Covid19 is having an enormous social and economic impact around the world. There will be substantial impacts on financial reporting from 31 December 2019 onwards. The upcoming financial reporting season is likely to be fraught and complex. If you are analysing financial statements through the upcoming reporting season, attention to detail, and fine combing the annual and interim financial statements will be even more important than ever; reliance on standard headline adjustments will not suffice.
The AMT Training team has got together and produced the following list of some key items to look out for. These will help you get on the front foot, once financials become available. Take care everyone:
1. Event after the reporting period
The global situation is changing materially day-by-day. Companies are required (IFRS and US GAAP) to disclose (in a note) any material events that happened between the year-end and the date in which the accounts were signed by the directors. Some companies have reported already, and this disclosure is currently quite limited, for example Delta Air Lines (signed 12 February), ANTA Sports (24 March), BP (18 March). This is likely a result of the full impacts of Covid19 not being understood at the signing of the financial statements. Make sure that you read the MD&A and the note on events after the reporting period.
2. Non-financial asset impairments
Long lived intangible assets and goodwill are impairment tested every year. Other assets are impairment tested if there is an indication that the value of the assets has deteriorated. The carrying value of the asset is compared to the higher for fair value and present value of future cash flow. Under either method Covid19 is likely to lead to substantial impairments, impacting both the balance sheet and the income statement.
Long term operating assets will not be the only assets impacted, impairments may also extend to associates (affiliates) and joint ventures, and inventories. Such impairments may be embedded within different line items within the income statement (both above and below reported operating profit), so care will be needed if you are trying to understand the underlying and ongoing performance of the business.
There is likely to some impact on lease contracts. For example, there may be extra lease incentives extended to a lessor, or there may be some form of government support for lessors. These extra ‘buffers’ are likely to be accounted for as a lease modification and would be spread over the remaining life of the lease contract.
4. Financial liabilities – Debt
The decline in operating performance may lead to a breach of covenants associated with previous borrowing. This may lead to a substantial change in the loan repayment terms. This may result in a reclassification of such financial liabilities from non-current to current.
5. Revenue recognition
Any declines in revenues will be understood as earned revenues are reported.
There may be further impacts on recognised revenues in relation to any revenue that is subject to some form variable consideration. This includes additional volume or pricing discounts. The variable consideration component of revenues is only recognised when it is highly probable that the amounts will not be reversed. Given the economic uncertainty, there may be a delay in such revenue being recognised.
Uncovering the true revenue impact will require a careful read and analysis of the underlying revenue recognition accounting policy and any associated disclosure.
6. Government assistance and grants
Where governments provide direct support and assistance to companies, depending on the form of this support, this may result in immediate or deferred recognition in the income statement.
7. Provisions (Reserves – US GAAP) and contingent liabilities
A provision (reserve) is recognised when the liability is probable, and a reliable estimate can be made. A contingent liability is disclosed in the notes; this is a liability that is possible.
Any upcoming restructuring provisions related to Covid19 will need to come hand-in-hand with a reliable estimate of the likely future cash outflows, which may not be possible at this time. As such a full indication of the extent of possible and probable future liabilities may require careful reading of both the provisions note and the contingent liabilities disclosure (remember that contingent liabilities will not be disclosed on the balance sheet, nor their impact recognised in the income statement until the future cash outflows are reliably known). Note that future business recovery costs are not included within provisions, and these may be required to be incorporated into any forecasting that you prepare.
8. Contingent assets
A contingent asset is an asset that is probable and is disclosed in the notes.
Insurance claims generally take time for any benefit to be realised. This is because any claim would need to first be accepted and then assessed for any payments that are to be made. As such there is likely to be a timing discrepancy between any insured costs and the recognition on insurance benefits. Careful reading of the contingent asset disclosure will reveal any probable income from insurance contracts that the entity has.
There are likely to be substantial changes to taxable profits, tax loss carried forward, temporary differences and tax legislation impacting both current and deferred taxes on both the income statement and balance sheet.
10. Going concern
Unfortunately, many businesses will face the question of whether they continue as a going concern. Under IFRS, financial statements are prepared in accordance with the IFRS even if a company is facing liquidation. Under US GAAP, if liquidation is determined to be imminent, the accounts are prepared on a ‘liquidation basis’, including the preparation of a statement of net assets in liquidation.