FINANCIAL REPORTING & IR

The outbreak of COVID-19 has had tragic consequences across the globe, with the full impact still unknown. Companies of all sizes and sectors are being impacted by the pandemic, either directly or indirectly, and the increased economic uncertainty may have significant financial reporting implications.

Preparing 2020 interim financial statements is likely to involve more than the usual updates since the last annual financial review. Investors and other users will expect information above and beyond what is typically disclosed. This article will provide an overview of some of the significant financial reporting issues that companies may need to consider when preparing their financial statements and common issues that have been identified to date. The list of issues will change as the general economic impact becomes more evident and the financial reporting impact on specific companies and sectors grows clearer. 

Valuation and presentation of assets and liabilities

• Fair value measurement of assets and liabilities may be challenging. The fair value of an asset (or liability) should reflect market conditions at the measurement date. This has become more challenging due to the uncertainty about the economic impact of COVID-19.
• Non-financial assets (e.g. property, plant and equipment, leased assets, intangible assets, and goodwill) may become impaired. Disruptions to business operations and increased economic uncertainty due to COVID-19 may trigger the need to perform impairment testing. Estimating future cash flows to calculate the recoverable amount will be challenging, given the high level of uncertainty.
• The economic forecast used to measure expected credit losses (ECL) may need to be updated. ECL is used to estimate the impairment allowance for certain financial assets, including trade receivables, and needs to incorporate forward-looking information that is available at the reporting date. This may be particularly challenging to do for the economic impact of COVID-19. Companies are expected to apply judgment and explicitly consider additional economic scenarios when measuring ECLs.
• Companies may need to record additional liabilities. Certain contracts may become loss-making as a result of any significant adverse impact, for instance production processes and supply chain disruption, labour shortages, and closures of stores and facilities. Some companies may struggle to fulfill legal or contractual obligations and may be subject to penalties, such as for delays or nonperformance. Some companies may decide to restructure their businesses, for example by downsizing or discontinuing specific operations. These impacts may result in a provision to be recorded for qualifying costs when certain conditions are met.
• The measurement of employee benefits may need to be updated. Market volatility and changes to remuneration policies may require updated actuarial valuations of defined benefit liabilities, revisions on the estimates used to recognize share-based payment expenses and the implications of any modifications to these arrangements.
• Changes to lease contracts should be properly reflected. In response to the COVID-19 pandemic, many lessees may seek rent relief from lessors in various forms such as one-off reduction in rent, a reduction for a defined period of time or a change in the nature of rent. Lessees may also decide to change the expectation of exercising the renewal or termination options in the lease contracts. These changes will need to be appropriately considered and measured.

Operating result implications

• Significant judgment may be required in accounting for government assistance. Governments around the world are responding to the COVID-19 outbreak by implementing a variety of measures to provide relief to companies and stimulate the economy. Companies will need to apply significant judgment as to how and when different forms of government assistance received are accounted for.
• Timing and amount of revenue to be recognized may be affected. Customers may now struggle to meet their contractual obligations. Some companies’ rights to payment may not be enforceable. Companies and their customers may seek to change the terms of existing contracts, including providing new incentives to respond to the impacts of the COVID-19 outbreak on their business. It requires significant judgment and regular reassessment to determine when and how revenue should be recognized.

Other significant financial reporting considerations

• Going concern considerations need to be continually assessed. Some companies in highly exposed sectors are immediately impacted, while other sectors may be more affected over time. Management needs to assess whether events or conditions caused by the pandemic, individually or collectively, cast significant doubt on the company’s ability to continue as a going concern and therefore require additional disclosure. In some cases, management will need to consider whether the going concern assumption is even still appropriate as a basis for the preparation of the company’s financial statements.
• Subsequent events caused by the COVID-19 pandemic need to be carefully considered and properly reported. Depending on whether the events provide evidence of conditions that existed at the reporting date, companies may need to adjust the amounts recognized in the financial statements or disclose the nature of the event and an estimate of its financial effect, if possible.

There are also a number of regulatory changes that have been introduced by regulators in many jurisdictions in response to the COVID-19 pandemic, including certain extensions of filings and exemptions from certain regulatory reporting requirements. Some investor protection efforts are also being made.

The above analysis does not provide an exhaustive list of all potential financial reporting issues relating to the COVID-19 pandemic implications. Investors will be keenly interested in understanding the implications of COVID-19 for the companies in which they are invested, and management should carefully anticipate and consider their questions and concerns in preparing quarterly reports.

Terry Liu, CPA, CA is a Senior Manager, and Rob Brouwer, FCPA, CPA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.