Wow 2020! Who could have predicted what our lives in May 2020 (and the near future) would look like? One of the few certainties that we have is that our lives, both in a personal and business sense, will not be the same again.
Now that we are starting to settle into the ‘new normal’, it’s important that business owners and directors understand the impact that COVID-19 is having on financial reporting (and associated audits).
Business impacts – what are we seeing?
The impacts of COVID-19 are wide reaching but, like many things, the answer to what is the business impacts is ‘it depends’ – we have seen a number of entities that are flourishing at the current time, however this is not the case for many other entities.
Entities are likely to have disaster planning policies in place, but not many of them would have anticipated this situation. It is important for Directors and those charged with governance to ensure that risk assessments are updated based on current information which may be almost a moving target.
Many businesses have seen significant changes in their operations, including:
- Staff working remotely. This involves considerations around insurance, health and safety, purchases of equipment, such as laptops and cyber-security, use of online platforms, as well as staff productivity, performance, and maintaining staff morale and mental health.
- Workforce flexibility around employers requiring employees to take annual or long service leave, reduced hours and pay cuts.
- Social distancing measures and additional cleaning in labour intensive workplaces, or other workplaces remaining open where work cannot be performed from home.
- Supply chain issues:
- where products are sourced from overseas, there have been arrival delays with many entities trying to source alternative local supply
- where products are sourced domestically, changes in working environments have caused delays and less productivity than normal.
- Closure of facilities, resulting in increased security costs to protect unoccupied buildings. Fixed costs have not reduced, yet there is no revenue.
- Inability to travel. Employees may not be able to visit certain sites, and planned maintenance or upgrades may have to be deferred, potentially impacting productivity, efficiencies and safety. There may also be implications relating to staff grounded in another country.
- Changing product mix. The business may be pausing production of luxury items to produce items which are considered more essential in this time.
- Landlord discussions, involving rent abatements, reductions and assistance from the Government for landlords and tenants.
- Liquidity decisions. Businesses prioritising where the cash should go (ie to employees, creditors or government liabilities), when cash reserves have been depleted due to declines in revenue.
- Overload of information. Businesses are being bombarded with information about COVID-19. The processing and dissemination of this information within the business is time consuming and often requires a dedicated resource depending on the industry.
- Negotiations around financing arrangements, including setting up short-term facilities and discussions about existing covenants.
- Changes in consumer spending habits. An online presence is enabling businesses to capitalise on the increase in online shopping, with many changing their parameters for free delivery.
- In the not-for-profit space there has been a reduction in both donations and available volunteers, however, in many cases, the need for the services provided by the not-for-profit has increased.
What are the associated financial reporting considerations?
When talking about judgements and estimates, we often hear that – other than cash – all items in the statement of financial position (balance sheet) involve estimation. This is a great starting point for the financial statement impacts of COVID-19, since all of our estimates, assumptions and judgements from even a month ago have been thrown in the air and shaken up. The documentation in relation to current estimates will be critical in understanding the basis behind any change in models.
The impact of COVID-19 is specific to each entity, however we have set out some of the more common financial reporting implications and considerations that we are seeing in the market. Many of the fair values or recoverable amounts are based on assumptions that are incredibly difficult to estimate, since we don’t know how long the current situation will go on for and the long-term effect of the restrictions.
- Property, plant and equipment, right of use assets, intangible assets and other assets in the scope of AASB 136. More generally, there is an impairment indicator in place today, which means that entities will need to estimate the recoverable amounts of the assets using either fair value less costs to sell or value in use (discounted cash flow calculation).
- Inventory. Depending on the inventory items held, there may be an increase in net realisable value provisions as consumers and businesses change their purchasing habits. Inventory with a short shelf life may be written off as the items are discarded due to a drop in demand. Where an entity holds high demand inventory then extra shifts of workers are needed to produce extra units and therefore penalty and overtime rates may cause increases in base costs.
- Receivables. AASB 9 requires entities to use the expected credit loss (ECL) model to estimate the impairment of receivables. There are many factors to consider in making this assessment, including:
- Changing of risk profiles where debtors were grouped for the ECL assessment in prior periods
- Unemployment rates causing an increase in bad debts
- Interest rates affecting the time value of money calculation
- Concentration of risk in certain businesses or geographical areas, which are more exposed to the issues arising from COVID-19
- Liquidity of your customers and therefore re-assessment of their ability to pay
- Deferral of payment, due to the time value of money and higher risk of non-payment, which could result in expected credit losses
- Fair value of collateral held. A decline in the fair value may mean that the collateral held no longer covers the debt
- Economic stimulus packages. What will this mean for customers and their ability to pay?
- Deferred tax assets. If an entity is incurring losses then the recoverability of the deferred tax assets recognised in prior periods could be in doubt.
Foreign exchange transactions
The significant movements in foreign exchange rates have caused large movements in balances / transactions held in other currencies. Many entities previously used an average rate to translate transactions in the income statement, however this may no longer be appropriate.
There may be a need for additional provisions based on changes in operations, such as onerous provisions for service contracts due to closure of facilities, rehabilitation or makegood provisions, where leases are being ended early, restructuring provisions.
Employee benefits provisions
The changes in the working environment mean that changes will occur in the amount of annual leave and long service leave provisions that are recognised. In some cases, the value of the provision may drop quite significantly as staff are being encouraged to utilise the leave at this time. Where employees are being stood down, there may be the need to pay out provisions which could exacerbate the liquidity issues. Where working hours are reduced (or perhaps increased), the calculation of employee benefit provisions will need to be carefully checked to ensure that the correct provision is being included.
Share based payment expenses
Where an entity is in the vesting period for a share based payment arrangement, the expense recorded depends on the probability of instruments vesting. The decrease in share prices and potential reduction of employees could change the estimates and therefore decrease share based payment expenses in the current year.
Fair value assessments
- Investments. Global share markets have suffered large decreases over the previous month or so and the value of listed investments held by entities has declined on the balance sheet. Where the investments in entities are unlisted, there are challenges around what the fair value of the investment is at the reporting period. Entities will need to consider the appropriateness of any valuation methodology in accordance with AASB 13.
- Infrastructure, property, plant and equipment (IPPE). Where IPPE is held at fair value, the entity is required to consider whether the current carrying amount is materially different from fair value and, if so, then amend the carrying amount. The restrictions in travel and other restrictions in place may mean that it is not possible for a valuer to inspect an asset in the usual manner.
AASB 15 has introduced a five-step process for recognising revenue, and COVID-19 issues could arise due to the following:
- Step 1: Is a contract still enforceable? There has been a significant number of cancelled contracts and refunds being provided through a customary business practice rather than any statutory obligation.
- Step 3: Revenue is recognised based on the best estimate of the consideration. Where there are KPIs in the contract, this best estimate may need to be changed, which could cause adjustment to the revenue recognition model.
- Step 5: If work performed is being delayed, then this could affect the timing of transfer of control and therefore revenue recognition.
- Capitalisation of costs or contract assets. The recoverability of these assets capitalised in accordance with AASB 15 will need to be considered.
What about going concern?
The following paragraphs show the guidance available in the accounting standards around going concern:
“An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so.” AASB 101
“Deterioration in operating results and financial position after the reporting period may indicate a need to consider whether the going concern assumption is still appropriate” AASB 110
“An entity should not prepare its financial statements on a going concern basis if events after the reporting period indicate that the going concern assumption is not appropriate.” AASB 110
To summarise these requirements, if at any time prior to the entity signing its financial statements there is evidence that the going concern basis is not appropriate then, regardless of when that evidence came to light or the circumstance arose, the financial statements that have not yet been signed SHOULD NOT be prepared on the going concern basis.
Given the fast moving environment we are operating in, the going concern assessment will need to be looked at throughout from reporting date until the date of signing ensuring that the most up to date information is being evaluated.
What will the audit look like?
In many cases, the external auditor will continue to perform the audit under the existing timetable, but the audit will be performed remotely rather than at a client’s site.
There will be many discussions and meetings via an online platform to ensure that sufficient, appropriate audit evidence is able to be collected.
Challenges will arise where entities have significant inventory balances, assets held at fair value, operations in locations which are in lockdown and information cannot be provided electronically, however we will work with our clients to ensure that a pragmatic compliant approach can be adopted where possible.
In relation to audit opinions, the answer to this will be on a case by case basis since the impact on each entity will be different and therefore a boilerplate paragraph in the audit opinion is not appropriate. Obviously, disclosures will be increased and there will be more attention and focus on risks faced at the current time as well as going concern issues and the associated implication on the audit report.
What about deadlines?
The Australian Charities and Not-for-profits Commission (ACNC) has announced an extension to the lodgement date for Annual Information Statements. If a charity had a lodgement date between 12 March 2020 and 30 August 2020, then this has now been extended to 31 August 2020.
A breaking announcement from the Australian Securities and Investments Commission (ASIC) on 9 April notes that the deadline for lodgement of unlisted entities with year ends between 31 December 2019 and 31 March 2020 has been extended by one month. Note, if the deadline for lodgement of the 31 December 2019 financial report for the entity has already passed (e.g. managed investment schedule deadline was 31 March 2020), then the extension does not apply.
ASIC had previously announced that they wouldn’t take action if annual general meetings for 31 December year ends were postponed by two months and supported companies using appropriate technology for these meetings, if permitted by their constitution.
In relation to later reporting periods, regulators have not made any announcements about any changes to reporting deadlines and therefore entities should work towards their existing financial reporting timetable. Only time will tell how long the current situation is in place and regulators have advised that they are monitoring the situation and will consider any changes needed.
While it might sound like an easy fix to extend deadlines, any extension will mean that future deadlines may also need to be pushed out otherwise the time between deadlines will be shortened and therefore the long term considerations need to be carefully weighed up.
Overall – what story should you tell in your financial statements through the disclosures?
One of the important things to think about is, to whom should you be telling the story? Obviously listed companies have continuous disclosure requirements, but other entities will need to consider which of their stakeholders need to be updated on the current situation. Think about banks, other fund providers, employees, creditors, trade unions etc.
Entities can then think about the story they should tell and how often. The fast changing environment means that one off communication is unlikely to be appropriate and regular updates may need to be provided as necessary.
It is acknowledged that there are so many things that we do not know at the moment but, when compiling your financial statements, please ensure that the story you tell is the most up to date one using the best information that you have. Provide as complete a story as possible, so users can read the disclosures and have some understanding of the impact of COVID-19 is having on your business.
Please contact your local Bentleys advisor for further information. We are doing everything we can to help businesses come out of this challenging time in good shape.
Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.