Coronavirus Outbreak: Covid-19 And Its Impact On FY20 Financial ReportingBloombergQuintOpinion
We are amidst an unfortunate coronavirus outbreak. This situation continues to evolve and is being monitored with various remedial and preventive measures being undertaken. We are faced with social distancing, restricted travel, scaling down of business operations, disruption in supply chains, reduced demand and an overall contraction of economic activity. As we cope with this situation and challenges, an aide-mémoire of some important implications for March 31, 2020, financial reporting is summarised here.
Impairment Of Non-Financial Assets
Due to the stock market turmoil, companies’ market capitalisation has declined and is now possibly lower than its equity or book value of net assets. This is a mandatory trigger requiring formal impairment assessment of the entity’s non-financial assets. Covid-19 repercussions of temporary ceasing or scaling down of operations, reduced demand, prices and therefore profitability are also indicators requiring impairment assessment. This assessment may now need to be also performed for an entity’s property, plant, equipment, and intangibles, in addition to goodwill, which was anyway tested at a minimum annually. Management will need to incorporate the effects of Covid-19 in its assumptions, cash flows, and projections.
Management may also need to closely review the build-up of any inventories and risk of obsolescence due to reduced demand and prices. This may require higher inventory write-downs to a lower net realisable value. Additionally, reduced production levels or idle capacity may need to be considered for the purpose of inventory valuation – because fixed overheads are absorbed basis normal production capacity.
Impairment Of Financial Instruments
This is another important area, where financial assets such as loans, debt instruments, lease, and trade receivables—that are not accounted at fair value through profit and loss—would need to be critically reviewed and estimates of provision for expected credit losses or ECL be updated to consider any effects of Covid-19.
For example, borrowers may be facing liquidity issues resulting in defaults or delays in repayment. This may imply a significant increase in credit risk of the borrower and consequent change in the stage or bucket of the provision from stage one (12 months ECL) to stage two (lifetime ECL). Estimates of the fair value of collateral may show declines, again causing a risk of higher ECL provision.
In these times, borrowers may try and renegotiate the terms of repayment, moratorium or other concessions such as lower interest rates. Though lenders may potentially need to recognise higher lifetime ECL provision due to significant increase in credit risk, the borrower may also need to account for such renegotiation of terms as either a modification or extinguishment of that borrowing.
Finally, management will need to consider its financial risk management disclosures. For example, incorporation of the impact of forward-looking information into its ECL estimate, details of any significant changes in assumptions, changes in the ECL resulting from assets moving from one stage to another, etc. NBFCs and asset reconstruction companies are expected to be more significantly impacted due to this and should also comply with the Reserve Bank of India’s latest requirements on the implementation of Ind AS.
Also read: How NBFCs And ARCs Need To Implement Ind AS
Scaled-down economic activity and reduced demand could result in higher than expected sales returns, cancellation or refund of already prepaid services, cash discounts to liquidate receivables, additional price concessions, which may be partially offset by lower volume discounts. All of this requires entities to revise their estimates of variable consideration and possibly downward reporting of revenues. Entities may also need to evaluate provision for liquidated damages for any delays in promised shipments. The impact of this could be across industries.
Leases And Onerous Contracts
The retail, travel, and entertainment industries have been severely hit by Covid-19. Typically, these businesses have significant fixed costs in the form of salaries and non-cancellable lease commitments. The overnight reduction of revenues has negatively impacted their performance, liquidity and may also call into question the continuing ability to operate as a going concern for some businesses. For example, the airline industry's viability is in question, if governments do not provide the necessary stimulus or bailout. In this regard, lessees may seek concessions from lessors in the form of deferment of rent payment or rent holidays, which may have a consequential impact on the amount of lease liabilities recorded on the balance sheet. Lessors may be adversely impacted, as variable rent basis revenue sharing would plummet.
Certain entities may have entered into contracts with fixed purchase or supply commitments at fixed prices, commonly known as ‘take or pay’ contracts. These entities may need to evaluate whether these contracts have become onerous either due to inability to supply or purchase such fixed quantities at the contractually fixed prices vis-à-vis now lower demand, prices or supply chain disruptions. Any potential losses will need to be accounted in accordance with Ind AS 37. There is also discussion about entities invoking ‘force majeure’ clauses in their contracts, the impact of which may need to be considered for financial reporting.
The Covid-19 situation may require restructuring of operations, modification of incentive plans such as share-based arrangements by relaxing certain performance conditions, additional benefits to employees, etc. Entities will need to evaluate the impact of such plans on their financial reporting. Due to these conditions, loan covenants of borrowers may be at risk of default. Such entities may need to obtain waivers from lenders or renegotiate the covenants, else long-term borrowings will get reclassified as current liabilities becoming payable on demand.
The government may provide relief or stimulus to businesses in the form of specific direct assistance to certain affected industries or other forms of tax rebates or holidays. For example, there have been reports of entities seeking extensions for payment of various government dues and taxes. Entities will need to evaluate whether these benefits should be accounted for as government grants under Ind AS 20.
Equity investments and linked mutual funds are likely to experience a significant decline in their fair value. However, entities relying on valuation models and unobservable (level three) inputs may need to critically revisit those assumptions considering revised cash flows, weighted average cost of capital/discount rates, exchange rates, etc.
Entities that have entered into cash flow hedging programmes to mitigate foreign currency or commodity price risk of their forecast purchases or sales may need to evaluate whether those transactions as forecast and their timing continue to be probable.
If not, this could require mark-to-market adjustments related to the underlying derivative contracts—or higher ineffectiveness—to be recorded in profit and loss, which until now may have been deferred in equity.
Finally, entities that have recognised deferred tax assets may need to review their estimates of future taxable income considering the impact of Covid-19 and may need to write-down the value of such assets if not considered recoverable in accordance with Ind AS 12. Separately, entities that may have previously asserted that undistributed earnings of subsidiaries will not be distributed to the parent may now decide to revisit their plans, and if such earnings are now probable of distribution, then additional deferred tax liabilities will need to be recorded to address any potential tax consequences.
Our regulators have been proactively responding to this situation and have already provided various relaxations. For example, the Securities and Exchange Board of India has permitted deferral of results by listed companies by 30 days to June 30, 2020, including extending the gap between board and audit committee meetings. Similarly, the Ministry of Corporate Affairs has provided relaxations from holding physical board meetings. Therefore, these and other measures should help entities to navigate through the challenging Covid-19 situation while complying with their reporting responsibilities.
Sumit Seth is a chartered accountant. Views expressed are personal.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.