COVID 19 is taking its toll, not just on precious human life, but also on businesses and financial markets. The economy is at an all-time slow now, and entities will have to be careful while considering the various accounting implications of the situation.
Though the pandemic has had far-flung impacts on almost the sectors, whether directly or indirectly; aviation, tourism, hospitality, and retail are among the most badly hit of these. And as time passes, more and more sectors are coming under the radar, as the lockdown is being extended in an attempt to control the spread of the virus.
This writes up seeks to identify some of the key financial reporting areas that entities need to consider, to determine the impact on their business, financial position, and ultimately their financial statements.
The Going Concern Assumption
All financial statements are prepared with the assumption that the business is a going concern, and will continue to operate for a considerable future period. The managers of the entity now need to assess the impact of the virus and the measures that need to be taken to ensure that the entity continues as a going concern.
A lot of sectors are experiencing a lot of disturbances in their supply chain. Seasonal inventories as well as perishable goods are at a high risk of loss, due to either damage or contamination, changes in the price level, physical deterioration, obsolescence, etc. Thus, companies need to assess whether or not on their reporting date, an adjustment is needed to be made to the carrying value of their inventory, to bring them to their net realizable value.
Additionally, under the presently ongoing unpredictable circumstances, estimating the net realizable value of the inventory is a challenge, thanks to the high volatility in the market.
Also, if the production level is abnormally low (for instance, due to the temporary termination of production), the entity will have to review the entire inventory costing. This is important to ensure that unallocated fixed overheads are accounted for the profit and loss in the period in which they have been incurred.
Entities, where AS is applicable, may have possibly postponed the recognition of revenue because of the uncertainties of collection. As per AS-9, entities are required to disclose all possible circumstances in which revenue recognition has been postponed. Additionally, if the contract with a customer includes certain variable components, such as discounts, the entity will also have to consider whether or not its previous estimates continue to be appropriate in this regard. Certain revenue contracts might turn less profitable or even loss-making now. For instance, an entity might incur increased costs that are difficult to recover, such as replacing employees or finding alternative suppliers.
The management needs to ascertain whether any of the entity’s contracts are in an ‘onerous’ position, and whether or not a liability or provision needs to be recognized.
Onerous contracts are the contracts where the costs that are associated with meeting the obligations and cannot be avoided; exceed the economic benefits which are expected to be received from it. As a result of the pandemic, a lot of contracts are at a high chance of becoming onerous. This might be for reasons such as an increase in the cost of material, labor, etc; penalty due to delay in supply of goods, etc.
The management needs to consider these onerous contracts and account for them as per AS 29 onerous. Additionally, if for some reason the management is unable to ascertain whether some of the contracts have become onerous or not, as a result of the inadequacy of information, the same needs to be disclosed.
PPE and intangible assets
Property, plant, and equipment might remain highly under-utilized for considerable periods. However, as per standards, depreciation needs to be charged, even if the PPE remains idle. Moreover, the virus has impacted the expected useful and residual life of PPE.
Significant changes have also occurred in the manner in which assets are being used. For instance, a lot of machines are sitting idle, which will affect their future productivity. Changes in certain legal factors and business climates have also affected the value of an asset considerably. For instance, a lot of businesses are now expecting a reduction in their export volume, as a result of border closings.
Moreover, the doubts surrounding the entity’s ability to continue as a going concern also impair the value of the assets.
Due to the economic condition, a lot of entities have had to downsize their workforce. The management needs to consider how and when to account for the expenses, in cases where the entity is offering termination benefits to the affected employees. The measurement of these defined benefit obligations involves making a couple of estimates and also a certain assumption. These include factors like a future salary increase, employee turnover, etc. Given the present certain, an entity also needs to consider the impacts of these benefit obligations.
Entities will have to consider the various requirements for making provisions for the fall in the value of their investments which is not temporary, as per the AS 13, Accounting for Investments.
As per AS 16, when the development of any asset is suspended, so is the capitalization of interest on it. Some financial institutions and creditors are also offering debt holders with the option of deferring the payment of the principal amount for some time. The management will have to calculate whether the change in these terms symbolized a modification of the debt obligation. Portions of the debt that are current versus non-current also need to be revisited.
Foreign currency translation
Entities need to translate their foreign currency transactions into that of the reporting currency. This is done using the spot rate in effect on the date when the transaction occurred. Practically, entities translate their revenues and expenses in a foreign currency using an average rate. However, due to the uncertainties around, economic rates are fluctuating. Entities, thus, need to revisit how they have been translating these transactions into their statements.
Insurance claims for business interruption
An entity might be covered under an insurance policy for losses that occur during a business interruption. If a business has been forced to temporarily cease even some of the operations as a result of the pandemic, it can recover some or all of these losses from the insurance provider. Also, if the entity has a clear right to reimbursement, these claims would be accounted as contingent assets in the financial statements.
Lease terms and contracts
Due to the pandemic, certain changes may be made in terms of the lease arrangements. The lessee might also have been granted some concession about the lease payment. While accounting for leases, these revised terms need to be accounted for. However, anticipated revisions need not be taken into account. Additionally, if the government has declared some compensation to the lessor for providing the lessee with this concession, it needs to be considered whether the same should be accounted for appropriately. Entities also need to ascertain whether their lease arrangements have become onerous as a result of the COVID 19.
AS 28 Impairment of Assets requires that an entity assesses at the end of every reporting period whether there is some indication that nonfinancial assets will be impaired. Due to the coronavirus outbreak, there can be cases of the temporary ceasing of operations or a decline in demand and prices as a result of reduced economic activities. The management can consider these factors as indicators that impairment testing is required for AS 28. However, if the entity is unable to do so because of a lack of information, the same needs to be disclosed.