Relevant information to the users of the financial statements or the need for subsequent event special notes?
In just three months, the COVID-19 outbreak impacted the modern world in an unprecedented way. The virus is crashing our everyday lives, is limiting our basic freedoms and threatens our future. Besides the tragic outcome on health, this pandemic keeps on having a heavy impact on a wide range of industries, its ramifications will likely continue from some time, and we cannot predict for how long.
- What implications will COVID-19 bring from an IFRS perspective?
- What are the main accounting matters we are most likely to deal with when preparing financial statements?
- How would this year look from this standpoint?
Although some circumstances related to COVID-19 arose before 31st December 2019, the World Health Organisation (WHO) decreed it as a global health emergency only at the end of January 2020. Therefore, after the end of the reporting period, and only after this announcement, the national governments have taken specific measures to tackle the pandemic.
With the hope of decreasing the spread of the virus, several national authorities are imposing tight restrictions which inevitably impact businesses in different sectors, such as manufacturing, hospitality, and transport. In fact, these restrictions have led to the limitation or suspension of economic activities with potential ripple effects on business operations.
„It’s fundamental to have an overview of the main accounting matters we are most likely to deal with when preparing financial statements as of 31st December 2019, according to the International Financial Reporting Standards (IFRS). Although most of the financial effects have come this year, reporting should anticipate some adjustments and/or expectations regarding 2020. In fact, the impact of the pandemic may lead to a more relevant disclosure to the financial statement users or may bring the need for subsequent event special notes.”, mentioned Ella Chilea, Partner, Audit & Assurance Services, Mazars Romania.
IAS 10 “Events after the reporting period” states that an event – when related to conditions existing at the balance sheet date – should be reflected in the financial statements. Otherwise, an event related to conditions arising after the balance sheet date does not affect financial statements.
„In some cases, an in-depth assessment may be necessary, when events occurred after the end of the reporting period to provide additional information about situations of uncertainty that already existed at the reporting date: consider, for example, the bankruptcy of a client after the balance sheet date due to the consequences determined by the COVID-19.”, mentioned Davide Pratticò, Senior Supervisor, Audit & Assurance Services, Mazars Romania.
The following specific aspects should be considered by the auditors or by the companies in relation to financial statements prepared in accordance with IFRS as of 31st December 2019:
According to IAS 36 “Impairment of assets”, an asset meets the criteria for a reduction in value, when its book value exceeds its recoverable value. The recoverable amount is defined as the higher of the ‘fair value less costs to sell’ and the ‘value in use’.
The determination of the recoverable value of an asset takes into consideration the information available after the end of the year, only if it represents conditions that existed at the balance sheet date.
COVID-19 does not impact on the impairment of assets.
2. FAIR VALUE
The fair value method, that indicates “the amount for which an asset can be exchanged, settled as a liability, or traded as a granted equity instrument, all between interested stakeholders, in a transaction carried out under objective conditions” reflects the assessment of the object of measurement at the balance sheet date, but not at a future date.
Other events, occurring after the valuation reference date, and therefore after the date of the financial statements, are included in the assumptions used in the computation of the fair value only if:
- they provide evidence of conditions existing on the valuation date and
- they were available for market operators on that date.
COVID-19 does not impact the fair value measurement.
The foregoing does not exclude the possibility that the directors must provide the information required by other standards (such as the IAS 10) on events occurring after the year-end, which expressly mentions in paragraph 22, letter g) “abnormal changes in asset prices or foreign exchange rates occurring after the balance sheet date”.
3.EXPECTED LOSSES FROM FINANCIAL INSTRUMENTS
Regarding the reduction in value for financial instruments not measured at the fair value through the income statement, IFRS 9 “Financial Instruments” guides the recognition of expected losses over the life of the receivables for which, after initial recognition, there has eventuated a significant increase in credit risk. This assessment is conducted on the information available at the reporting date and that which may have become available subsequently.
Therefore, assumptions related to COVID-19 can be included in the expected loss assessment techniques. In this regard, adequate qualitative and quantitative disclosure is also required.
Once again, the directors must provide, if relevant and reasonably determinable, the appropriate disclosure required, as per IAS 10, concerning subsequent events of a non-adjusting nature.
Regarding going concern, IAS 10 provides that, in the preparation of the financial statements, directors and management must assess the company’s ability to remain in business for the foreseeable future. An entity is assumed to be a going concern in the absence of significant information to the contrary, which may lead to a scenario, where the entity might be forced to halt operations and liquidate its assets in the near term at very low fire-sale prices.
The assessment of the business continuity should also be based on all the information available after 31st December 2019, and this information might relate to the existence of any significant uncertainties deriving from the unpredictability of the emergency developments: if a company, with good historic profitability, relies on external financial resources and, due to the COVID-19 emergency, it incurs in the suspension of operations in March 2020. The directors should take into consideration a wide range of factors related to any adverse economic situation, the impact on expected profitability, and the ability to repay debt.
Therefore, companies must consider whether the COVID-19 and its effects impact the assumption of going concern or make adjustments at the time horizon took into account for the assessment.
5.FINANCIAL REPORTING DISCLOSURE
IAS 10 states that the disclosure of the financial statements may include those events, occurred after the balance sheet date, but they do not require an accounting entry in the balance (non-adjusting events).
Furthermore, IAS 1 “Presentation of Financial Statements” requires, in general, the disclosure regarding future developments and on the other main causes of uncertainty.
The directors should, therefore, consider the impact on their economic activities generated by the COVID-19 emergency and provide adequate information regarding the assets and liabilities that are particularly exposed to the uncertainty of the estimates, which generally include assumptions made by the directors about the future recoverability of an asset or the extinction value of a liability, such as:
- variable fees according to IFRS 15 “Revenue from Contracts with Customers”;
- net realizable value of inventories, according to IAS 2 “Inventories”;
- recoverability of prepaid taxes, according to IAS 12 “Income Taxes”;
- the residual value of fixed assets, intangible assets and rights of use, according to IAS 16 “Property, Plant, and Equipment”, IAS 38 “Intangible Assets” and IFRS 16 “Leases”, respectively;
- provisions for risks, according to IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”.
Appropriateness of the disclosure will depend on a case-by-case analysis based on specific facts and circumstances attributable to both the company’s business sector and the potential impact of the risks related to COVID-19 on its economic activity.
Therefore, management must evaluate whether, in this regard, further and more detailed information is necessary.
„Consultants can play an important role in the evaluation of the abovementioned impacts on assets and liabilities as of 31st December 2019, if we consider the conditions already existing at the financial reporting date, and those that may be disclosed as subsequent events. Together, we can rethink the business and transform its operations, having in mind the safety of the employees and taking care of the company’s financial goals.”, mentioned Ella Chilea, Partner, Audit & Assurance Services, Mazars Romania.