Supporting International Standards

Summary of Covid-19 Financial Reporting Considerations

Christopher Arnold, Stathis Gould | June 3, 2020

 

The magnitude of disruption from the Covid-19 pandemic has significantly impacted organizations of all sizes, across all industry sectors. Management and those charged with governance (TCWG) are having to make difficult decisions daily about operational, financial, and strategic matters.

The consequences on financial statement reporting and audit engagements are complex. There is an unprecedented level of uncertainty about the economy, future earnings and many other inputs that represent fundamental elements of financial reporting.  There will be multiple financial reporting implications to be considered by preparers of financial statements for the purposes of reporting in the short and potentially medium term.

The responsibility for preparing and overseeing financial reporting is with management, with oversight from TCWG. They will have to exercise significant judgment in the current business environment. Of particular importance is:

  • Balancing the timeliness of reporting against the reliability and integrity of reported information that appropriately incorporates managements best judgments and estimates.
  • Appropriately assessing going concern and disclosures of substantial doubt/ material uncertainty when it exists.
  • Providing a fair view and presentation of the performance and position of the entity, which is likely to require comprehensive disclosure of forward-looking information and cash flow impacts.
  • Maintaining an environment of integrity and transparency as the basis for trustworthy and ethical decision-making across the organization
  • Ensuring effective internal controls over financial reporting and emerging risks and taking advantage of extended reporting deadlines, as needed.

This web page covers many of the key financial reporting challenges and implications from Covid-19 and highlights various resources which are available on the dedicated IFAC Covid-19 website. References and quotes are given from numerous international standards. Not all aspects of those international standards are discussed – as such, readers should refer to those international standards for all the requirements. There may be differences in approach depending on whether financial statements are prepared using IFRS or national GAAP.

Professional accountants must remain focused on their ethical responsibilities and on the public interest. It is important for them to exercise heightened diligence and professional judgment to combat higher risks of financial misrepresentation and fraud, and to ensure government and other assistance is used appropriately. The application of the IESBA International Code of Ethics for Professional Accountants (including International Independence Standards), including compliance with the fundamental principles (integrity, objectivity, professional competence and due care, confidentiality and professional behavior) is key to preservation and expansion of public trust in all professional accountants .

Professional accountants will be asked to produce, analyze, and deliver the information upon which critical decisions will be made. The Code requires that in preparing or presenting information, professional accountants do so in a manner that is intended neither to mislead nor to influence contractual or regulatory outcomes inappropriately. The Code also requires professional accountants to exercise professional judgment to represent the facts accurately and completely in all material respects; describe clearly the true nature of business transactions or activities; and classify and record information in a timely and proper manner.

Click on the topic area below to expand the content and related resources:

 
   
  • Events After the Reporting Period

    IAS 10 Events After the Reporting Period contains requirements for when adjusting events (those that provide evidence of conditions that existed at the end of the reporting period) and non-adjusting events (those that are indicative of conditions that arose after the reporting period) need to be reflected in the financial statements. Amounts recognized in the financial statements are adjusted to reflect adjusting events, but only disclosures are required for material non-adjusting events.

    Judgment is required in determining whether events that took place after the end of the reporting period are adjusting or non-adjusting events. This will be highly dependent on the reporting date and the specific facts and circumstances of each company’s operations and value chain. Management may need to continually review and update the assessments up to the date the financial statements are issued given the fluid nature of the crisis and the uncertainties involved.

    With respect to reporting periods ending on or before 31 December 2019, there is a general consensus that the effects of the COVID-19 outbreak are the result of events that arose after the reporting date (e.g., in the UK, the Financial Reporting Council has stated that COVID-19 in 2020 was a non-adjusting event for the vast majority of UK companies preparing financial statements for periods ended 31 December 2019). For later reporting dates (e.g. February or March 2020 year ends), it is likely to be a current-period event which will require ongoing evaluation to determine the extent to which developments after the reporting date should be recognized in the reporting period.

    If management concludes the impact of non-adjusting events are material, the company is required to disclose the nature of the event and an estimate of its financial effect. If it cannot be reliably quantitively estimated, there still needs to be a qualitative disclosure, including a statement that it is not possible to estimate the effect. Management should also consider whether it is able to properly assess going concern, in the event that it can not reliably quantify the affect of non-adjusting events.

    Examples of non-adjusting events that would generally be disclosed in the financial statements include breaches of loan covenants, management plans to discontinue an operation or implement a major restructuring, significant declines in the fair value of investments held and abnormally large changes in asset prices, after the reporting period.

     

 
  • Fair Value Measurement and Impairment of Non-Financial Assets

    A change in the fair value measurement affects the disclosures required by IFRS 13, Fair Value Measurement, which requires companies to disclose the valuation techniques and the inputs used in the FVM as well as the sensitivity of the valuation to changes in assumptions. Disclosures are needed to enable users to understand whether Covid-19 has been considered for the purpose of FVM. A key question is what conditions and the corresponding assumptions were known or knowable to market participants at the reporting date.

    For 2020, fair value measurements, particularly of financial instruments and investment property, will need to be reviewed to ensure the values reflect the conditions at the balance sheet date. This will involve measurement based on unobservable inputs that reflect how market participants would consider the effect of Covid-19 in their expectations of future cash flows related to the asset or liability at the reporting date.

    During the current environment, the volatility of prices on various markets has also increased. This affects the FVM either directly - if fair value is determined based on market prices (for example, in case of shares or debt securities traded on an active market), or indirectly - for example, if a valuation technique is based on inputs that are derived from volatile markets. Consequently, special attention will be needed on the commodity price forecasting that is used in developing fair value conclusions.

    Impairment of Non-Financial Assets

    IAS 36, Impairment of Assets ensures that a company’s assets are carried at not more than their recoverable amount (the higher of fair value less costs of disposal and value in use) and requires companies to conduct impairment tests when there is an indication of impairment of an asset at the reporting date. Indicators of impairment include significant changes with an adverse effect on the company that have taken place during the reporting period or will take place soon in the market or economic environment in which the company operates.

    The scope of assets subject to the requirements in IAS 36 is broad. It includes property, plant and equipment (carried at cost or revalued amount), intangible assets (carried at cost or revalued amount), goodwill, right‑of‑use assets (if carried at cost), investment property (if carried at cost), biological assets (if carried at cost) and investments in associates and joint ventures accounted for using the equity method.

    Companies will need to assess whether the impact of Covid-19 has potentially led to an asset impairment. For most companies, the economic effects are likely to trigger an impairment test for long-lived assets and other asset groups. Estimates of future cash flows and earnings are likely to be significantly affected by direct or indirect impacts. Asset impairment may also reduce the amount of deferred tax liabilities. Management may need to make estimates about expected timing of reversal of the deductible and taxable temporary differences when considering whether a deferred tax asset can be recognized. Ongoing identification and evaluation and re-evaluation are essential to understand the extent of the need for recognition and for what periods.

    Valuation of inventories is subject to IAS 2 Inventories - requiring measurement at the lower of their cost and net realizable value (NRV). In the current environment, the NRV calculation will likely require more detailed methods or assumptions (e.g. companies may need to write-down stock due to less sales). Interim inventory impairment losses should be reflected in the interim period in which they occur, with subsequent recoveries recognized as gains in future periods.

    Areas where additional judgment is needed to evaluate fair value measurement and value in use projections include:

    • When entities have difficulty incorporating uncertainties in future cash flows for value in use. The question arises whether uncertainty can be incorporated by adjusting the discount rate instead. For some entities, uncertainty about the future may mean that it is challenging to forecast more than one set of cash flows. In this case, a sensitivity analysis may be achieved using a range of discount rates together with estimates of the timing of economic recovery.
    • It is difficult to obtain a meaningful baseline economic forecast to develop estimated future cash flow scenarios that are the basis for fair values, including further plausible downside economic scenarios specific to the entity.
    • Determining key inputs and assumptions, such as:
      • Timing of economic recovery.
      • Shape of projected GDP growth — V, U, or W shape (W shape takes into account second or third lockdown periods, which are uncertain).
      • Forecast period before there is a “new normal” which will be more challenging in some industries (e.g., travel, leisure, and hospitality).

    There is a need for clear and transparent disclosures by companies on how fair value measurement and value in use have been determined, including key inputs and assumptions as well as disclosures of significant non-adjusting post balance sheet events.

   
  • Lease Accounting

    The objective of IFRS 16, Leases is to report information that faithfully represents lease transactions and provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.

    Lessees are required to recognize assets and liabilities arising from all leases unless the lease term is 12 months or less or the underlying asset has a low value. Lessors classify leases as an operating lease or a finance lease. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. Otherwise a lease is classified as an operating lease.

    In the current environment, lessees may be seeking rent concessions from lessors. This may take the form of reduced or free rent for a period, a deferral of rent or some other type of relief (e.g. fixed rent payments becoming variable). The accounting implications of an agreed change to rent will depend on whether the change was envisaged in the original lease agreement.

    The IASB has issued an amendment to IFRS 16 to make it easier for lessees to account for Covid-19 related rent concessions. The changes:

    • Provide lessees with an exemption from assessing whether a Covid-19 related rent concession is a lease modification.
    • Requires lessees that apply the exemption to account for Covid-19 related rent concessions as if they were not lease modifications and to disclose the fact if the exemption is applied.
    • Requires lessees to apply the exemption retrospectively in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors but not require them to restate prior period figures.

    The amendment is effective June 1, 2020, but lessees can apply the amendment immediately in any financial statements (interim or annual) not yet authorized for issue.

    The FASB (through Staff Q&A) addressed certain challenges for lessors and lessees by permitting payment holidays/deferrals arising as a result of COVID-19 not to be considered a lease modification.

    In many geographies, IFRS is subject to an endorsement process before becoming a part of the accounting framework (e.g., EU endorsement). This often takes a significant amount of time. If the anticipated amendments to IFRS 16 are not endorsed in a particular geography in time for them to be implemented before the 30 June 2020 period ends, challenges noted below will apply:

    • A large number of contracts may need to be analyzed in a short period of time to assess whether the concessions or relief constitute lease modifications or changes in variable lease payments. This is a more pervasive issue for retailers and sectors that use equipment, such as airline and extractive companies. The current wording of IFRS 16 was not designed for the circumstances we are in now. Lease modification accounting may lead to:
      • Significant balance sheet adjustments and benefit from the lease concession spread over the remainder of the lease term.
      • Potential impairment issues if the new discount rate is lower and resulting lease liability is remeasured (higher) with an associated adjustment being made to the right-of-use asset (right-of-use asset balance potentially cannot be recovered).

    Certain of the amendments noted above result in a number of different approaches being permitted when accounting for the effects of lease payment holidays or deferrals. There is a need for clear and transparent disclosures about the approach that has been followed and its related impact.

 
  • Hedge Accounting

    Covid-19 may reduce the probability of a hedged forecast transaction occurring or affect its timing. Consequently, the hedge accounting criteria in applicable financial reporting standards may no longer be met, for example if a hedged financial asset becomes credit impaired.

    If a hedged forecast transaction is no longer highly probable to occur, hedge accounting is discontinued and the accumulated gains or losses on the hedging instrument need to be reclassified to profit or loss. Significant amounts may be recorded in the profit or loss account as a result of failing hedge accounting criteria.

    Hedged items that could be affected due to Covid-19 include:  Sale or purchase volumes that fall below the levels originally forecasted; planned debt issuances that are delayed or cancelled such that interest payments fall below levels originally forecasted; business acquisitions or disposals that are delayed or cancelled.

    There is a need for clear and transparent disclosures by companies about the use of hedge accounting, the effects of current and expected future conditions and amounts reported in the profit and loss account. For example, IFRS 7, Financial Instruments: Disclosures requires disclosure of defaults and breaches of loans payable, of gains and losses arising from derecognition or modification, and of any reclassification from the cash flow hedge reserve that results from hedged future cash flows no longer being expected to occur. Disclosures include quantitative data, for example about liquidity risk, and narrative disclosure, for example how risk is being managed.

 
  • Deferred Tax Assets/ Government Support

    IAS 12, Income Taxes deals with the accounting treatment for income taxes. It requires an entity to recognize a deferred tax liability or (subject to specified conditions) a deferred tax asset for all temporary differences, with some exceptions. Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the statement of financial position. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. 

    There may be still be uncertainties at the year-end in estimating whether there will be sufficient future taxable profits against which to utilize the historic tax losses and this uncertainty will require the need for judgment when calculating deferred tax asset balances.

    Covid-19 has prompted various forms of government relief programs.  In general, government support can be split into two types — changes in tax laws vs. direct assistance via government grants or loans. In accordance with IAS 20, Accounting for Government Grants and Disclosure of Government Assistance there will be different accounting treatments for government funding depending on whether it is received through a tax concession or a government grant.

    Government support often may be conditional on companies complying with specified conditions (e.g., retain 90 percent of employees on payroll). Professional accountants are required to understand and comply with any new laws or regulations introduced in response to the pandemic, as might apply to their particular circumstances. It is also important they uphold the profession’s responsibility to act in the public interest, for example, ensuring government and other assistance is used appropriately.

    If the Government support is through income tax laws, the timing of recognition would depend on timing of enactment of the law. In accordance with IAS 12, deferred tax assets are measured at the tax rates that are expected to apply to the period when the asset is realized based on tax rates/ laws that have been enacted or substantively enacted by the end of the reporting period (similar to deferred tax liabilities and current tax). If the support is through a government grant, recognition is based upon reasonable assurance that entity will comply, and the grant will be received.

    Clear and transparent disclosures by entities about government support, both for amounts already obtained and in the future, together with assessments of compliance with conditions is helpful to users in understanding other aspects of financial reporting, such as the basis of going concern.

    In accordance with IAS 12, the carrying amount of deferred tax assets are reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilized. Any such reduction is subsequently reversed to the extent that it becomes probable that sufficient taxable profit will be available.

    Covid-19 may impact projections of future taxable profits (some may reduce while others increase) and will be affected by various factors, such as:

    • Changes in cashflow forecasts.
    • Modifications in the company tax strategy.
    • Changes in tax law due to government intervention measures (e.g. an extended period to use tax losses carried forward).

    In addition, some of the changes may impact the timing of the reversal of temporary differences.

 
  • Revenue Recognition

    IFRS 15, Revenue from Contracts with Customers establishes the principles that an entity applies when reporting information about the nature, amount, timing and uncertainty of revenue and cash flows from a contract with a customer.

    In accordance with IFRS 15, an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. An entity applies five steps:

    • Identify the contract(s) with a customer
    • Identify the performance obligations in the contract
    • Determine the transaction price
    • Allocate the transaction price to the performance obligations in the contract
    • Recognize revenue when (or as) the entity satisfies a performance obligation

     Covid-19 could affect the assumptions made by management in measuring the revenue from goods or services already delivered, particularly for variable consideration and for the anticipated outcome of contacts extending over multiple reporting periods.

    For example, reduced demand could lead to an increase in expected returns, additional price concessions, reduced volume discounts, penalties for late delivery or a reduction in the prices that can be obtained by a customer. A company may also modify its enforceable rights or obligations under a contract with a customer such as granting a price concession in which is it is necessary to consider whether the concession is due to the resolution of variability that existed at contract inception or a modification that changes the parties’ rights and obligations.

    FASB has voted to extend by one year the effective date of its revenue recognition standard to all private companies and private not-for-profit entities that have not yet issued their financial statements. The effective date will be for fiscal years beginning after December 15, 2021.

 

This webpage will continue to evolve. Readers are invited to share experiences on areas covered, additional challenges and other resources which they have found particularly helpful.

General Resources

The following general resources may be helpful (please note that all resources are listed alphabetically by author and reflect no order of relative importance):

Professional accountants may also be interested in the dedicated IFAC Covid-19 audit considerations web page.

 
 

Christopher Arnold

Head of SME/SMP and Research, IFAC

Christopher Arnold is the head of SME/SMP and Research at IFAC. He was previously an Audit Manager for Deloitte and qualified as an accountant in a mid-tier accountancy practice in London (now called PKF-Littlejohn). Christopher started his career as a Small Business Policy Adviser at the Association of Chartered Certified Accountants (ACCA). See more by Christopher Arnold

Stathis Gould

Director, Advocacy, IFAC

Stathis Gould heads up the development of international services for professional accountants working in business and industry at IFAC. A key element of his work is developing thought leadership and guidance in support of finance professionals and their roles facilitating sustainable organizational performance. Before moving to IFAC, he was at the Chartered Institute of Management Accountants (CIMA) responsible for planning and overseeing a program of policy and research. Prior to serving the accountancy profession, Mr. Gould worked in various roles in the private and public sectors in the UK. See more by Stathis Gould

 

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