Covid-19: Potential Impact on Financial Reporting

Covid-19: Potential Impact on Financial Reporting

Introduction:-

The rapid outbreak of the coronavirus (COVID-19) presents an alarming health crisis that the world is grappling with. The impacts of the COVID-19 pandemic are unfolding in real time.The COVID-19 outbreak has already had a significant effect on the economies of affected countries and international financial markets. As the companies in India approach their year end, there is an urgent need to evaluate the impacts of the outbreak on their accounting and financial reporting.

Key Impacts on financial reporting:-

The financial reporting impacts of the COVID -19 outbreak will depend on facts and circumstances, including the degree to which a company's operations are exposed to the impacts of the outbreak. Some of the key accounting and financial reporting considerations for the companies are explained below:-

Going concern:- The outbreak of COVID-19 has caused a significant deterioration in economic conditions for some companies and an increase in economic uncertainty for others.

Management would need to assess whether the current events and conditions cast significant doubt on the company's ability to continue as a going concern, or in severe cases, whether the going concern assumption is still appropriate as a basis for the preparation of the company's financial statements. In many cases, budgets and forecasts that may have been used to support management's initial going concern assessment may now be of limited relevance given the rapidly changing economic and business circumstances and may require significant revision to be able to support management's assessment in the current environment.

It would be critical to understand what impacts current events and conditions have on a company's operations and forecast cash flows, with the key immediate issue being whether the company still has sufficient liquidity to continue to meet its obligations as they fall due to the extent the events and conditions are identified that may cast significant doubt on a company's ability to continue as a going concern, disclosure would be required if these events constitute material uncertainties or management's conclusion involved significant judgement (e. a 'close call scenario). Additionally, Ind AS 107. Financial instruments:

    Disclosures requires disclosure of quantitative data about liquidity risk arising from financial instruments. A company also needs to explain how it is managing this risk including any changes from the previous period and any concentrations of liquidity risk.

      

        Impact on accounting estimates:-

     Various accounting estimates, which depend on future forecasts, could be impacted by the outbreak. Examples of specific areas that may be impacted include:

      

       Impairment of non-current assets and goodwill:-

        Many companies may be facing the problem of low demand for their products or services or may be affected by the restrictions imposed by the government. Certain companies may be dependent on supply chains or may have production facilities in the states in India and abroad affected by lockdown. This situation could be an impairment trigger, and require an impairment test. However, it could be a challenge for many companies to estimate future cash flows due to the increase in economic uncertainty.

     

     Onerous contract provisions:- 
       
       Customer contracts may become onerous if, for example, suppliers are unable to fulfil their obligations under the contract as a result of closure or reduced production by manufacturing plants, which would necessitate recognition of a provision. Delay in fulfilment of contractual obligations may also result in penalties to be provided for.

      Valuation of inventory:

         There could be a significant impact on the inventory valuation on account of forced plant shutdowns, decline in net realisable value due to reduction in demand and non-fulfillment of sales and purchase contracts.

      Expected Credit Losses (ECLs): 

        Certain sectors and regions may be particularly severely affected by the economic effects of COVID-19. Hence, companies would need to consider the impact of COVID-19 appropriately while recognising ECLS. However, the companies may find it challenging to incorporate into their measurement of ECLs the forward looking information relating to the economic impact of COVID-19 that is available without undue cost or effort at the reporting date.

     Deferred tax assets: 

        The recoverability of deferred tax assets may be impacted by changes to future forecasts.

        Insurance Claims :  
         
         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.

      Fair Value Assessment:- 

        The fair value of an asset (or liability) is determined as per the market conditions at the measurement date. Due to uncertainty of the economic impact of COVID-19, 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 including considerable change in the valuation techniques being adopted by the companies on account of change in the market conditions and related observable inputs, redundant previous information, etc. Appropriate disclosures to address the change would become necessary.     

As    As per Ind AS 1, Presentation of Financial Statements and Ind AS 113, Fair Value Measurement a company would need to provide sensitivity disclosures along with disclosure of the key assumptions and judgements made by management. This is likely to enable users to understand how fair value has been determined and categorisation of fair value hierarchy.

     Revenue recognition: Companies would need to assess the impact on revenue recognition aspects such as revision of estimates of variable consideration and also timing of revenue recognition whether consideration is probable in case of sales to customers in COVID-19 affected states in India and regions around the world. Also, they should consider related impact on recoverability of trade receivables including estimate of expected credit losses.

    Lease accounting: A company which is a lessee would need to assess its right-of-use assets for impairment. Similarly, 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. Other impact areas could be determination of lessee's incremental borrowing rate on account of change in its borrowing costs consequent to decline in its credit rating, reassessment of lease contracts including lease term and revenue recognition by lessor.

    Internal controls over financial reporting: Companies should also evaluate the effect on internal control over financial reporting, if any, For instance, new controls or modification in controls would be required where companies have enhanced/modified IT access to enable remote work forces.

   Employee benefits: Market volatility and changes to remuneration policies may impact how companies estimate and measure employee benefits and recognise 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.

   Government grants: Management would need to monitor government actions and legislation to identify all assistance given amid COVID-19 definition of a government grant. Companies that have not previously received government grant may need to develop new accounting policies and procedures and significant judgement may be required to address newly implemented government programmes

    Companies could consider expanding disclosures on the accounting policies for government grants and the impact of grants and other assistance on the financial statements.

     Disclosures in the annual reports:- Other information that accompanies the financial statements may include additional discussion of risks associated with the outbreak if the expected impacts could be significant. Management would need to consider whether the explanation of events relevant to understanding the impact on the entity complies with regulatory requirements and responds to regulators' and users' expectations.

   Disclosures should include identification of key assumptions about the impact of COVID-19 on material estimates and sources of estimation uncertainty that could result in material adjustments to the carrying amount of assets and liabilities, including sensitivity analysis.

     Potential impact on audit, an auditor's report and completion of the last quarter's results and annual financial reporting process:-

    Companies may face challenges in helping auditors to conduct their audits as it may be difficult to provide them access to their establishments (eg. not being able to observe management's inventory counts or to physically verify fixed assets after year-end). Also in certain situations, companies may have challenges in obtaining access to management and others, including legal counsel, management's experts due to travel restrictions. They may not be able to provide the anticipated audit evidence e.g. there could a significant decline in response rates for bank and/or debtor confirmations. For large companies with various overseas components, there could be a significant challenge to work with component auditors and managements of the overseas components.

      
         These challenges could lead to certain implications in the auditor's report which may include:

     Reporting of a new Key Audit Matter (KAM) in response to additional audit work necessary as a result of the outbreak.

        An emphasis of matter paragraph relating to a significant uncertainty arising from the outbreak

        A qualification or adverse opinion in respect of inadequate disclosures in the financial statements.

      -CA Dhruv Anand

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