Following the COVID-19 pandemic, organizations and governments have imposed travel restrictions and quarantines. This situation will likely result in business disruption to entities, their suppliers, and customers. International Financial Reporting Standards (IFRS) entities should consider the impact of the virus on their financial statements in accordance with the disclosure requirements of International Accounting Standard (IAS) 1 Presentation of financial statements, including the potential need for disclosing the primary sources of uncertainty and the risk of a material adjustment in a subsequent period. IAS 10 Events after the reporting period, clarifies that adjusting events are events that had evidence of conditions that existed at the reporting date and that non-adjusting events arise from conditions after the reporting date. Therefore, the impact of COVID-19 should be assessed based on the facts and circumstances at the reporting date for adjustments. Information obtained following the reporting date, but before issuance of the financial statements should be considered for subsequent event disclosure. IFRS entities should consider the following when making these determinations:
IAS 2 Inventories requires that declines in inventory net realizable value be expensed in the period in which they occur. A loss to the net realized value may result from damage, contamination, spoilage, physical deterioration, obsolescence, fluctuations in price levels, reduced demand or other causes. Seasonally dependent items should also be assessed for potential loss. Unplanned work stoppages, labor or material shortages, or production bottlenecks could cause production levels to drop below normal capacity levels. If this happens, management will need to consider the effects on its inventory costing. During abnormally low production management should expense uncaptured overhead in the period in which it occurs, rather than adjusting the overhead absorption rates.
Financial Instruments within the scope of IFRS 9 Financial instruments should consider the impact of COVID-19 for the potential expected credit loss. Instruments such as trade and other receivables, contract assets, loans receivable, and lease receivables should be considered for collectability. If the risk of an expected credit loss has significantly increased, management should consider the need for additional reserves based on the facts and circumstances that exist at that date. In instances where collection on these financial instruments is delayed, a credit loss should be recorded if the entity is not able to recover compensation for the lost time value of money. IFRS requires that forward-looking information be considered when assessing the need to record a potential credit loss. Consideration should also be given to governing agencies enacting legislation that modifies payment terms. Lessors granting payment concessions to lessees should determine if concessions should be allocated over the remaining lease period as a lease modification. Any incentives provided by various governmental authorities should be considered for treatment as government grants by both the lessor and lessee.
Financial Instruments with readily observable fair values, such as debt and equity securities, should be recorded at their market price at the reporting date. If investment valuations are not readily available at the reporting date, indirect considerations should be disclosed as to how the valuation was derived. Under IFRS, the reporting date acts as a hypothetical exit date for the instrument. Therefore, subsequent market fluctuation should not be considered for adjustment at the reporting date, but should be considered for subsequent event disclosure.
Hedge transactions should be assessed to determine if the criteria for hedge accounting is still achieved. If hedged future cash flows are no longer anticipated then hedge accounting should be discontinued going forward.
Business disruption could result in long-lived assets being underutilized in the short term. Similar to the treatment of overhead during abnormally low periods, IAS 16 Property, plant and equipment requires that depreciation begin once the assets are placed in service and continue if sitting temporarily idle or being underutilized. The capitalization on interest for construction-in-process should be suspended temporarily if construction of that asset is suspended in accordance with IAS 23 Borrowing costs.
Long-lived and indefinite-life assets should assess potential impact of the virus under IAS 36 Impairment of assets. Indefinite-life assets, including goodwill, should be tested for impairment at least every year and whenever there is an indication that these assets might be impaired. Temporary closures, decline in demand, or reduced income could indicate impairment. Management should also consider the impact to operating cash flows and assumptions for long-term cash flow forecasts. Discount rates should also be revisited for country risk, rate risk, and risk to the individual asset or group of assets. Publically traded entities should also consider any impact to their share price and market capitalization as potential indicators.
The COVID-19 outbreak could affect revenue estimates on current and future customer contracts under IFRS 15, Revenue from contracts. This includes customer contracts with variable consideration such as volume discounts, early payment discounts, refunds, co-op agreements, price concessions, performance bonuses and penalties. At the contract inception, the company is required to estimate the amount of variable consideration to which customers will be entitled to in exchange for transferring promised goods or services. The amount of variable consideration an entity should include in the transaction price is constrained to the amount for which it is highly probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainties related to the variability are resolved. Capitalized contract assets should also be assessed for realizability of their related revenue.
Organizations may need to obtain additional financing to manage the situation and may need to obtain waivers for failed covenants. Failed covenants could result in modifications of loan terms including loans to be due on demand. In severe situations, entities may need to consider if they remain a going concern within one year after the date of issuance in accordance with IAS 1 Presentation of financial statements. Additional disclosures in the financial statements are required if substantial doubt exists and to discuss management’s plans to address the substantial doubt.
As the situation continues to develop, many entities may first report the impact of COVID-19 on their interim financial statements. Interim disclosures should be provided in accordance with IAS 34 Interim financial reporting, to ensure that information is reliable at the interim reporting date and all relevant information has been properly disclosed. For entities with significant impact, disclosure should be made for the impact on operating results along with the effect to the balance sheet and the statement of cash flows. Revisions to credit losses and changes to significant estimates should also be disclosed as should subsequent events following the interim period.
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