Accounting considerations related to the Coronavirus 2019 Disease
The coronavirus 2019 (COVID‑19) pandemic is affecting economic and financial markets, and virtually all industries are facing challenges associated with the economic conditions resulting from efforts to address it. For example, many entities in the travel, hospitality, leisure, and retail industries have seen sharp declines in revenues due to regulatory and organisational mandates (e.g. “shelter in place” mandates, school closures) and voluntary changes in consumer behaviour (e.g. “social distancing”).
As the pandemic increases in both magnitude and duration, entities are experiencing conditions often associated with a general economic downturn. This includes, but is not limited to, financial market volatility and erosion, deteriorating credit, liquidity concerns, further increases in government intervention, increasing unemployment, broad declines in consumer discretionary spending, increasing inventory levels, reductions in production because of decreased demand, layoffs and furloughs, and other restructuring activities. The continuation of these circumstances could result in an even broader economic downturn, which could have a prolonged negative impact on an entity’s financial results.
This article lists certain key IFRS accounting considerations related to conditions that may result from the COVID‑19 pandemic. The significance of the individual issues below will of course vary by industry and by entity. These accounting considerations are explored in more detail in the IFRS in Focus publication.
Explore the key IFRS accounting considerations
Entities need to consider all available information to develop estimates and apply consistent assumptions across all relevant assessments (e.g., forecast revenues may be relevant to both impairment tests and recognition of deferred tax assets). The financial statements should provide appropriate disclosure for significant judgments and sources of estimation uncertainty, and the disclosures must reflect the conditions at reporting date.
The uncertainties about the impact of the COVID-19 pandemic make the going concern assessment more difficult, owing to the extent and duration of social distancing measures in effect in many jurisdictions and the impact on the economy. Companies should consider the impact of these matters on the entity’s specific circumstances. In particular, the current and potential cash resources, including access to existing and new financing facilities, and factoring and reverse factoring arrangements, need to be considered up to the date of the authorisation of the financial statements.
Whilst the events stemming from COVID-19 are extremely volatile, entities are nevertheless required to consider conditions as they existed at the reporting date when evaluating subsequent events, including those related to the expected credit loss on receivables, inventory obsolescence, impairment analyses, variable and contingent consideration estimates, and other factors. With respect to reporting periods ending on or before 31 December 2019, it is generally appropriate to consider that the effects on an entity are the result of events that arose after the reporting date that may require disclosure in the financial statements but would not affect the amounts recognised.
The impact of COVID-19 may give rise to material expense or income items for many entities, which require separate disclosure under IAS 1:97. Examples of such items include restructuring provisions and impairment losses related to non-financial assets.
Because of the significant impact of COVID-19 on their performance and financial position, entities may consider providing new APMs or adjusting the existing APMs. Rather than adjusting existing APMs or including new APMs, the European Securities and Markets Authority (“ESMA”) urges entities to improve their disclosure and include narrative information.
Entities will need to assess whether the impact of COVID-19 has potentially led to an asset impairment, including for assets subject to the requirements of IAS 36, valuation of inventories, and assets relating to costs to obtain or fulfil a revenue contract and up-front payments to customers under IFRS 15.
The impact of Covid-19 may have a far-reaching impact on accounting for financial instruments, potentially impacting expected credit losses, fair value measurements, liquidity risk management, classification of financial assets (e.g. assets may no longer meet the “held to collect” classification), debt modifications, changes in estimated cash flows, hedge accounting, and financial vs non-financial assets and liabilities. For example, contracts that the Company previously expected to be physically settled and accounted for as own use may now be net settled and therefore come in scope of the IFRS 9 fair value accounting requirements.
Business disruptions associated with the COVID-19 pandemic may prevent an entity from entering into customer agreements by using its normal business practices, which may make the determination of whether it has enforceable rights and obligations challenging. In addition, because many of its customers are experiencing financial difficulties and liquidity issues, an entity may need to develop additional procedures to properly assess the collectability of its customer arrangements and consider changes in estimates related to variable consideration (e.g. because of greater returns, reduced usage of its products or services, or decreased royalties).
In response to Covid-19, an entity may be considering or implementing restructuring plans. The Company can only recognise a restructuring provision when the Company has (1) a detailed formal plan for the restructuring; and, (2) raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. Additionally, any part of the business that is available for immediate sale in its present condition, and completion of such a sale within one year is highly probable, should be classified as held-for-sale and accounted for by applying IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
Because of the impacts of COVID-19, unavoidable costs of meeting the obligations under the contract may exceed the benefits expected to be received, resulting in an onerous contract under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
Entities that incur losses stemming from the COVID-19 pandemic may be entitled to insurance recoveries. Consistent with the requirements of IAS 37 on contingent assets, such a reimbursement should be recognised only when it is virtually certain that it will be received if the entity settles the obligation.
Impairments to right-of use (ROU) assets could occur as a result of business closures, supply chain disruption, or other consequences of the pandemic that negatively affect the future cash flows expected to be derived from the use of the underlying asset. Impairment is assessed by applying the requirements in IAS 36. Lessees in some affected markets are receiving rent abatements or other economic incentives, which require special consideration and are covered in more detail in the IFRS in Focus publication.
The COVID-19 pandemic may give rise to specific transactions or events that could change a reporting entity’s governance rights over other legal entities and thereby affect accounting conclusions for consolidation. For example, in some circumstances the lender will have obtained control of the borrower when a lender’s rights under a loan agreement are enforceable upon default or breach of a loan covenant by the borrower. Additionally, there may be a time lag between the parent accounts and the reporting date of a subsidiary. In this case, the parent should consolidate the financial information of the subsidiary using the most recent financial statements of the subsidiary adjusted for the effects of significant transactions or events that occur between the date of those financial statements and the date of the consolidated financial statements. The difference between the date of the subsidiary’s financial statements and that of the parent’s financial statements should be no more than three months and the length of the reporting periods and any difference between the dates of the financial statements should be the same from period to period.
The COVID-19 pandemic may be causing delays in closing financial transactions, including business combinations, and appropriate identification of the acquisition date is key as it is the date on which the acquirer begins consolidation of the acquiree. When considering disposal of certain assets or group of assets, entities should ensure that assets held for sale are identified and accounted for under IFRS 5, and must re-evaluate whether an asset (or a disposal group) which has been classified as held for sale prior to the COVID-19 pandemic continue to meet the IFRS 5 held for sale classification.
The significant economic uncertainty associated with the COVID-19 pandemic may affect the measurement of defined benefit obligations and plan assets under IAS 19. Pension plans may hold significant amounts of assets that do not have an active market, such as investments in hedge funds, structured products, and real estate assets that may become more illiquid, making their valuation more complex. Appropriate determination of the fair value of such assets is important in the determination of the funded status of a defined benefit plan. In addition, the sensitivity analysis and the range of reasonably possible changes to existing actuarial assumptions required by IAS 19:144 may need to be revised given the volatility in the markets.
Some businesses may cease operations or operate at reduced capacity as a result of the impacts of COVID-19, which could affect the probability that vesting conditions for share-based payments with performance conditions will be met under IFRS 2 Share-based Payment. In addition, entities may decide to modify the terms or conditions of an equity-settled award, and, because of the modification, may need to recognise additional compensation expense for any incremental value provided.
Entities may be considering (or implementing) restructuring plans to mitigate their exposures associated with unforeseen consequences of the COVID-19 pandemic. Proposed measures may include stay bonuses, salary continuation, temporary suspension of employment, and termination. The nature and characteristics of each proposed action may affect the timing of the recognition of the benefits provided to employees in the financial statements.
IAS 21:32 The Effects of Changes in Foreign Exchange Rates provides an exception that allows gains and losses on certain intragroup foreign currency items of a long-term investment nature to be recognised in other comprehensive income instead of being recognised in profit or loss. For an item to qualify as a long-term investment, the entity must be able to assert that “settlement is neither planned nor likely to occur in the foreseeable future”. An entity that has characterised an intra-group item as part of its net investment in the entity may need to reassess whether that designation is still appropriate in the current economic environment.
In response to the COVID-19 pandemic, governments in many jurisdictions are considering, or have implemented, legislation to help entities that are experiencing financial difficulty stemming from the pandemic. Such assistance may be in the form of income-based tax credits that are dependent on taxable income or other forms of relief that is not dependent on taxable income (e.g. payroll tax credits, tenant reliefs and other similar subsidies). Some relief programmes will clearly be in the scope of IAS 20, because they are calculated and distributed to an entity without any link to taxable income, and other relief programmes will be clearly in the scope of IAS 12.
Entities should consider how profitability, liquidity, and impairment concerns that could result from the impacts of COVID-19 might also affect their income tax accounting under IAS 12. For example, a reduction in current-period income or the actual incurrence of losses, coupled with a reduction in forecasted income or a forecast of future losses, could result in a reassessment of whether it is probable that some or all of an entity’s deferred tax assets can be recovered. Such assessments will be particularly challenging in situations in which the changes in current and projected future profitability actually result in, or are expected to result in, cumulative losses and the entity has not had a stable earnings history before the impacts of COVID-19.
Unstable trading conditions and shortages of cash flows in the affected regions may increase the risk that entities breach financial covenants. Entities should consider how the breach of a loan covenant may affect the timing of repayment of the related loan and other liabilities (e.g. it becomes repayable on demand) and how it affects the classification of the related liabilities at the reporting date.
Entities preparing their interim financial reports applying IAS 34 Interim Financial Reporting are required to apply the same accounting policies as will be applicable in their next annual financial statements.
IAS 7 defines cash equivalents as short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Entities may need to consider whether investments classified as cash equivalents continue to meet the requirement for such a classification. For example, clauses in the fund’s documents may grant the fund manager the ability to restrict redemption in exceptional circumstances that may apply to the COVID-19 pandemic and may limit an investor’s ability to redeem the units.
IAS 23 Borrowing Costs requires that borrowing costs which are directly attributable to the acquisition, construction or production of a qualifying asset be included as part of the cost of that asset. However, if the entity suspends activities related to development for an extended period, capitalisation of borrowing costs should also cease until such time as activities are resumed. As a result of COVID-19, entities may have interrupted the development and construction projects. If this is the case, borrowing costs incurred during the period of suspension are not considered to be a necessary cost of development and therefore should be recognised as an expense.
For practical reasons, it is common for entities that engage in a large number of foreign currency transactions to use a monthly or quarterly rate of exchange to measure those transactions in their accounting records and to disregard day-to-day fluctuations in exchange rates. When this approach is used, care must be taken to ensure that the result is not materially different from what it would have been if actual rates had been used for translation. As a result of COVID-19, entities may recognise large one-off transactions or be exposed to significant and unexpected movement in exchange rates. Entities will need to evaluate if foreign currency transactions should be analysed into shorter periods (e.g. quarterly periods, months or weeks) with an average rate determined for each, or even a date-specific exchange rate.
Entities operating in jurisdictions where distributable profits are established on the basis of profits determined in accordance with IFRS Standards, will need to consider how the effect of the COVID-19 pandemic on their financial statements may affect their ability to declare dividends.
Webcast series on accounting considerations related to COVID-19
Deloitte has produced a video series to support businesses that are affected by COVID-19. These short and informative videos (4-10 minutes in length) supplement this article.
Please click to access the videos on IAS Plus.
To see more detailed considerations for each of the factors above, refer to the IFRS in Focus.