EY on How Audit Committees Can Prepare for First Quarter Reporting

The EY Center for Board Matters has issued How audit committees can prepare for 2021 Q1 reporting. The report notes that companies are navigating “ongoing global volatility, an uneven economic recovery and changes in the US administration” and that, in this “uncertain and fluid business landscape”, audit committees are focused on “reviewing scenario plans, stress tests and enterprise risk management (ERM) information while overseeing high-quality financial reporting.” The EY Center suggests a range of specific matters for audit committee consideration in their oversight of 2021 first quarter reporting.

The topics the EY Center identifies, and examples of the issues or actions that it recommends audit committees consider, are summarized below. (In some cases, issues and actions have been shorten or paraphrased.)

Risk Management

Audit committees should continue to monitor the economic recovery and other drivers of risk. Examples of actions the EY Center suggests audit committees may want to take include:

• Evaluate audit plan adjustments to address changes in risk profile, risk appetite and tolerances identified by the ERM program. Evaluate how internal audit’s risk coverage has been adjusted due to travel restrictions. Consider whether the key control validation process has materially changed and any impacts on the control environment.

• Determine whether the organization has assessed and modeled the effects of potential changes to US, state, and foreign tax laws, including impacts on “significant transformations” such as workforce changes, digital and supply chain transformation, and M&A.

• Evaluate whether company plans will change risks or necessitate changes in the design of internal controls. Consider how process changes, such as those stemming from COVID, are impacting the performance and effectiveness of key controls.

• Evaluate whether new fraud risks have arisen or existing fraud risks have changed.

• Consider additional metrics the board and audit committee should monitor in the changing environment.

Accounting and Disclosures

Audit committees should assess accounting and disclosure implications arising from ongoing impacts of the pandemic, changing business environment, and macroeconomic conditions. Examples of accounting and disclosure impacts cited by EY include:

• Asset realizability and impairment (e.g., inventory, indefinite‑lived intangible assets including goodwill, long‑lived assets, and other investments).

• Revenue recognition, with a focus on material modifications to existing contracts and arrangements, variable consideration and changes in estimates, and collectability assessments.

• Loss contingencies, changes in assumptions and ranges in estimates related to contractual commitments, guarantees, indemnifications, self-insurance, legal exposures, and other contingencies.

• Fair value measurements for financial and nonfinancial assets and liabilities.

• Accounting related to employee transition matters (e.g., termination, severance, furlough) and changes to employment benefits.

Financial Reporting

Audit committees should monitor developments at the SEC and other regulators and assess the impact on reporting requirements and disclosures. Examples of possible audit committee actions in this regard include:

• Consider the implications for the timing of SEC filings, such as the likelihood of financial statement adjustments after the earnings release and the likelihood of material subsequent events that may bear on the fairness and completeness of the financial statements in the earnings release.

• Discuss implications for operations, liquidity, and financial condition. Consider enhancements to MD&A disclosures, including any known material events and uncertainties related to forward-looking information, such as the company’s ability to meet its short-term and long-term cash needs.

• Monitor how the company is addressing the SEC’s new requirements for disclosures about human capital resources. Consider any voluntary human capital-related disclosures in the company’s public communications (e.g., in a sustainability report).

• Re-evaluate the use of non-GAAP measures. Consider whether any COVID-19-related adjustments are appropriate and whether any changes in non-GAAP financial measures (or key performance indicators) are appropriately disclosed and consistently applied.

Growing ESG Expectations

Climate change, and ESG issues more broadly, are a focus of the Biden Administration and the SEC. If ESG metrics are key performance indicators in an SEC filing, it is critical that audit committees consider:

• Data quality and controls.

• Disclosure processes and controls.

• Consistency in disclosures across the company’s various external reporting outlets (e.g., SEC filings, earnings releases, annual report and shareholder letter, and sustainability report).

• The role of internal and external audit.

Inquiries with Management, Compliance Personnel, and Auditors

The EY Center suggests that audit committees consider new questions, in addition to the usual inquiries, as part of their dialogue with management, compliance and the auditors. Examples are:

• How have management and the auditors adjusted their approach to physical inventories and cycle counts?

• Can financial reporting, compliance, and audit procedures (internal and external) be adequately performed through physical and remote working procedures? What options are there to facilitate timely collection, processing, and reporting of information for internal use and regulatory filings?

• What more should be done through technology, training, and manager support to optimize remote working, connectivity, engagement, security, and productivity?

• How is the organization monitoring compliance with federal, state, and local regulations and guidelines around reopening of businesses, employee/customer health and safety, privacy, and confidentiality?

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The EY Center’s report also lists the top ten global risks in 2021, as determined by the World Economic Forum (WEF). According to the WEF, the three highest 2021 risks, based on likelihood of occurrence, are extreme weather, climate action failure, and human environmental damage. The greatest risks, ranked by impact, are infectious diseases, climate action failure, and weapons of mass destruction. The Center suggests that “audit committees should evaluate whether management has considered these global risks in its risk assessments and risk mitigation strategies to be adaptive to the changing external environment.”

Comment: While the EY Center’s report is aimed specifically at first quarter reporting, the topics discussed have broad relevance and are a good checklist for matters that audit committees may want to focus on throughout the current year. The list of issues is extensive and detailed, and audit committees may want to review it to identify any gaps in, or additions to, the issues the committee plans to consider in the first quarter of 2021 and beyond. For other agenda suggestions, see What Should be on the Audit Committee’s 2021 Agenda?, January-February 2021 Update.