The infection caused by the new corona virus (Covid-19) is flaring up all over the world. While countries implement measures to combat it, companies must make important operational decisions, and there is no doubt that its devastating impact will have consequences for the world economy.
What about accounting? Is there an impact of the Covid-19 virus on the obligations of accountants and auditors when preparing financial statements in accordance with International Financial Reporting Standards (IFRS), as well as auditing them, again according to the rules defined in International Auditing Standards (IAS)?
Most entities have focused on employee protection, the perception and management of business-threatening risks, as well as the management of disruptions in supply chains due to efforts to combat the spread of the corona virus.
The pervasive impact of the pandemic on businesses and supply chains will become clearer in the future, while global economic recovery will depend on the success of the affected countries in dealing with the consequences of the virus.
Which industries will be (are) affected?
The global financial consequences are likely to be felt across all industries and activities. Companies in the tourism, transport of people and goods, catering, logistics, automotive industry and aviation sectors are especially exposed. In contrast to those parts of the economy, providers of services related to the Internet and information technology in general are exposed to the least discomfort.
Also, entities engaged in the retail sale of consumer goods, especially those sellers of seasonal goods, will be exposed to a higher business risk than usual. In the conditions of eventual accompanying panic among the population, it is very ungrateful to predict the pace and dynamics of demand, in which way it is more difficult to optimize the procurement of stocks of trade goods.
As a classic example of an endangered business, due to a damaged supply chain, we can cite, for example, the automotive industry where battery packs are obtained from Asia (China, South Korea) and installed in America, Germany, Austria. There are an incredible number of such examples in the automotive industry, as well as in other parts of globally intertwined industries.
Management concerns
Questions for assessing the impact of the corona virus on the entity's business that management can and must ask themselves certainly include, but are not limited to, the following:
What is the impact on cash flows? Is the company directly or indirectly dependent on the supply of goods or services generated in the affected regions? What is the possible impact of the crisis on sales, that is, on demand? What happens to the company's business if the employees are infected? How vulnerable is the firm to unexpected market price movements?
What to do?
In order to adequately manage risks and to reduce them at least partially, entities should pay special attention to cash flow management. It is necessary for companies to actively reassess their cash needs as soon as possible, taking into account various potential scenarios, as well as potential risks related to their suppliers and customers. After that, the elaboration of the corresponding, corrected activities should be started according to the earlier conclusions.
The answers to the above-mentioned questions will be the first indicator of how serious the impact on the entity's business is in general. Then, he will additionally explain the impact of the consequences of the virus on financial reporting and in which part it could-must be reflected in the amounts and/or (only) disclosures in the notes to the financial statements.
Korona against the accountant on December 31, 2019
The impact of the pandemic on IFRS financial reporting could be multi-layered. The first thing, in terms of reporting, that could and should be done is to assess whether in this case it is an event that is corrective or non-corrective in nature, using the provisions listed in International Accounting Standard 10 (IAS 10) Events after the reporting period.
Corrective events are those events that provide evidence of circumstances that existed at the end of the reporting period and require the entity to adjust amounts already recognized in its financial statements to reflect corrective events after the reporting period.
Non-corrective events are those that indicate circumstances that occurred after the reporting period. An entity does not adjust amounts recognized in its financial statements that reflect non-adjusting events occurring after the reporting period.
The answer to this dilemma is in direct correlation with the day on which the balance sheet is drawn up, that is, with the reporting date. What our accountants are most likely to be interested in, we believe, is the annual financial report for 2019.
As of December 31, 2019, the later declared corona virus pandemic can be considered a non-corrective event. Accordingly, the declaration of a pandemic has no effect on the recognition and measurement of assets, capital and liabilities, but it may have an impact on disclosure requirements, that is, notes that are an integral part of financial statements.
If the assessment of the management of the entity that prepares the financial report is that the crisis that occurred in 2020 will have such an impact on the company's financial position that it can be considered an important event, then all the information that is important in the specific case would have to find its place in the note that would deal with "Events after the reporting period".
This includes a description of the implications of the crisis occurring on the day following the reporting date, as well as a description of all actions taken by the executive to respond to the problem that has an impact on the company's financial position. It is necessary to disclose the eventual financial effects, if it is possible to calculate them.
For example, how much damage society has suffered thanks to unfortunate events. Or say, the disclosure of the estimated effects on the impairment of financial and non-financial assets, violations of the provisions of agreements (so-called covenants), changes in debt agreements (loans, loans and borrowings), losses due to problems in the supply chain, instability in foreign currency markets, after the reporting date.
However, this is certainly not the end of the analysis, because the management must also decide on the question of whether the company's financial statements are prepared in accordance with the assumption of continuity of operations in the foreseeable future, or not.
The entity's management must assess whether current events and emerging conditions cast significant doubt on the company's ability to continue as a going concern. If the conclusion is that the consequences of the pandemic have led to a pervasive deterioration of the financial position of the entity after the reporting date, which is so serious that the preparation of financial statements can no longer be carried out in accordance with the assumption of the principle of continuity of operations, the financial statements must be adjusted to the new situation.
Now the approach regarding measurement, recognition and disclosure is changing with a special emphasis on requirements regarding assets held for sale, classification of liabilities and financial instruments, impairment testing and measurement of provisions. In short, all long-term items become current, revolving, short-term, that is, due. There are no more reservations, but they are translated into regular obligations. A whole set of corrections must be implemented in that case.
Corona vs. accountant at some later date in 2020
For the reporting dates after December 31, 2019, it is certain that the management of the companies will have to take into account all relevant assumptions and estimates, which in translation means that we expect the existence of corrective events, as a reflection of the strong impact of the crisis on the entity's financial position. Therefore, such events must be involved directly through the disclosed amounts in the financial statements on a certain day, that is, for a period after January 1, 2020.
It is most likely that the subject of re-examination will have to be: assets and liabilities measured at fair value; possible decrease in the value of intangible and tangible assets; net recoverable amount of inventory; Recoverability of deferred tax assets; expectations regarding credit losses, i.e. losses on the value of financial instruments; classification of financial obligations as current or long-term, and classification of items presented as assumed obligations
The market value measurement reflects conditions on the measurement date. This can be particularly challenging when the fair value measurement is based on rapidly changing circumstances.
The current situation may initiate the need to test for possible asset impairment, for example, due to significant negative changes in the market for products or services that the company offers, or massive order cancellations.
In addition, the impairment test itself may indicate that it is necessary to adjust expectations about future cash flows. Further, there may be less demand for some goods, which in turn may generate pressure on selling prices and/or result in lower inventory turnover, which further implies the necessity of additional write-downs (value adjustments) to the net recoverable amount.
As the economic outlook deteriorates and a company's earnings decline, the recoverability of any recognized deferred tax assets should be carefully reviewed. After all, this applies as a general rule for all asset positions.
Expected credit losses are based on information about past events, current conditions and forecasts of future economic conditions. The economic difficulties of customers and the negative economic outlook in general may require that additional amounts be transferred to the long-term provisions account to cover the risk of expected credit losses on financial instruments.
If the company's financial situation worsens, the company may be at risk of creditors gaining the right to activate contractual clauses (covenants) declaring all obligations due. If this cannot be remedied before the reporting date, the classification of the corresponding financial obligations as current liabilities is required, regardless of the initially agreed maturity date.
Liabilities that previously meet the definition of assumed liabilities may need to be reassessed and recognized on the balance sheet.
Corona vs. auditors
As far as auditors are concerned, the answer in this situation is identical to the one that would be given if it were a crisis caused by any other disorder and not a pandemic.
The auditor should reach a conclusion on the appropriateness of management's application of the going concern basis of accounting in the preparation of financial statements (hereinafter referred to as "Basis"). The auditor's judgment must identify whether a material uncertainty exists regarding events or conditions that, individually or in the aggregate, may cast significant doubt on the entity's ability to continue as a going concern. Depending on the judgment the auditor makes regarding the appropriateness of applying the Basis, several implications for the Auditor's Report are possible.
When the Basis is not suitable
If the financial statements are prepared on a going concern basis of accounting, but according to the auditor's judgment, the application of the going concern basis of accounting in the preparation of financial statements is not appropriate, the auditor will express a negative opinion.
When is Basis appropriate?
If adequate disclosure has been made in the financial statements about a material uncertainty, the auditor expresses an unmodified opinion, but the auditor should include a separate section entitled "Material uncertainty related to going concern" to draw attention to the note in the financial statements in which the disclosures have been made and indicate that these events or conditions indicate the existence of a material uncertainty that may cast significant doubt about the entity's ability to continue as a going concern permanency and that the auditor's opinion was not modified on that issue.
When adequate disclosure of a material uncertainty has not been made in the financial statements, the auditor will express a qualified opinion. The Basis for Qualified Opinion Section of the Auditor's Report will state that there is a materially significant uncertainty that may cast doubt on the entity's ability to continue as a going concern and that the financial statements do not adequately disclose this matter.
Ružica Majkić
Director, Certified Auditor
