Revenge spending: Auditors are facing a new challenge – The Economic Times

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SynopsisGoing concern is a concept in auditing where auditors have to raise red flags for heavily debt ridden or other companies on whether they would survive for next one year.

Multiple companies facing cash flow issues in sectors like hospitality, aviation, entertainment and auto are taking a position that consumers will splurge on revenge spending and higher sales in second half of the year will more than compensate for the losses from lockdown as auditors discuss impairment and going concern issues with company managements.

If the first Covid wave brought going concern situations, the second one has brought ‘revenge spending’ for auditors to analyse.

As many auditors reach out to companies suffering from ballooning debt and plummeting sales, the companies are dishing out rosy pictures claiming that half of the third quarter and the fourth quarter will ring in growth.

“For estimating future cash flows, companies have been doing scenario planning and despite the probability of the third wave, most companies including those in the hospitality, auto and tourism sectors, feel there could be aggressive buying. There seems to be a consensus that the fourth quarter could see a spurt in sales for many companies due to the pent-up demand,” said Sriraman Parthasarathy, partner, Deloitte India.

Perhaps this would be the first time when the phrase revenge buying will enter financial statements.

In many cases, the management representatives have predicted that things will start returning to normal beginning October as the vaccination drive reaches a critical mass.

“In sectors such as hospitality, aviation, theatres and malls, where there could be a ‘going concern’ issue in the current pandemic, an auditor will reach out to the company and flag this. Depending upon the management responses, coupled with the facts on its business continuity, the auditor will decide on going concern,” said Jeenendra Bhandari, partner, MGB & Co LLP.

Going concern is a concept in auditing where auditors must raise red flags for heavily debt ridden or other companies on whether they would survive for next one year.

In 2020, many auditors were quick to qualify the financial statements of companies.

Revenge Spending: Auditors are Facing a New Challenge

This time around while the things are only getting worse as corporate debt has increased and there is a fear of a third wave, many companies are claiming this is the fag end of the crisis.

Auditors can contradict the company’s stand in the financial statements.

“In order to assess the going concern assumption of a company, auditors will need to critically assess these factors and conduct a detailed evaluation and gather evidence to obtain comfort including but not limited to, reviewing and discussing the business plan during and post pandemic, possible speed of recovery post the second wave, servicing of debt obligations, cash flow position and the previous year’s performance post the first wave, which can also be a guiding factor,” said Nikhil Singhi, senior partner at Singhi & Co.

“The auditor always approaches any issue on a conservative basis, so future revenues or contracts are never recognised even when the company is able to demonstrate a spurt in future revenues. These facts could be a fresh fund raise or enough cash reserves or even a bank debt restructuring exercise undertaken, which can demonstrate the ability of an enterprise to survive and grow in future,” said Bhandari.

Industry experts say that in Europe, US and even in China, whenever the infection rates subdued, people rushed to buy expensive cars, bikes or booked long vacations.

Industry trackers say that it is possible to build predictive models around this and the revenge buying sectors or companies can be identified.

“The predictive scenario of projected cash flows, its basis and the reasonability of these assumptions would be evaluated by the auditors to measure the sensitivity of these assumptions to changes, including by use of advanced audit analytics,” said Parthasarathy.

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