03/04/2020 As the world adjusts to the coronavirus outbreak, we all face the difficult challenge of responding to the impact it is having on our lives. As well as issues of health and wellbeing, corporates face additional economic challenges presented by the disease. So how should corporates qualify events from an accounting perspective?
In terms of accounting implications, the current consensus is that an entity shall not adjust the amounts recognised in its financial statements (1) as at 31 December 2019 to reflect events caused by the Covid-19 outbreak that occur after the reporting period. That is unless such events seriously call into question the validity of the ‘going concern’ assumption (2). Consequently, the Covid-19 outbreak impact on end of 2019 financial statements is viewed as a non-adjusting event and limited to disclosures only.
At a more granular level, however, corporates may seek clarification relating to issues such as credit losses, cash flow forecasts and fair value. In terms of the impact on the provision of expected credit losses, the erosion in the credit quality of customers due to the Covid-19 outbreak is caused by events that occurred in 2020. As a consequence, the impairment of trade receivables at 31 December 2019 shall not include the effects of the outbreak.
Cash flow forecasts should also not consider the effects of the outbreak, insofar as business plans are based on the existing situation as at 31 December 2019 when there were no observable indications that asset values had declined due to Covid-19-related events. Similarly, the fair value (level 3) of unlisted securities shall not be reassessed as any erosion of customer credit quality due to coronavirus occurred in 2020.
Notwithstanding these issues, it is essential that corporates can assess whether the going concern assumption is still appropriate. Factors to consider include all the existing and anticipated impacts of the outbreak on the economic conditions of the entity. These factors include any significant decline in revenue; significant erosion of profits due to higher costs or incurrence of unforeseen expenses; breach of debt covenants; cash flow issues; and expected impacts of announcements of government support to the economy.
In addition, corporates should consider events both before and after the reporting date, up to the date of authorisation for the issue of the financial statements. They should not consider the accounting qualification of events, i.e. irrespective of whether those events are adjusting or non-adjusting.
Adhering to IFRS
So what are the accounting implications if such assessments conclude that the validity of the going concern assumption is seriously undermined? Under International Financial Reporting Standards (IFRS), an entity shall not prepare its financial statements on a going concern basis if management determines after the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so. In such a case, the financial statements at 31 December 2019 shall, therefore, be prepared from a business termination perspective based on net asset values.
In terms of disclosures in the notes of financial statements, corporates must approach this with the key principle in mind; to ensure the adequacy and the relevance of the information disclosed in order to assess significant sources of estimation uncertainty at the end of the reporting period. To achieve the objective of measuring the risk of material adjustment to the carrying amounts of assets and liabilities within the next financial year, items to consider include information about non-adjusting events after the reporting period (3). Such items would include the nature of the event and an estimation of its financial effect or a statement that such an estimation cannot be made.
Other important considerations in terms of disclosures would be information about the assumptions made for the future, and other major sources of uncertainty at the end of the reporting period (4), as well as information regarding why financial statements are not prepared on a going concern basis (5). Also, any material uncertainties that may cast significant doubt upon the entity’s ability to continue as a going concern, albeit without questioning the relevance of the going concern assumption.
It’s worth pointing out that European Securities and Markets Authority (ESMA) expects issuers to provide both qualitative and quantitative information on the actual and potential impacts of the outbreak.
Finally, as the pandemic persists and we head into a period of economic uncertainty in 2020, and beyond, we need to be mindful that regulatory bodies are continually assessing the impact of Covid-19. Discussions on how to account for such events continue, and corporates need to be alert to further changes and interpretations in the coming months.
(1) IAS 10.10 non-adjusting events
(2) IAS 10.14-16
(3) IAS 10.21
(4) IAS 1.125 and following
(5) IAS 10.16