Accounting in the age of coronavirus

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Accounting in the age of coronavirus

• 27 June 2020
• Accounting
• South African Accounting Academy

There are several challenges arising from the coronavirus that impact the accounting profession.

One of the key issues will be the Going Concern status of auditied entities. The International Federation of Accountants (IFAC) points out that IAS 1 Presentation of Financial Statements requires management to assess a company’s ability to continue as a going concern.

“Material uncertainties that cast significant doubt on the company’s ability to operate under the going concern basis need to be disclosed in the financial statements,” says IFAC.

Factors weighing on the going concern status are, crucially, sufficient liquidity to continue to meet obligations, which is in turn impacted by travel bans, operating restrictions, government assistance and potential sources of replacement financing as well as the financial health of suppliers and customers.

Auditors and accountants are going to provide detailed assumptions used in making the going concern call, with various scenarios – each underpinned by clearly articulated assumptions – which will need to be updated regularly to reflect changing conditions.

One thing is for sure: these are going to be tough times not just for companies, but also for their accountants.

Revenue recognition

Take revenue recognition for a start, which is International Financial Reporting Standards (IFRS) 15 Revenue from Contracts with Customers.

The inability of companies to perform on contracts due to the Covid-19 lockdown will impact hundreds of thousands of companies worldwide. For example, penalties being applied in terms of contracts for non-performance, cancelled contracts or the inability to supply goods in terms of the contractual obligations. Events such as these are happening daily through no fault of the companies concerned. This will impact revenue recognition and in many cases revenue already recognised has to be reversed where refunds have to be made due to non-delivery. This would also impact VAT payments already made, requiring an offset against future VAT payments.

Impairment of assets

SA Institute of Chartered Accountants (SAICA) has issued some guidance on the accounting issues arising from Covid-19, including the need for potential impairment of non-financial assets. International Accounting Standards (IAS) 36 Impairment of Assets requires entities to conduct an impairment test annually at yearend in event of an impairment indication having arisen.

This will be particularly applicable in hardest-hit sectors such as tourism and travel, requiring an impairment assessment of cash generating units, in addition to the usual impairments relating to goodwill and intangible assets.

Impairment of non-financial assets

IAS 36 ensures that a company’s assets (including property, plant, equipment and intangibles) are carried at not more than their recoverable amount, ie. the higher of fair value less costs of disposal and value in use. Companies are required to conduct impairment tests when there is an indication of impairment of an asset at the reporting date. Indicators of impairment include significant changes with an adverse effect on the company that have taken place during the reporting period or will take place soon in the market or economic environment in which the company operates.

Fair value measurements

“Discount rates and measurements in accordance with IFRS 13 Fair Value Measurement should reflect the views of market participants and COVID-19 data at the measurement date,” according to SAICA.

IFRS 13 requires companies to disclose the valuation techniques and the inputs used in the FVM as well as the sensitivity of the valuation to changes in assumptions.

According to IFAC, disclosures are needed to enable users to understand whether COVID-19 has been considered for the purpose of FVM. A key question is what conditions and the corresponding assumptions were known or knowable to market participants at the reporting date.

“For 2020, fair value measurements, particularly of financial instruments and investment property, will need to be reviewed to ensure the values reflect the conditions at the balance sheet date. This will involve measurement based on unobservable inputs that reflect how market participants would consider the effect of COVID-19 in their expectations of future cash flows related to the asset or liability at the reporting date.”

Investment property valuations will obviously be impacted by occupancy rates and rental trends, which is something that will require constant monitoring. The same is true of financial instruments subject to volatile swings in valuation.

Inventories

IAS 2 Inventories requires the measurement of inventories at the lower of cost or net realisable value (NRV). However, the determination of NRV may prove troublesome during the COVID-19 economic downturn.

In the current environment, the NRV calculation will likely require more detailed methods or assumptions e.g. companies may need to write-down stock due to less sales. IFAC advises that interim inventory impairment losses should be reflected in the interim period in which they occur, with subsequent recoveries recognized as gains in future periods.

Similarly, entities may need to review the costing of inventories upon abnormal low utilisation of production capacity. The review should ensure that unallocated fixed overhead costs are recognised in the statement of profit or loss as oppose to capitalisation of these overheads against the cost of inventories.

Measuring expected credit loss assessments (ECLs) under IFRS 9 Financial Instruments

Provisions will have to be made on estimates of expected credit losses by banks and lenders, and is something that is likely to show changes month-to-month. This is another evolving area that will require ongoing guidance from the securities and markets authorities.

Hedge accounting

COVID-19 may reduce the probability of a hedged forecast transaction occurring or affects its timing. If a hedged forecast transaction is no longer highly probable to occur, hedge accounting is discontinued and the accumulated gains or losses on the hedging instrument need to be reclassified to profit or loss, advises IFAC.

IFRS 7 Financial Instruments: Disclosures requires disclosure of defaults and breaches of loans payable, of gains and losses arising from derecognition or modification, and of any reclassification from the cash flow hedge reserve that results from hedged future cash flows no longer being expected to occur. Disclosures include quantitative data, for example about liquidity risk, and narrative disclosure, for example how risk is being managed.                                                                                      

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