The coronavirus pandemic has had a major impact on businesses, however, the extent to which this will affect the financial statements, in terms of both measurement and disclosure, will depend on the particular facts and circumstances of the entity. As per the report of ICAEW, the Financial Reporting Faculty provides a checklist of some of the factors to consider when preparing a (your client’s) accounts. This checklist focuses mainly on companies with 2020-year ends.
What are the conditions that existed at the balance sheet date?
A fundamental principle in the preparation of accounts is that they should reflect the conditions that existed at the balance sheet date (FRS 102.4.1).
The information which comes to light after the balance sheet date that provides evidence of conditions that existed at the balance sheet date (adjusting post-balance sheet events) should be reflected in amounts recognised in the accounts. Information indicative of conditions that arose after the balance sheet date (non-adjusting post balance sheet events) should be disclosed when material (FRS 102.32.2) but does not affect the measurement of amounts at the balance sheet date unless the business has ceased to be a going concern. In a continually evolving situation, establishing what is adjusting and what is non-adjusting will involve a significant amount of judgement.
Is the business a going concern?
An entity is a going concern unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. When assessing whether the going concern basis of accounting is appropriate, the management must consider all of the available information about the future which is at least, but not limited to, 12 months from the date when the financial statements are authorised for an issue (FRS 102.3.8). The impact of COVID-19 must therefore be reflected in the going concern assessment for all accounts not yet authorised for issue. If the business is not a going concern adjustment may be necessary to the carrying amounts of assets and liabilities in the financial statements.
To what extent are tangible and intangible assets impaired?
Whereas the assessment of going concern takes account of events and conditions that existed after the end of the reporting period when assessing the recoverability of tangible and intangible assets (for example goodwill and/or property, plant, and equipment) this assessment must be based on conditions and impairment indicators that existed at the balance sheet date.
COVID-19 means that many businesses are not able to operate as normal. This, combined with the negative impact on the economy more generally, are likely to be indicators of impairment to the extent these conditions existed at the balance sheet date. In such circumstances, the entity will need to assess the recoverable amounts of the assets affected (FRS 102.27.5).
Will stock be sold for at least its carrying value?
Stock will need to be written down when the estimated selling price less costs to complete and sell is less than its carrying value (FRS 102.27.2) based on the conditions which existed at the balance sheet date. This will be particularly relevant when stocks have a short shelf life or when there is likely to be a long-term reduction in demand for the product. There may also be higher input costs and delivery charges affecting the estimated costs to complete and sell.
Is there objective evidence that debtors are not recoverable?
When there is objective evidence that debtors were not recoverable as at the balance sheet date they must be written down immediately (FRS 102.11.21), for example, there is evidence of the significant financial difficulty of the debtor and/or a failure to pay debts when due. Adverse market or economic conditions can also be evidence of impairment. If debts have been renegotiated, reclassification or remeasurement may be required to reflect the new contract terms.
Are fair value measurements reliable?
When assets are measured at fair value eg, property or investments, there may be difficulties in determining fair value measurement (physical inspections might not be possible or there might not be an active market at the balance sheet date). The appendix to Section 2 of FRS 102 provides guidance on the hierarchy to use when estimating fair values.
Have any existing contracts become onerous?
Some contracts that may have previously been considered profitable (or break-even) may now be considered onerous eg, operating leases for aircraft, restaurants, or retail space. A provision will be required for any present obligation at the balance sheet date (FRS 102.21.11A). Note that a provision for future operating losses is not permitted (FRS 102.21.11B).
Are there any restructuring plans?
Many businesses will be reviewing their operations, for example reducing staffing levels, mothballing certain activities, or selling some of the company’s assets. A restructuring provision must be recognised only to the extent that there is a constructive obligation at the balance sheet date (FRS 102.21.11D), alongside the general recognition criteria for provisions.
Will any losses be covered by insurance policies?
Insurance recoveries should be recognised only when virtually certain (FRS 102.21.13). If the insurance recovery is probable at the balance sheet date, a description of the contingent asset and, when practicable, an estimate of the financial effect must be disclosed. If an insurance recovery becomes virtually certain after the balance sheet date, the amount should be disclosed as a non-adjusting post balance sheet event when material (FRS 102.32.2).
Have bank and other loans been renegotiated? Have covenants been breached?
Bank and other loans may require reclassification or remeasurement if terms have been breached or renegotiated at the balance sheet date e.g., transfer from non-current to current liabilities or recalculation of implicit rates of interest.
Have contracts with employees been modified or terminated?
If contracts have been modified or terminated this may have implications for the amount recognised as employment costs to the entity. It may also have an impact on, for example, accrued bonus payments, pension liabilities and share-based payments. There may be additional holiday pay accruals for employees who have been permitted to carry forward statutory annual leave not taken due to COVID-19.
What has been received by way of government assistance?
The government has introduced a range of initiatives to help businesses including the Coronavirus Job Retention Scheme, business rates holidays, grants for certain sectors and government-backed loan arrangements. Government grants may not be recognised until there is reasonable assurance that the entity will (a) comply with the conditions attaching to them and (b) the grants will be received (FRS 102.24.3A). An entity must recognise grants either based on the performance model or the accrual model. Grants related to income are presented as part of profit or loss, either separately or under a general heading such as ‘other income’.
COVID-19-related rent concessions
When rent concessions have been granted as a direct consequence of COVID-19, recent amendments to FRS 102 require a lessee (or lessor) to recognise any change in the operating lease payments (or income) on a systematic basis over the periods that the change is intended to compensate (subject to certain conditions).
Are there implications for tax payable and deferred tax?
Some tax liabilities may have been deferred so their classification between current or non-current may need to be reconsidered. Deferred tax assets must be recognised only to the extent that it is probable that they will be recovered against the reversal of deferred tax liabilities or other future taxable profits (FRS 102.29.7).
What needs to be disclosed?
Disclosure requirements vary according to the size of the entity and whether it applies to Section 1A Small Entities. However, all accounts are required to give a true and fair view.
Disclosures may be necessary for key judgements in applying accounting policies, new accounting policies e.g., government grants, and key sources of estimation uncertainty when disclosure is required by FRS 102 or for companies subject to the requirements of FRS 102 Section 1A to meet the objective of giving a true and fair view.
In these times of significant uncertainty, it has never been more important to be transparent about risks faced and the assumptions used and making the disclosures as specific to the business as possible.
If management concludes that the entity is a going concern, but is aware, in making its assessment, of material uncertainties related to events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern, details of those uncertainties must be disclosed (FRS 102.3.9).
Dividends and other distributions
Directors will need to consider whether they can lawfully pay dividends (e.g., under rules on distributable profits and capital maintenance) and, if they can, whether they ought to do so (e.g., considering possible reputational issues, particularly when the company has benefited from substantial government assistance). The law is complex.