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 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.
Many governments have already announced measures to provide both financial and nonfinancial assistance to disrupted industry sectors and affected business organizations.
In this context, transparency is key. There is a vital need for reliable information to regain trust in uncertain times, and part of that will be provided through financial reporting. The impact on financial reporting may not be the first thing that comes to mind as a consequence of the outbreak, but there is an important and challenging role here for preparers of financial statements, audit committees and auditors.
There will be a number of areas for discussion, but four issues will be priorities: going concern and liquidity; impairment assessment; contract modifications; fair value measurement.
Understandably, management affected by the crisis will be concerned about the survival of their organizations. And the key will be cash flow – does the business have enough cash to survive the next six to 12 months?
When preparing financial statements, management has to make an assessment of a company’s ability to continue as a going concern, and whether the going concern assumption is appropriate. In the current circumstances, management will need to consider the existing and anticipated effects of the coronavirus outbreak on activities in its assessment.
Given the unpredictability of the potential impact, there may be material uncertainties that cast doubt on the company’s ability to operate under the going concern basis. If the company, nevertheless, prepares the financial statements under this assumption, it must disclose these uncertainties.
The degree of consideration required, the conclusion reached, and the required level of disclosure will depend on the circumstances in each case, as not all companies will be affected in the same manner and to the same extent. Significant judgment and continual updates to the assessments may be required given the evolving nature of the outbreak.
At the end of each reporting period, companies are required to assess whether there is any impairment for nonfinancial assets. An asset is impaired when a company is not able to recover its carrying value, either by using it or selling it.
The adverse impact on companies caused by measures to stop the spread of the disease, such as temporary manufacturing plant closures and travel and import/export restrictions, can be considered an impairment indicator.
When assessing impairment, companies are required to determine the recoverable amounts of the assets. This calculation requires an estimate of expected future cash flows and expectations about variations in cash flows. The forecasted cash flows should reflect management’s best estimate of the economic conditions that will exist over the remaining useful life of the asset.
With the current situation, significant challenges are expected as to whether the forecast of budgets for future cash flows can be supported by subsequent performance. The more the current environment is uncertain, the more important it is for the company to provide detailed disclosure of the assumptions taken, the evidence on which they are based and the impact of a change in key assumptions.
Companies affected by the COVID-19 outbreak may experience cash flow challenges as a result of disrupted operations, higher operating costs or lost revenues. They may need to obtain additional financing, amend the terms of debt agreements or obtain waivers if they no longer satisfy debt covenants. In such cases, they will need to consider whether any changes to existing contractual arrangements represent a substantial modification or potentially a contract extinguishment.
There are also consequences for lenders. Financial institutions, such as banks and insurance companies, are being asked to help borrowers by providing relief on cash-flow obligations. These will be considered contract modifications and will require institutions to think about the measurements of their loan portfolio and expected credit losses. Similarly, real estate companies will have to consider the consequences if they provide relief to lessees on rents.
Companies are required to measure some of their assets and liabilities at fair value. This is a date-specific exit price estimate based on assumptions that market participants would make under current conditions.
When making assessments and judgments for measuring fair value, the company should consider the conditions and corresponding assumptions that were known or knowable to market participants. The fair value measurement (FVM) impact would depend on the evaluation of whether the severity of the outbreak at the reporting date would have impacted participants’ valuation assumptions at that time.
Companies will also need to consider making related disclosures that could reasonably be expected to influence decisions that the users of general-purpose financial statements would make on the basis of those financial statements. Disclosure may be needed to enable users to understand whether or not the outbreak has been considered for the purpose of FVM. Users should understand the basis for selecting the assumptions and inputs that were used and the related sensitivities.
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.