Co-authored by Miriam Hanley (Technical Specialist) and Biane Aliyar (Technical Senior)
DD: +44 (0)1784 497116
The spread of the Coronavirus (COVID-19) continues to dominate the news, with major implications for public health and the NHS. It is also causing economic disruption and we wanted to explore the accounting implications of Coronavirus.
The financial reporting areas covered in this document are as follows (click each link to jump to a sector of interest):
Events after the reporting period
Events after the reporting period are defined under FRS 102, section 32 as those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are authorised for issue.
There are two types of events:
those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the end of the reporting period); and
those that are indicative of conditions that arose after the end of the reporting period (non-adjusting events after the end of the reporting period).’
Amounts in the financial statements must be adjusted in response to adjusting events whilst only disclosures are required in response to material non-adjusting events.
For December year-ends given at this date, few cases had been confirmed and the virus had only just been identified with very little evidence around human to human transmission, these events would be likely to represent non-adjusting post balance sheet events.
The requirement for non-adjusting post balance sheet events is that an entity shall disclose the following:
(a) the nature of the event; and
(b) an estimate of its financial effect, or a statement that such an estimate cannot be made.
In terms of the disclosing the nature of the event the entity will need to consider the impact of coronavirus on the business and the circumstances in which the business operates. This assessment may involve considering the impact of the virus in the countries in which it operates, on the supply chain and the broader impact on the global economy, for example customer confidence, future buying intentions and their ability to pay.
For March year-ends however and as we progress in to 2020 year ends we would need to assess and consider further whether the numbers in the financial statements are impacted. This will vary business to business, for example if a company with a January 2020 year end is reliant on Chinese manufactured goods the impact of Coronavirus would probably start impacting the numbers in the balance sheet date. However, if a January 2020 year end was reliant on Italian manufactured goods, this would probably be deemed as a non-adjusting event, as Italy was not recorded to be impacted until February.
Many Companies will experience supply chain disruptions as a result of imposed travel restrictions and social distancing measures in place across the world It is therefore important that companies consider and assess whether the value of assets such as goodwill or PPE are impaired, based on conditions at the balance sheet date.
Under FRS 102, section 27 for assets other than inventories it is a requirement to consider annually whether there are indicators of impairment for example there could be a significant decrease in the market price of an asset or a significant adverse change in the extent or manner in which an asset is being used or its physical condition.
If it is confirmed that indicators of impairment exist then an impairment review is carried out to compare the carrying amount of the asset with its recoverable amount, which is the higher of its fair value less cost to sell and its value in use. As a consequence of coronavirus, the value in use calculations may need to be revised/adjusted to reflect the economic conditions at the balance sheet date, specifically to address increased risk and uncertainty.
Per FRS 102, section 11 at the end of each reporting period, an entity shall assess whether there is objective evidence of impairment of any financial assets that are measured at cost or amortised cost. If there is objective evidence of impairment, the entity shall recognise an impairment loss in profit or loss immediately.
Examples of objective evidence that debtors are not recoverable are:
(a) significant financial difficulty of the issuer or obligor;
(b) a breach of contract, such as a default or delinquency in interest or principal payments;
(c) the creditor, for economic reasons relating to the debtor’s financial difficulty, granting to the debtor a concession that the creditor would not otherwise consider; or
(d) it has become probable that the debtor will enter bankruptcy.
Additionally, under FRS 102, section 27 inventory is tested for impairment at each reporting date. If an item of inventory is impaired, the entity shall reduce the carrying amount of the inventory to its net realisable value, and this could be due to reduced movement in inventory, or inventory obsolescence due to lower than expected sales as a result of coronavirus.
Potential disruptions to supply chains caused by coronavirus, may result in companies experiencing lower production levels than normal. If this is the case, then companies should consider the impact this will have on its inventory carrying amount. The amount of fixed overhead allocated to each unit of production for example depreciation or rent of property or equipment is not increased when production is lower than normal capacity levels. Instead the excess capacity costs as a result are expensed in the period they are incurred and no adjustment is made to the overhead absorptions rates. It is therefore important that companies exercise judgment to determine when production is lower than normal capacity.
Another implication of coronavirus is that some entities may not be able to fulfil its supply contracts due to imposed restrictions etc. It is important therefore that management should consider if any of its contracts have become onerous. Onerous contracts are those contracts for which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
If an entity has a contract that is onerous, under FRS 102, section 21 the entity recognises and measures the present obligation under the contract as a provision.
Additionally, for certain companies there will be increased risk of onerous leases. For example, a retailer may determine that a retail store is trading at a loss, i.e. revenue generated from sales does not cover the cost of goods sold, lease rental and other overheads, and therefore there would need to be consideration of whether an onerous lease provision is needed.
Companies will also need to recognise a redundancy provision in situations where staff redundancies are communicated before the year-end.
Companies may experience poor financial performance as a result of Coronavirus, which may lead to entities breaching their bank covenants. Companies should consider in the event of a breach of bank covenants whether loans need to be reclassified. For example, if they become repayable on demand, their presentation in the financial statements will need to change to a current liability to reflect this.
An entity will need to carefully consider the impact of coronavirus and the social distancing measures and how these effect the company’s significant specific circumstances. When assessing going concern, management must take into account all available information about the future, which is at least but not limited to 12 months from the date that the financial statements are authorised for issue. In considering the impact of coronavirus, companies may need to forecast various scenarios. For example, what would happen in the event social distancing continued for one month, 3 months etc. Companies will also need to consider the impact on liquidity and any government assistance they expect to receive.
An entity in these instances may need to consider additional disclosures of any material uncertainties that cast significant doubt upon the entity’s ability to continue as a going concern and in some circumstances it may be necessary to consider whether its appropriate to prepare the accounts on the going concern basis.
Under FRS 102, section 1A small entities are encouraged only to provide disclosure in respect of material uncertainties in respect of going concern. Companies must be mindful however of the Companies Act requirement to prepare financial statements which give a true fair view and therefore the fact should consider any additional disclosure required in order to meet this.
Recognising Governments Assistance
As a result of Coronavirus, the government have introduced a series of measures to support entities. Government grants are defined in the standards as assistance by government in the form of transfers of resources to a company in return for past or future compliance with specified conditions relating to the operating activities of the company. Companies that are receiving assistance from the government, will need to consider the financial reporting requirements. Under FRS 102, section 24 Government grants, including non-monetary grants shall not be recognised until there is reasonable assurance that:
(a) the entity will comply with the conditions attaching to them; and
(b) the grants will be received.
In terms of disclosure for government assistance, an entity will need to disclose the following:
- the accounting policy adopted for grants;
- the nature and amounts of grants recognised in the financial statements;
- unfulfilled conditions and other contingencies attaching to grants that have been recognised in income; and
- an indication of other forms of government assistance from which the entity has directly benefited.
One of the measures introduced by the government is the job retention scheme, in which companies will receive 80% of the wages for employees that are furloughed. Under FRS 102, section 24, this amount should be recognised gross as other income in the profit or loss statement.
Small entities are exempt from the main disclosure requirements above under FRS 102, section 1A and there are no explicit requirements for them in respect of government grants.
As with all other areas however, companies for whom government grants are significant will nonetheless need to consider carefully whether they need to give more information and disclosure, in order to ensure the financial statements give a true and fair view.
Companies should consider whether to refer to the possible impact of coronavirus in their reporting of principal risks and uncertainties in the strategic report. When mitigating actions can be taken, these should also be reported alongside the description of the risk itself.
Small companies are exempt from the requirement to prepare a strategic report and, therefore, the requirement to report on principal risks and uncertainties.
For more information on any of the above items covered in this document, contact Menzies Technical Manager Miriam Hanley.
The ICAEW has produced a checklist which includes the different factors to consider when preparing accounts in light of Coronavirus.