The impact of Covid-19 on financial reporting (Part 2)
SoluGrowth further unpacks the impact of Covid-19 on your business’s accounting.
We discussed reporting on non-financial and financial assets, liabilities that are likely to be affected by the Covid-19 pandemic and the resulting lockdown in South Africa in The impact of Covid-19 on financial reporting (Part 1). Now let’s look at leases, revenue recognition, provisions, events after reporting, going concern and income taxes.
Covid-19 has forced some entities to halt their business operations entirely, which in turn has left them with no revenue. Thus, many lessors have granted lease concession to lessees and lessees should consider these concessions as lease modification.
The International Accounting Standard Board (IASB) has issued an amendment to IFRS 16 Leases, which states that, as a practical expedient, lessees may elect not to assess if the rent concession made due to Covid-19 is a lease modification when certain requirements are met. If a lessee applies this amendment, it should disclose this in the financial statements.
Lessors should consider if the asset, as a result of the loss of rental income, is impaired in accordance with IFRS 9. Lessees should assess if the right of use of an asset is impaired in accordance with IAS 36.
IFRS 15 Revenue from Contracts with Customers requires entities to recognise revenue when it is probable that the customer will pay the transaction price. Some customers may be unable to meet some of their payment obligations during the pandemic so that entities will have to assess which customers will not pay and not recognise revenue on those transactions.
Revenue is measured at an amount net of any discounts and rebates. Decreases in sales will lead to an increase in expected returns, additional price concessions, reduced volume discounts, penalties for late delivery or reduced prices for customers. These elements require significant judgement and hinge on estimation uncertainty regarding the amount of consideration to be recognised at the contract inception date. The Covid-19 pandemic will, therefore, result in entities having to remeasure their variable consideration.
Some entities might apply Force Majeure to reduce contract scope or get out of the contract entirely. In instances like these, entities should consider whether Force Majeure is a contract modification and how it will affect the contract price and revenue recognition. IFRS 15 also requires that entities disclose information that allows users to understand the nature, amount, timing, and uncertainty of cash flows arising from revenue.
Entities that receive Government Relief Grants during the pandemic must assess whether the grant meets the requirement of IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.
Lockdown has, unfortunately, resulted in retrenchments and business restructuring for many entities. IAS 37 states that provisions on these can only be recognised when:
- An entity has a present obligation
- An outflow of resources is probably required to settle the obligation; and
- A reliable estimate can be made.
Management should have created a legal or constructive obligation, by communicating their intentions to all affected retrenchments or restructures for provision to be raised. There should also be a detailed plan for how retrenchments and restructures will be implemented.
An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. Covid-19 may result in contracts becoming onerous if an entity is unable to deliver or if there is a reduction in demand. IAS 37 requires an entity to recognise and measure present obligation under onerous contracts as a provision. It also requires entities to disclose the nature of the obligation and expected timing of the outflow of economic benefits.
Most governments around the world have used economic stimulus packages – namely of income tax concessions, reliefs, and rebates – to assist entities during these unprecedented times. Entities will have to assess the impact of these measures on their accounting for income taxes under IAS 12.
Items such as deferred tax assets and liabilities must be measured at the tax rates expected to be applicable when the asset is realised, or the liability is settled. Entities must also consider the implications of laws that were enacted, or substantively enacted, by the end of the reporting period alongside new tax enactments brought about by the pandemic. Entities will need to make these assessments based on the specific guidance per jurisdiction.
Uncertainties surrounding entity taxes could also see entities recognising additional liabilities in accordance with IFRIC 23 Uncertainty over Income Tax Treatment for uncertain tax positions.
Events after reporting
Entities should consider whether the impacts of Covid-19 constitute an adjusting event or a non-adjusting event, under IAS 10 Events After the Reporting Period. An event will be an adjusting event if there is evidence that conditions existed at the end of the reporting period.
If management finds that Covid-19 is a non-adjusting event, the impact on the financial statements will still be significant. This means management will still need to disclose the impact of Covid-19 on their financial statements.
Financial statements are prepared on a going-concern basis, unless management intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. Management should consider the potential implications of Covid-19, and the measures that have been taken to control it, when assessing the entity’s ability to continue as a going concern, factoring in any decline in business operations.
As businesses continue to seek solutions that will enable them to recover from the impacts of the Covid-19 pandemic, quality and accuracy of financial reporting should not fall by the wayside.