COVID-19: Other effects on the financial statements

Asset impairment and impairment of the going concern assumption are two of the most adverse consequences of COVID-19 on entities’ financial reporting.

Entities may have to amend the figures in their 2019 financial statements or include disclosures in this regard.

Impairment of assets

With the objective of performing year-end impairment tests, or those currently required to be performed by ALL entities worldwide that apply International Standards, to measure the effects on financial reporting, an initial question with respect to the effects of the coronavirus pandemic is whether any impairment is required to be recognized in the December 31, 2019 financial statements, or whether this should be considered as a post-statement date event that does not involve an adjustment.

The requirement, in accordance with IAS 10 – Events occurring after the reporting period, is to account for significant changes in business and economic conditions as non-adjusting events, because the development and spread of the coronavirus occurred, conclusively, after January 2020.

As of December 31, 2019 only certain events and associated actions had taken place, according to information received by media outlets around the world.

However, although cases were reported to the World Health Organization – WHO – on December 30, 2019, the announcement of the coronavirus as a global health emergency was only made until January 31, 2020, after which date governments took action. In addition, significant determinations made by the Chinese government and its private sector entities were only made in early 2020.

On this basis, and as expected, the forecasts, projections and associated assumptions used for impairment testing purposes reflected little or no change as a result of the coronavirus outbreak.

The reason for this is that, in measuring the recoverable amount of financial and non-financial resources/assets, it is necessary to use projections that are based on reasonable and supportable assumptions that represent management’s best estimate within the range of economic conditions that will exist over the remaining useful life of the asset. Those reasonable and supportable assumptions should be made as of the reporting date (December 31, 2019).

Accordingly, the forecasts, projections and valuations used for the impairment calculations as of December 31, 2019 will need to be carefully reviewed to ensure that the significant effects of the coronavirus outbreak (an event subsequent to the non-adjustable statement of financial position date) is not being incorporated through the use of hindsight.

However, it will be necessary to ensure that appropriate disclosures of subsequent non-adjustable events are made in the financial statements for the period ended December 31, 2019.

Paragraph 21 of IAS 10 requires that:

“If events occurring after the reporting period that do not involve adjustment are material, not disclosing this information may influence the economic decisions that users can make on the basis of the financial statements. Accordingly, an entity shall disclose the following information about each material category of non-adjusting events occurring after the reporting period:

–thenature of the event; and

–anestimate of its financial effects, or a statement of the impossibility of making such an estimate.”

Required disclosures in the 2019 financial statements

So, disclosures in the financial statements as of December 31, 2019 that may be required as a result of the coronavirus outbreak include:

–estimatesof impairment of financial assets (expected credit losses) and non-financial assets;

– covenantdefaultson loans or other arrangements;

–triggersof conditions giving rise to debt or other instruments that require redemption (or repayment at the option of the counterparty);

–waiversor changes to contractual terms of loans or other arrangements;

– supply chaindifficultiesor other business disruption;

–handlingsuspension or termination of contracts; and

–assessingwhether a contract for the sale or purchase of goods or services is an onerous contract.

Going concern assumptions

IAS 10 – Events occurring after the reporting period contains specific requirements for considering the going concern assumption in an entity.

Unlike projections used for impairment purposes, when assessing the going concern assumption entities should consider events both before and after the reporting date.

To comply with IAS 10 it is necessary to consider whether events that occurred after the reporting date of the general purpose financial information, i.e. after December 31, 2019, in relation to the coronavirus outbreak, have caused a relevant deterioration in the economic conditions of the entity or have given rise to a material uncertainty.

If so, it is necessary to assess whether this raises clear doubts about the entity’s ability to continue as a going concern (see paragraph 16(b) of IAS 10). In extreme cases, it will be necessary to consider whether the assertions of those managing the entity (Law 222 of 1995, articles 22, 23 and 37), for the period ended December 31, 2019, should be prepared on a going concern basis.

If it is concluded that the going concern basis is not appropriate, then the financial statements shall be prepared on another basis. Now, in the latter case, paragraph 25 of IAS 1 requires disclosure that the financial statements have not been prepared on a going concern basis, together with the reasons why the entity is not considered a going concern.

“in some cases the implications of the coronavirus outbreak are such that there is or may be significant doubt about an entity’s ability to continue as a going concern.”

Although it is possible to conclude that it remains appropriate for financial statements to be prepared on a going concern basis, in some cases the implications of the coronavirus outbreak are such that there is or may be significant doubt about an entity’s ability to continue as a going concern.

In such cases, to the extent that there is material uncertainty about whether the going concern assumption is appropriate, disclosures should be included in the financial statements. In making its going concern assessment, information that is available after the reporting date should be taken into account. Paragraph 26 of IAS 1 requires that:

“(…) management shall take into account all available forward-looking information, which shall cover at least the next twelve months from the end of the reporting period, but not be limited to that period. The degree of detail of the considerations will depend on the facts presented in each case (…)”.

Accordingly, management’s assessment of going concern needs to incorporate all relevant information, including forward-looking information for an appropriate period, that has been available up to the date the general purpose financial statements are authorized or approved for issue. This includes:

–updatedforecast financial information;

– updated sensitivityanalysis(which may require additional information and/or different possible variances to be included); and

–compliance withbanking and other covenants (e.g., some structured debt arrangements, including contractual terms that mean debt is repayable if financial results are actual plus a specified percentage below initial forecasts).

As it is, in circumstances where the coronavirus outbreak gives rise to material uncertainty about the entity’s ability to continue as a going concern, but it has been concluded that the going concern basis of preparation remains adequate, management needs to include expanded disclosures to support its conclusion that the going concern basis is adequate. These will include:

– adequatedisclosuresabout the coronavirus outbreak and management’s plans for dealing with its effects; and

– cleardisclosure that there is a material uncertainty about the entity’s ability to continue, and, therefore, it may not be able to realize its assets and pay its liabilities in the ordinary course of its business.

Source: Update