As per report published by credit rating agency Moody’s investor service, there is drop expected in global GDP as depicted in chart published by Moody’s below. The good news is that market is expected to come back positive and strong.

From financial statements perspective, almost every event that impacts business has a financial reporting implication for a company and the changes COVID-19 has brought on the business environment is no exception. When there is an economic downturn, questions naturally turn to whether or not a company’s assets are impaired. Given the severity of the broad COVID-19 impacts on the economy, industries and individual businesses, here is an article on some of the accounting and reporting implications that companies need to consider on the financial statements for periods ending after 31 December 2019 of entities whose business is affected by the virus There are broad IFRS implications, including:

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• non-financial assets;

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• financial instruments and leases;

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• revenue recognition;

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• non-financial obligations;

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• going concern;

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• disclosures: and

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• interim financial statements

Background

Companies need to consider whether they face any accounting or disclosure implications resulting from the coronavirus outbreak. Many countries have required companies to limit or suspend business operations and have implemented travel restrictions. Financial services entities such as banks that lend to affected entities, insurers that provide protection to affected individuals and businesses, and funds or other investors that invest in affected entities are also likely to be affected. These actions have disrupted supply chains and curtailed operations of many companies around the world. Companies that have already been affected include those in the tourism, hospitality, transportation, retail, entertainment and manufacturing sectors. Measures taken to contain the virus have affected economic activity, which in turn has implications for financial reporting. Management should carefully consider the impact of the COVID-19 on both interim and annual financial statements. The impact could be significant for many businesses. The implications for financial statements include not only the measurement of assets and liabilities but also disclosure and possible impact on going concern assumption.

Accounting considerations

Inventories

IAS 2 Inventories requires that fixed production overheads are included in the cost of inventory based on normal production capacity. Reduced production might affect the extent to which overheads can be included in the cost of inventory. Unplanned work stoppages, labor or material shortages, or production bottlenecks could cause production levels to drop below normal capacity levels. If this happens, a company will need to consider the effects on its inventory costing. The amount of fixed overhead allocated to each unit of production is not increased when production is abnormally low, and the costs associated with underutilized capacity (known as “excess capacity costs”) are expensed in the period they are incurred without adjusting overhead absorption rates.

Companies will need to use judgment to determine when production is lower than normal capacity. The range of normal capacity can vary based on business- and industry-specific factors.

Entities should assess the significance of any write-downs and whether they require disclosure in accordance with IAS 2.

Property, plant and equipment

The current situation might mean that property, plant and equipment is under-utilised or not utilised for a period or that capital projects are suspended. IAS 16 Property, plant and equipment requires that depreciation continues to be charged in the income statement while an asset is temporarily idle. IAS 23 Borrowing costs requires that the capitalisation of interest is suspended when development of an asset is suspended.

At the end of each reporting period, an entity is required to assess whether there is any indication that an asset may be impaired (i.e. its carrying amount may be higher than asset’s fair value less costs of disposal and its value in use). IAS 36 has a list of external and internal indicators of impairment. If there is an indication that an asset may be impaired, then the asset’s recoverable amount must be calculated.

Financing receivables and contract assets

Entities with financing receivables (e.g., loans, trade accounts receivable) and contract assets should consider the guidance under IFRS 9 to evaluate whether and to what extent the coronavirus affects the collectibility of their receivables and contract assets. Even when a borrower is expected to repay all amounts owed but later than contractually required, there will be a credit loss if the lender is not compensated for the lost time value of money.

IFRS 9 requires that forward-looking information (including macro-economic information) is considered both when assessing whether there has been a significant increase in credit risk and when measuring expected credit losses. Forward-looking information might include additional downside scenarios related to the spread of COVID-19.

Leases

A lessor and a lessee might renegotiate the terms of a lease as a result of COVID-19 or a lessor might grant a lessee a concession of some sort in connection with lease payments. In some cases, a lessor might receive compensation from a local government as an incentive to offer such concessions. Both lessors and lessees should consider the requirements of IFRS 16 Leases and whether the concession should be accounted for a lease modification and spread over the remaining period of the lease. Lessors and lessees should also consider whether incentives received from a local government are government grants. Even when a borrower is expected to repay all amounts owed but later than contractually required, there will be a credit loss if the lender is not compensated for the lost time value of money.

Management should consider the need to disclose the impact of the downturn on the impairment of financial assets.

Impairment under IAS 36 Impairment of assets

The spread of virus has led to factors that are likely to reduce future cash flows or increase operating and other costs. These factors are considered as indicators of impairment. Management should consider specifically the requirements under IAS 36 and IAS 1 to disclose assumptions and sensitivities in the context of testing goodwill and indefinite lived intangible assets. The disclosure requirements in IAS 36 are extensive. Management should consider specifically the requirements to disclose assumptions and sensitivities in the context of testing goodwill and indefinite lived intangible assets. Management should consider whether there is any impact on timing on future cash flows, decline in market capitalization, changes in discount rate etc.

Management should also consider the requirements in IAS 1 Presentation of financial statements to disclose the major sources of estimation uncertainty that have a significant risk of resulting in a material adjustment to the financial statements in a subsequent period.

Associates and joint ventures accounted for using the equity method

Entities should consider whether there are any changes in circumstances that might require an impairment assessment for equity method investments. If there has been a significant decline in the value of an investee, an investor would need to exercise judgment to determine whether the decline is other than temporary. An impairment loss is recognized for a loss in value of an investment that is other than a temporary decline.

Going concern

Management should consider the potential implications of COVID-19 and the measures taken to control it when assessing the entity’s ability to continue as a going concern. Management should consider the impact of measures taken by governments and local banks in its assessment of going concern. Management should also remember that events after the reporting date that indicate an entity is no longer a going concern are always adjusting events.

Material uncertainties that might cast significant doubt upon an entity’s ability to continue as a going concern should be disclosed in accordance with IAS 1.

Revenue recognition

The coronavirus outbreak could affect revenue estimates in new and ongoing customer contracts in the scope of IFRS 15: Revenue from Contracts with Customers. This is because when a contract with a customer includes variable consideration (e.g., discounts, refunds, price concessions, performance bonuses and penalties), an entity is generally required to estimate, at contract inception, the amount of consideration to which it will be entitled in exchange for transferring promised goods or services. The amount of variable consideration an entity can include in the transaction price is constrained to the amount for which it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainties related to the variability are resolved. An entity that makes such an estimate is also required to update the estimate throughout the term of the contract to depict conditions that exist at each reporting date. This will involve updating the estimate of variable consideration (including any amounts that are constrained) to reflect an entity’s revised expectations about the amount of consideration to which it expects to be entitled, considering uncertainties that are resolved or new information about uncertainties related to the coronavirus outbreak.

Provisions

Management’s actions in relation to the virus should be accounted for as a provision only to the extent that there is a present obligation for which the outflow of economic benefits is probable and can be reliably estimated. For example, a provision for restructuring should be recognised only when there is a detailed formal plan for the restructuring and management has raised a valid expectation in those affected that the plan will be implemented. IAS 37 does not permit provisions for future operating costs or future business recovery costs.

Events after the reporting period

The global situation is evolving rapidly. Management should therefore consider the requirements of IAS 10 Events after the reporting period and in particular whether the latest developments provide more information about the circumstances that existed at the reporting date. Events that provide more information about the spread of the virus and the related costs might be adjusting events. Events, such as the announcement or enactment of new measures to contain the virus or decisions taken by management are likely to be non-adjusting. Clear disclosure of non-adjusting events is required when this is material to the financial statements.

Article prepared by: Rishi Aggarwal – Partner (Audit & Assurance)

This document is only for information purposes and should not be construed as advice. It does not necessarily cover each aspect of the topic with which it deals. You should not act upon the contents of this document without receiving formal advice on your particular circumstances. If you would like to discuss any audit related matters, please drop us an email at info@premier-brains.com or call us at + 971 4 3542959.

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