The impacts of the outbreak on financial statements will depend on facts and circumstances, including the degree to which a business operation is exposed, and the sensitivity of amounts recorded in the financial statements to the volatility of economic conditions. This article looks at some of the aspects that needs to be considered by the companies while preparing financial statements.
Management would need to assess the company’s ability to continue as a going concern, and whether the going concern assumption is still appropriate as a basis for the preparation of the company’s financial statements. The liquidity issue requires immediate consideration. Budgets and forecasts may require significant revision to be able to support management’s assessment in the current environment.
Impact on revenue recognition will include aspects such as revision of estimates of variable consideration and timing of revenue cognition including assessment of whether consideration is probable. The impact on recoverability of trade receivables including estimate of expected credit losses would also require to be assessed.
Impairment of non-current assets and goodwill
Impairment test needs to be carried due to severe economic contraction acting as an impairment trigger. Market assumptions and discount rates used to estimate future cash flows needs to be updated to reflect the risk environment at there porting date. Robust disclosures will be required regarding the assumptions used to understand the degree of estimation uncertainty that exists in estimating the recoverable amount and the sensitivity of the recoverable amount.
Changes to remuneration policies may impact the estimation and measurement of employee benefits and recognition of share-based payment expenses. Modifications to share-based payment arrangements will need to be assessed as to whether they are either beneficial or non-beneficial to the employees and accounted for accordingly.
There could be significant impact on the inventory valuation due to decline in net realizable value because of forced plant shutdowns, reduction in demand, and non-fulfillment of sales and purchase contracts.
Expected Credit Losses (ECLs)
Due to the gravity of economic effects, companies will have to revise their estimates of ECL. Current uncertainty may result in an increase in its provision for ECL due to greater probability of defaults, possible decreases in the value of collateral and other assets, etc. Relevant disclosures should be provided to enable better understanding of credit risk, timing, and uncertainty of future cash flows.
Onerous contract provisions
Customer contracts may become onerous due to non-fulfillment of obligations under the contract as a result of considerable reduction of production, which would necessitate recognition of a provision. Delay in fulfillment of contractual obligations may also result in penalties to be provided for. Companies should consider providing meaningful disclosures about judgments and estimates applied in recognizing and measuring provisions.
Fair value assessment
Due to current economic uncertainty, there would be a significant change in the assumptions used to measure fair value of the assets and liabilities of a company at the end of the reporting period. Valuation techniques will require considerable change. Appropriate disclosures to address the change would become necessary.
Lessee would need to assess its right-of-use assets for impairment. Lessors would need to ascertain whether some of their underlying assets held for lease are to be considered for impairment due to decrease in demand for such assets or steep decline in rentals.
There will be reassessment of lease contracts including lease term and revenue recognition by lessor. Based on reassessment, the lessee will be required to remeasure its lease liability using a revised discount rate which will significantly impact the carrying amount of lease assets and liabilities. This may in turn affect the amount and profile of depreciation and interest expense recognized subsequently.
Government actions and legislation providing assistance needs to be monitored to find out whether they meet the definition of a government grant. Companies receiving government grants for the first time may need to develop new accounting policies and procedures. Expanding disclosures on the accounting policies for government grants and the impact of grants and other assistance on the financial statements would be required.
Deferred tax assets
Their coverability of deferred tax assets may be impacted since companies’ projections of future taxable profits due to changes in forecast of cash flows, tax strategies, government assistance programs, etc.
The companies may evaluate the terms of their insurance policies and estimate possible compensation surrounding loss of profits and business disruption, etc. including timing of recognition of such claims.
Internal Controls Over Financial Reporting
Impact on ICFR needs to be evaluated by the companies. For instance, new controls or modification in controls would be required where companies have enhanced/modified IT access to enable remote working environments.
Disclaimer: This content is meant for information only and should not be considered as an advice or opinion, or otherwise. AKGVG & Associates does not intend to advertise its services through this.
CA Tushar Goel
AKGVG & Associates