In the past few months, coronavirus has become the most talked about word everywhere.
No wonder - not only does it take the lives of our loved ones, it also affects our daily lives in different ways.
In many countries, people cannot go to work, children cannot go to school, stores are closed, machines are silent, and the buzz has stopped.
The fact is that the governments of many countries have taken certain measures to stop the spread of the infection and that these measures affect the financial statements in a different way.
In this article, I have tried to describe my point of view on the greatest effects of the pandemic on the financial statements, based on current IFRS rules.
At the end of the article, you can find some of my personal thoughts (but feel free to skip this part).
I think that only a few elements of the financial statements remain intact and free from any effect of the current situation.
However, let me summarize the main considerations for you:
Does the going concern principle still apply?
To stop the rapid spread of the infection, many governments have restricted commercial operations.
Retail stores are closed. The factories are inactive and people stay at home.
This means that many companies have stopped generating income.
So can they survive the next 12 months?
In the conceptual framework, the entity must prepare the financial statements in the assumption of going concern, that is to say that it will continue its activities for the foreseeable.
According to IAS 1, management must assess going concern when preparing the financial statements.
This means that the evaluation is NOT carried out on the reporting date (e.g. December 31, 2019).
It is made BEFORE the publication of the financial statements.
Now, the pandemic broke out in January 2020 and no one could foresee or assume the financial effects of the pandemic itself and the measures taken to stop it.
However, if you are still preparing financial statements during the pandemic, you should certainly assess your entity's ability to survive and continue:
- Are you financially strong?
- Are your assets of high quality?
- Can your business survive for the next 12 months or so?
- Will you be able to find other sources of funding for your business?
After performing this assessment, you have two choices:
1. You believe that your business IS in operation.
In other words, management believes that one entity will survive the pandemic.
However, in this case, you should at least indicate in the notes to the financial statements that, although the financial statements have been prepared on a going concern basis, there are many uncertainties surrounding the valuation.
2. You feel that your business is NOT in operation.
In other words, management does NOT believe that an entity will survive within 12 months.
In this case, the financial statements must be prepared differently.
Expected credit loss on financial assets
Even if you are not directly affected by the virus and its associated measures, your customers can still be affected.
And, they can be seriously affected in a way that prevents them from paying you.
Therefore, the expected credit loss on your financial assets may be much greater than you have estimated based on your historical information and previous forecasts.
You can imagine that all the predictions made before the epidemic are simply obsolete and no longer apply.
IFRS 9 states that expected credit losses should reflect an unbiased, probability-weighted amount determined by assessing a range of possible outcomes
And, you must take reasonable and justifiable information on past events, current conditions and forecasts of future economic conditions available at the date of the report.
The forced closure of companies by governments is very crucial forward-looking information that only became available after the end of 2019 in many countries.
Yes, it is true that the first reports of the virus appeared before the end of 2019, but it is doubtful that anyone could have estimated the severity of the impact on the company.
So, in my opinion, although ECL at the end of 2019 will probably not integrate the effect of all the measures taken in 2020 to stop the virus (because the information was not available on the date of declaration), it should include at least one estimate of the effects of the virus on businesses.
However, if you have trade receivables or loans with accounts receivable whose activities and cash flows are barely affected by the virus and related measures, perhaps you should incorporate this forward-looking information into the ECL measure in periods following.
Let me give you a very short illustration.
Example: ECL and coronavirus pandemic
Let's say you have a debtor who owes you 1,000 CU (currency units). The debtor operates a chain of retail clothing stores.
Due to the coronavirus pandemic situation, the local government has ordered the shops to be closed and the debtor loses income.
Now the debtor has not gone bankrupt or anything, but it is clear that he will not be able to repay the debt according to the contract.
On the basis of current events, statistical models of pandemic scenarios prepared by experts and evaluating the debtor's financial statements, you have identified three different scenarios:
1. The pandemic will be over within a month, the stores will reopen and in this case the customer will experience a 10% drop in income. This decrease will not affect the debtor's ability to pay in full on time, as their financial situation is stable. However, statistical models of pandemics estimate the probability of this development at 10%.
2. The pandemic will take longer and stores will reopen after 6 months. In this case, the client suffers a significant drop in income, but he can still recover and you will lose 30% of the claim. The probability of this scenario is 70%.
3. The pandemic will be terrible and the stores will not reopen until after 1 year. The debtor will go bankrupt, however, you can recover part of the receivable from the sale of the debtor's property up to 10% of the receivable (your loss is therefore 90%). The probability of this scenario is 20%.
|1) Shops open in 1 month||0%||10%||0|
|2) Shops open in 6 months||30%||70%||210|
|3) Shops open in 1 year||90%||20%||180|
- Here, we do NOT take into account only the most likely outcome. In such a case, ECL would only have been 210. Instead, we weight all of the scenarios and the loss is 390.
- ECL = CU 1,000 times LGD times the probability
This is a very simple illustration of the integration of new prospective information into the calculation of the ECL following the pandemic coronavirus measurements.
And, as you can see, we face many uncertainties and estimates.
The IFRS Foundation has published a document providing brief guidance on this issue. You can access it here.
Impairment of assets
IAS 36 lists some external indicators of asset impairment and I consider government measures to stop the infection to be very important.
Therefore, yes, in many companies, the external indicator of impairment exists and you need to test your assets for impairment.
Especially in sectors such as tourism, catering, entertainment and others, the fair value of assets as well as the value in use will fall, for a very simple reason:
The estimated future cash flows generated by the asset (or the cash-generating unit) are much lower. Closed businesses generate no cash flow during closing.
You can see the example with making cash flow projections for the impairment test here.
Events after the reference period
According to IAS 10, you must:
- Identify important events occurring after the end of the reference period,
- Determine whether they adjust or not, and
- Adjust financial statements to adjust events or disclose events without adjustment.
The pandemic and related measures to prevent it are certainly an important event after the reporting period.
However - are they adjusted or not?
Here I would like you to think a little.
What are the events affecting your business?
- Is this a virus epidemic in itself?
- Or measures to prevent government-imposed spread?
In most cases, government action is the major event, not the virus itself.
These measures only intervened after the end of 2019 and are therefore not adjusted, therefore no accounting entries before the year in this regard.
However, I believe that most of these events will have a significant impact on the financial statements, so entities should disclose the existence of these events and try to estimate the financial impact.
In my opinion, these are the regions most affected by the current pandemic situation.
However, the list is not exhaustive.
Here is the short list of other potentially affected items:
- Provisions under IAS 37 - you may need to think about restructuring plans or provisions for onerous contracts;
- Stock measurement in accordance with IAS 2 - perhaps the value of stocks of different types will decrease, simply because some of them may have an expiration period (and you cannot sell them due to business closures retail), or customers are willing to spend less because they earn less money;
- Contract with clients under IFRS 15 - well, some clients will not have enough money to fulfill their contractual obligations and this may result in early termination of contracts, modification of contracts, changes in variable considerations, etc.
- Leases under IFRS 16 - in some cases, lessors may need to change lease payment schedules to make life easier for their tenants, or simply because the government has asked them not to charge rents for one certain period. This can result in lease modification accounting; or taking into account variable rental payments;
And I can continue - indeed, this situation can affect just about everything in the financial statements.
My goal here was to highlight the main things to watch out for.
The Final word
I want you know that we all are on the same boat.
And I'm also aware that most of us have never faced anything like this so far.
At the same time, Everyone is panic and afraid of the virus and the economic stress it causes - which is understandable.
However, as difficult as it may seem, I try to stick to the following points:
- No fear and no panic. Stress causes a "fight or freeze" stress reaction. This means that all resources are spent on fighting the enemy and that nothing is left for regeneration and repair. Simply put, stress weakens your immune system and you will get sick more easily. Therefore, use your whole brain to divert your thinking as much as possible from panic and fear events.
- Lots of love. Love, gratitude, joy and other pleasurable emotions do just the opposite of stress - they actually strengthen your immune system. Spend your time with your loved ones, use it to reconnect, to talk and have fun.
- Do not stop learning. Now is the time to take the online courses you've always wanted to Learn. The Courses are US CPA, USCMA, accounting, IFRS, and EA… and many of these courses are here Please Visit: Simandhar Education.
Stay strong and healthy!
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