 If an organisation participates in a defined benefit pension scheme, it may be required to recognise the deficit or surplus of that scheme as at year-end. The significant uncertainty associated with the COVID-19 outbreak will affect the measurement of pension scheme assets or liabilities in the following ways, in addition to the general valuation difficulties above:

There may be increased complexity in valuing scheme assets, particularly where assets do not have an active market or where the valuation is affected by the volatility in the financial markets.

Actuarial assumptions used to project the defined benefit obligation may require updating due to the outbreak, including financial assumptions such as discount rates and salary growth. As for general valuations, we would expect any changes in assumptions would be disclosed, along with any sensitivity analysis of these assumptions.

Inventory valuations

2.6 In addition to the general valuation difficulties set out above, we anticipate specific inventory challenges in relation to the outbreak, including:

organisations may encounter difficulties estimating the value of inventories held due to the volatile market conditions or a lack of a market in which to sell inventory due to lockdown restrictions;

organisations may encounter greater obsolescence of perishable stock due to lockdown restrictions; and

practical difficulties in completing physical inventory counts due to lockdown restrictions.

Completeness of liabilities

2.7 The impact of COVID-19 may impact on the liabilities of an organisation. For example, new liabilities could emerge due to legal cases, contractual obligations, commitments or changes in assumptions and policies. The impact of COVID-19 could also lead to onerous contracts, as plans for contracts held could have changed, costs may have increased, or an organisation may be unable to fulfil contracts previously signed.

2.8 Management should consider the following areas in assessing the completeness of liabilities for financial statements:

Consideration of all major contracts to identify potential onerous contracts.

Re-assessment of the likelihood of open legal cases at the reporting date in consideration of the COVID-19 context.

Use of the best available information to value new liabilities identified.

Disclosure of assumptions made about material estimation uncertainty in relation to liabilities.

Going concern

2.9 An entity is a going concern unless management either intends to cease the activities of the organisation or has no realistic alternative but to do so. For some organisations, the impact of COVID-19 may leave management with no realistic alternative but to cease its activities. When preparing the financial statements, management is responsible for completing a full assessment of whether the organisation is a going concern, considering the impacts of COVID-19 and other events on the long-term viability of the organisation.

2.10 There may be material uncertainty related to going concern, caused by COVID-19 casting significant doubt on the organisation’s ability to continue to operate. Where this is the case, the financial statements must clearly state that there is material uncertainty related to going concern, and therefore it may be unable to realise its assets and discharge its liabilities in the normal course of business. The principal events or conditions casting doubt should be clearly disclosed in the financial statements.

2.11 For central government organisations that follow the Government Financial Reporting Manual, it is rare that activities completely cease, and it is more likely that the activities of an organisation that may be closing are transferred to an organisation that is continuing. In this case, going concern is presumed by virtue of the functions transferring, and therefore financial statements are prepared on this basis, but we would still expect management to document its consideration of the impact of COVID-19 on its future business plans.

2.12 Management should consider the following areas in making its going concern assessment:

All information available about the future, including impacts of COVID-19 on the organisation’s future performance and agreement of future funding. This should be updated and considered until the financial statements are published.

A view of at least, but not limited to, 12 months from the date when the financial statements are published.

Specific considerations for the organisation and its specific risks.

Events after the reporting period

2.13 The impacts of the COVID-19 pandemic emerged in March 2020 around the year-end for many government organisations, increasing the likelihood of events after the reporting period that may require disclosure in the financial statements. This may include events such as new liabilities for the organisation as a result of new COVID-19-related activities, changes in key contractual arrangements impacting the organisation, or impacts on the recoverability of the organisation’s asset values.

2.14 Management are required to consider two types of potential events after the reporting period:

those that provide evidence of conditions that existed at the date of the financial statements (adjusting events); and

those that provide evidence of conditions that arose after the date of the financial statements (non-adjusting events).

2.15 Adjusting events would lead to the financial statements of an organisation being updated for the impact of the change, whereas non-adjusting events are only disclosed if material to the organisation, in the events after the reporting date note.

3 HM Revenue & Customs, UK Property Transactions Statistics, April 2020 update, available at:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/886277/MPT_Com_May_20__cir_.pdf

Part Three

Control environment

3.1 The internal controls in place at many organisations may have stopped, required modification or been overridden by new controls introduced to adapt to the impact of the COVID-19 outbreak. Changes may have been made at pace to respond to a dynamic environment, which may impact effectiveness.

3.2 This part outlines some areas where controls may have changed as well as potential questions for audit and risk committees to ask in the context of COVID-19.

3.3 There may be changes in controls over preparing the financial statements in the following areas:

Remote working may have impacted the ability for controls to operate as designed. Due to the quick transition, controls may have been changed at pace or not be operating as intended, increasing the risk of fraud and error.

Operational imperative to deliver more quickly or due to changes in staff availability may mean standard procedures needed to be overridden.

New activities not previously undertaken by the organisation may mean new processes were introduced at speed and may not be as robust.

Senior management oversight may have been reduced due to urgent operational priorities.

IT security systems may not have been designed for large-scale remote working and controls may have been reduced by the changed ways of working.

3.4 Where internal controls have been implemented or revised, management should consider whether it is sustainable in the longer term for the controls to operate in this way. For example, an increased burden on specific members of the organisation may be appropriate in the short term but, as the outbreak continues, there is a risk that the organisation becomes overly reliant on a small group of individuals. Management should consider how it can reinstate or strengthen the controls that are in place in order to operate in the current conditions for a sustained period. In the longer term, management should also consider what the desired control environment will look like and how to achieve it, when the outbreak has passed.

3.5 We would expect organisations to consider their risk assessments when making changes to their internal controls, enhancing and prioritising the critical controls needed to reduce the risk of fraud or error.

Part Four

Regularity of expenditure

4.1 In response to COVID-19, organisations have been required to increase spending and, in some circumstances, incur expenditure on activities outside those permitted by original authorising legislation or other applicable delegated authority.

4.2 This part outlines the relevant regularity considerations for organisations, along with potential questions for audit and risk committees to ask in the context of COVID-19.

4.3 During the current circumstances, organisations and their accounting officers should still ensure that all expenditure adheres to the principles in Managing Public Money:4

Regularity: if a proposal is outside an organisation’s framework of authorities, it is deemed irregular. The framework of authorities can be the legal powers, parliamentary authority, HM Treasury delegations or voted spend. If a department exceeds its spending limits authorised by Parliament, this is irregular and results in an excess vote and qualified regularity audit opinion.

Propriety: if a proposal does not meet “standards of public conduct”, such as appropriate governance or parliamentary expectations.

Value for money: if an alternative proposal, or doing nothing, would deliver better value (cheaper, higher quality or more effective use of funding).

Feasibility: where there is a significant doubt about whether the proposal can be implemented accurately, sustainably or to the intended timetable.

4.4 Accounting officers should bring to the attention of the relevant minister any conflict between their instructions and the principles in Managing Public Money. If the minister decides to continue with this course of action even though the accounting officer has advised the instructions conflict with Managing Public Money, it would be expected that a ministerial direction would be provided. During the outbreak we have seen an increased use of ministerial directions. Where ministerial directions are required, management should bring the matter to the attention of the audit and risk committee and it should be disclosed in the corporate governance report.

Procurement Policy Note 02/2020

4.5 In response to the COVID-19 outbreak, the Cabinet Office has issued Procurement Policy Note (PPN) 02/2020 which sets out its expected approach for supplier payments during the outbreak.5 This PPN aims to ensure the continuity of service during the outbreak and ensure suppliers can resume normal contract delivery after the outbreak is over. The PPN is clear that the usual Managing Public Money principles of spend being regular, proper and value for money still apply.

4.6 The PPN instructs contracting authorities to pay all suppliers as quickly as possible to maintain cash flow and protect jobs. It advises that contracting authorities should take action to continue to pay suppliers at risk due to COVID-19 to ensure continuity and retention of the supply going forward. Where necessary, advanced payments to suppliers are permitted under the PPN.

4.7 Where the provisions of this PPN are being used by management, we would expect them to be clear that this was required to ensure continuity of service during the outbreak (or after the outbreak) and for all appropriate checks to be carried out and documented on the relevant suppliers before payments are made. The PPN requires suppliers to act on an open book basis, so we would expect management to have received relevant supporting data for payments made.

Fraud and error

4.8 A specific area of regularity that is impacted by COVID-19 is the potential for fraud and error in expenditure, which is heightened due to the pace of the COVID-19 response. This risk could manifest in several ways, including:

procurement risks: new supply chains created at pace not allowing for complete risk assessments or single tender actions with no other options;

contractor risks: new contractors being used at pace not allowing for appropriate due diligence;

payments/grants/loans risks: new or expanded support schemes in place to support employers, employees and businesses during the outbreak that may not have appropriate controls in place; and

cyber security risks: enhanced risk of cyber-attack, leading to fraud or error.

4.9 Instances where controls do not operate as intended due to the outbreak, or where organisations are required to spend at pace may also increase the likelihood of fraud and error.

National Audit Office’s Fraud and Error Framework

4.10 The Fraud and Error Framework (Appendix Three) is used to assess the effectiveness of an organisation’s response to fraud and error risk. The framework can provide prompts to support departments and larger organisations in regular reporting to the Cabinet Office on fraud risks and incidents. In responding to the outbreak, audit and risk committees may find the framework helpful in considering an organisation’s risk and exposures to fraud or error that arise from changes to business as usual, or when introducing new activities.

4 HM Treasury, Managing Public Money is available at: www.gov.uk/government/publications/managing-public-money

5 Procurement Policy Note 02/2020 is available at: www.gov.uk/government/publications/procurement-policy-note-0220-supplier-relief-due-to-covid-19

Appendix One

Key questions to ask

Appendix Two

Further resources

Below is a selection of guidance and insights that may be useful.

1 HM Treasury, Managing Public Money, March 2018, available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/742188/Managing_Public_Money__MPM__2018.pdf

2 HM Treasury, Audit and risk committee handbook, March 2016, available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/512760/PU1934_Audit_committee_handbook.pdf

3 The Institute of Chartered Accountants in England and Wales, Coronavirus: (COVID-19): considering going concern, 2020, available at: www.icaew.com/technical/audit-and-assurance/coronavirus-considering-going-concern

4 The Pensions Regulator, COVID-19 guidance for employers, April 2020, available at: www.thepensionsregulator.gov.uk/en/media-hub/press-releases/2020-press-releases/new-covid-19-pension-guidance-published-for-employers

5 The Royal Institution of Chartered Surveyors, Valuation practice alert COVID-19, 2020, available at: www.rics.org/uk/upholding-professional-standards/sector-standards/valuation/valuation-coronavirus/

6 The Institute of Chartered Accountants in England and Wales, Coronavirus and financial reporting, 2020, available at: www.icaew.com/coronavirus/financial-reporting

7 Financial Reporting Council, FRC COVID-19 Response, 2020, available at: www.frc.org.uk/covid-19-guidance-and-advice

8 International Auditing and Assurance Standards Board, Subsequent Events in the Current Evolving Environment, 2020, available at: www.iaasb.org/publications/subsequent-events-current-evolving-environment-audit-considerations-impact-covid-19

9 HM Treasury, Addendum to Government Financial Reporting Manual 2019-20: minimum reporting requirements, 2020, available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/884468/2019-20_Government_Financial_Reporting_Manual_-_addendum.pdf

10 HM Government, The Orange Book: Management of Risk – Principles and Concepts, 2020, available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/866117/6.6266_HMT_Orange_Book_Update_v6_WEB.PDF

Appendix Three

National Audit Office’s Fraud and Error Framework

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