COVID-19 and your Financial Statements
In the first of this series, we highlight key matters to consider when preparing your financial statements.
With the Corona Virus (COVID-19) already impacting the country, many businesses are faced with operational and financial difficulties. The South African national lockdown that became effective at midnight on 23 March 2020 is anticipated to affect almost all sectors. The impact of COVID-19 must therefore be considered by all entities. This includes the impact on their financial reporting requirements.
This newsletter introduces the first of several matters to consider when preparing financial statements of entities during this period. These are:
- Events after the reporting period
- Going concern
Events after the reporting period
Entities must consider whether the outbreak of the COVID-19 virus, and the declaration of a National State of Disaster, is indicative of an adjusting or non-adjusting event. In order for it to be classified as an adjusting event, entities must assess whether there are any indicators that indicate that the event existed at year-end. Entities must ensure that only readily available information at the reporting date is considered.
IAS 10 Events after the Reporting Period, provide detail on when a subsequent event requires adjustments to the financial statements or whether it only requires additional disclosure. Firstly, entities will need to distinguish between the event being the outbreak of the virus itself or if the event is rather the restriction and containment measures implemented internationally as well as in the country in which the entity reports in.
Once the trigger to the subsequent event has been identified, entities are required to determine whether the event is classified as an adjusting event or non-adjusting event. Examples of non-adjusting events will include the significant decrease in the fair value of investments in listed entities as changes in fair values are not indicative of events existing at year-end. An example of an adjusting event could be an increase in the entity’s expected credit loss (ECL) based on an increased credit risk due to the outbreak of the virus and containment measures implemented by governments. This is due to the fact that IFRS 9 Financial Instruments requires an entity to determine a weighted average of the probability of default by considering past, current and forward-looking information.
When assessing whether the going concern assumption is appropriate, entities must consider information available for at least the next 12 months from the date of the financial statements. This, in itself, may be difficult to obtain due to the uncertainty of the outcome of the outbreak including for how long restrictions will be in place.
Entities must consider the wide-ranging effects of the virus and the restrictions entities are facing. This could impact on the delivery of goods and services to customers, purchasing of goods required to be delivered based on promises to customers etc. The working capital cycle may severely affect the entity’s ability to settle its debts as they become due as well as default on payments on loans and facilities.
Any relief sought by entities through government assistance or relaxation of repayments by banking institutions require a careful assessment as to whether this is considered a breach of covenant, thereby affecting disclosure in the risk management note in the financial statements.
The impact of the current situation must be disclosed in the financial statements, together with the entity’s assessment of the potential impact it has on the entity and its operations. In addition to the impact, entities are encouraged to also disclose what mitigating factors and/or alternative actions the entity have taken to address any potential going concern uncertainties.
The above two matters require disclosure in the financial statements, based on the results of the evaluations performed by the entity.
In addition, it is expected that the above two matters will require significant estimation and judgement. We remind you that IAS 1 requires an entity to disclose any significant estimates or judgements made in preparing the financial statements. If material, these disclosures may include:
- Evaluation of the financial health and quality of assets;
- Estimation of the future economic benefits that can be derived from assets;
- Judgements made as to whether subsequent events are adjusting or non-adjusting events; or
- The factors that give rise to uncertainty how any significant doubt over estimation is reduced to ensure that there is no material uncertainty especially when there is an increased reliance of government assistance, alternative sources of financing and potentially a greater impact of time value of money.
We will continue to provide you with insights into how COVID-19 and containment measures may affect your financial reporting. Our communication over the next few weeks will discuss, in no particular order and not limited to:
- Recognition and measurement of provisions in terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets with specific focus on restructuring plans and onerous contracts;
- Measurement of inventories in terms of IAS 2 Inventories;
- Potential early termination of contracts by customers, modification of contracts or changes in variable transaction prices under IFRS 15 Revenue from Contracts with Customers;
- Lease modifications as a result of lease payment deferral and/or government assistance under IFRS 16 Leases;
- Impairment of assets, both non-financial assets in terms of IAS 36 Impairment of Assets, and financial assets in terms of IFRS 9 Financial Instruments;
- Fair value determination in terms of IFRS 13 Fair Value Measurement
For any queries, please contact your PKF liaison.