On March 11, 2020, the World Health Organisation (WHO) officially declared that COVID-19 can be characterised as a ‘pandemic’. A pandemic is a strong, exceptional form of epidemic, in terms of its geographic reach. Whilst the health-related implications of a pandemic can be read in the WHO’s official communication in this link, the economic pinch of efforts made to limit the spread of the pandemic are inevitably being felt in a number of sectors. This has implications on accounting and financial reporting. There are a number of considerations that need to be made by preparers.
Relevant considerations can be split, broadly speaking, in three categories, as described below.
Category 1 – Financial reporting date prior to COVID-19 advent; financial statements authorized for issue after COVID-19 advent including economic consequences
Example: an entity authorizing its 31 December 2019 financial statements in April 2020.
In this case many dilemmas may be triggered as follows:
Preparer A: Malta hasn’t yet experienced major chaos, such as Italy and China. The business has not been really impacted by the virus in 2020, let alone in 2019. Can we sign off the 2019 financial statements as if nothing happened, and then pick up the matter in the next year financial year?
Preparer B: We are expecting a negative financial impact on the business in the coming months. Should we disclose such impact in our financial reports, or can we just ignore it? Can we reflect the impact in the 2020 financials?
Preparer C: I have clients who prepare financial statements under IFRS as adopted by the EU, and companies preparing under GAPSME. When it comes to the impact of COVID-19, are there relaxations under GAPSME for 2019 financial statements?
Preparer D: To what extent can hindsight be used when in the 2019 financial statements?
The first assessment to make is whether the entity is a going concern.
Entity Is Not A Going Concern
If the entity has no realistic alternative but to cease trading indefinitely as a result of COVID-19, such as by liquidation, the financial statements shall not be prepared under the going concern basis but under another convention, such as the break-up or liquidation basis, in which case, IAS 1 requires a series of disclosures.
Material uncertainty on Going Concern
If due to the implications of COVID-19, management has significant concerns about the entity’s ability to continue as a going concern but the going concern assumption is considered to be still appropriate, the uncertainties must be disclosed.
Entity Is A Going Concern
If the entity is a going concern, it needs to be assessed whether events after the financial reporting date are adjusting or non-adjusting events. In our view, the impact of COVID-19 after the reporting period would be a non-adjusting event. Nonetheless, when deciding whether events are adjusting or non-adjusting one would need to assess whether the event indicates a condition that already existed at the balance sheet date. If a customer of a reporting entity had a healthy financial position before COVID-19 struck, the bankruptcy of the customer due to COVID-19 is clearly not a condition existing at the balance sheet date.
For non-adjusting events, no adjustments are passed, but the following is disclosed for each material category:
- The nature of the event.
- An estimate of its financial effect, or a statement that such estimate cannot be made.
Use Of Hindsight
Sometimes, standards permit explicitly the use of hindsight. For instance, lessees using the cumulative catch-up approach when transitioning to IFRS 16 ‘Leases’ are permitted to use hindsight when determining the lease term. This means that a company may theoretically consider any revised lease term expectations resulting from COVID-19, and apply them at the date of transition.
Category 2 – Financial reporting date after COVID-19 advent; economic impact encountered between financial reporting date and date financial statements authorised for issue
Example: An entity signing off its 31 March 2020 financial statements in June 2020 (economic impact felt as from April or May 2020).
The difference between Category 1 and Category 2 is that in the case of Category 2, the financial reporting date is after the onset of COVID-19 which may possibly mean that the economic conditions that are felt after the financial reporting date are likely to have been existing at the financial reporting date. Therefore, such consequences are adjusting events. Numerous accounting areas are potentially affected as revisited further below.
Category 3 – Financial reporting date after COVID-19 Advent; economic impact encountered before financial reporting date
Example: An entity signing off its 30 June 2020 financial statements in October 2020 (economic impact felt as from April or May 2020).
In this case, the potential accounting areas affected are booked during the reporting period in question. These accounting areas are also being revisited further below.
Revisiting of accounting areas likely to be impacted by COVID-19 advent
The following accounting areas may be of relevance to professionals given the reality of COVID-19, and deserve revisiting. Some of them are adjusting events (for the purposes of category 2 above) and some others are booked as they happen (for the purposes of category 3 above).
Non-Current Assets
Depreciable assets are still to be depreciated during periods of inactivity.
Most non-current assets are also within the scope of IAS 36 ‘Impairment Of Assets’. IAS 36 requires annual testing for some assets and testing only in the event of an indicator of impairment, in the case of other assets. It is likely that some assets will need to be tested for impairment. A deep understanding of impairment principles (for instance to identify cash generating units) and detailed communication with management (for instance, to obtain revised forecasts) will be crucial.
IAS 23 ‘Borrowing Costs’ requires capitalising finance costs attributable to long term development projects. In case of a prolonged suspension of the project for health or economic reasons, finance costs cannot be capitalised during such period. GAPSME provides an option to capitalise finance costs, but if the entity chooses this option, it is also prohibited to capitalise them during suspension periods.
Inventories
The advent of COVID-19 might cause inventory to have a net realisable value that is lower than its cost.
Financial Instruments
Preparers following IFRS 9 ‘Financial Instruments’ need to follow the expected credit loss (ECL) model. COVID-19 might increase the impairment amount, for instance due to recognition of lifetime ECL rather than 12-month ECL, due to loss rates increased to cater for forward-looking information, or for loss in time value of money when payments are delayed.
Preparers following GAPSME need to apply an incurred loss model instead. An impairment is recognised only if a loss event occurs that will impact future cash flows.
Revenue
IFRS 15 ‘Revenue From Contracts With Customers’ contains significant guidance for the timing of revenue, and for the amount of revenue recognition in instances where there is variable consideration. GAPSME lacks guidance in relation to variable consideration, meaning possibly a simpler assessment of revenue.
Provisions
Three criteria need to be met in order to recognise a provision. The following principles are to be revisited given the imminent potential turmoil:
- Future operating losses are not to be provided for.
- In order to provide for restructuring costs, these must be supported by a detailed plan, and need to be communicated to those concerned.
- If a contract is onerous, it means that the entity has a contractual obligation that it needs to meet, even though it will not recover the expected benefits from it (in this case due to COVID-19). In this case it would need to provide for it.
- If the decision to lay off workers triggers certain obligations such as termination benefits, a provision needs to be booked.
- Any insurance recoveries that an entity may have are only booked when the entity is virtually certain of receiving the benefits.
GAPSME Not Resulting In A True And Fair View
If GAPSME financial statements do not result in a true and fair view, it is possible to depart from GAPSME. Departure from GAPSME has certain disclosure requirements.
Government Assistance And Government Grants
As a result of the fiscal and financial measures announced by the Maltese government and any other future measures to be announced in the coming weeks in response to COVID-19, one needs to make a clear distinction between those which fall under IAS 12 ‘Income Taxes’, and those within the scope of IAS 20 ‘Accounting For Government Grants And Disclosure Of Government Assistance’. Any incentives in the form of tax incentives, such as reduced rates of taxes would fall under IAS 12, whereas any form of assistance in the form of grants such as compensation of employee benefits would fall under IAS 20.