The actual day to day of doing an audit and preparing financial statements is pretty seamless – even down to physical asset verification and attending a stocktake – and can be done largely remotely. It’s one area that’s been business as usual for us, and you can read more about our remote audits here.
However, it’s what goes into those accounts that’s likely to be feeling the effects of COVID-19. Companies with both 2019 and 2020 year ends will have to consider how the pandemic is affecting their business, and how this will need to be reflected in the financial statements.
That can make the prospect of preparing financial statements daunting, and companies may be considering extending their accounting reporting period, or applying for a 3 month extension for filing at Companies House, which we discussed here.
Will you need to adjust your accounts?
News started to emerge about a serious virus in China in late 2019, but it wasn’t until March 2020 that the World Health Organisation (WHO) declared a global pandemic, and the UK went into lockdown.
So, if you have a 2019 or a January/February 2020 year end, the effect of COVID-19 is generally considered to be a ‘non-adjusting post balance sheet event’ – one that you’ll no doubt be talking about extensively in your financial statements, but not adjusting the figures reported in your balance sheet.
However, for March 2020 year ends onwards, the effects of the virus on various accounting issues should be reflected in those financial statements, which we’ve covered in more detail below.
Impact on the carrying value of your assets
Where credit is extended to individual customers or distributors, businesses will now need to assess their customers’ ability to pay, and the risk that receipts may be delayed or defaults might increase – particularly where credit insurance may now be unavailable.
In sectors such as retail, many companies are turning to payment providers such as Klarna to enhance the selling experience for the buyer by offering extended credit, whilst mitigating credit risk.
In many sectors, and retail in particular, the valuation of stock will be one of the areas most affected by COVID-19, from the loss of perishable items that couldn’t reach customers in time, to excess holdings of seasonal, or trend-led items. We’re expecting an increase in stock write-downs.
Companies will need to consider:
- Perishable or seasonal stock holdings
- Reduced customer confidence may affect their willingness to purchase goods perceived as non-essential
- The ability to repurpose stock, for example, by rolling forward to future seasons. Where this will include having to adapt the item, e.g. by changing labelling or packaging, or incurring additional stockholding costs to hold the item for extended periods, this will need to be taken into account.
Property and fixed assets
Investment property is generally carried at fair value and should reflect the market conditions at the reporting date.
If the company is expecting to incur future operating losses, this could be an indication that assets could be impaired, such as trading property, plant and machinery or fixtures and fittings. When undertaking an impairment review, businesses will need to take into account that cash-flows to be generated from that asset may be lower due to restrictions to trading from shutdowns, reduced capacity and employee availability.
The effects on other assets
- Investment – valuations such as share portfolios or investment in group companies will need to be reviewed.
- Intangible assets – IP and the goodwill valuation of acquired subsidiaries or businesses will need to be considered.
- Prepayments or deposits – where items have been paid for in advance but are no longer going ahead, or the company is due a credit or refund, for example for travel, exhibitions, and conferences, then the company will need to consider the recoverability of this amount and the likelihood of receiving a future benefit from that asset.
- Deferred tax assets – when considering if they’re recoverable, we now need to think about the effect of a future downturn in profitability
- If you’re adopting IFRS 16, right-of-use assets arising, for example under lease contracts for retail space, might now be impaired if you’re restricted from trading due to lockdown restrictions.
- Finally, where you have insurance in place for the effects of the pandemic, and are expecting a pay out, you can only recognise this as an asset where it is virtually certain it will be received. Until this is the case, you can disclose the fact in your financial statements.
Liabilities and provisions
The level of liability and provisioning may increase – not least because of additional financing or government support, which we’ve covered in the next section.
- The classification of bank or other borrowings may need to be reflected as a current rather than longer-term liability if breaches in covenants or other terms now mean the amount is technically repayable on demand.
- At the year end, VAT or other HMRC liabilities may be higher than usual if the company has chosen to defer VAT payments or make time to pay arrangements.
- Onerous contract provisions are expected to increase where businesses are unable to access leased locations due to lockdown restrictions, or where the forecast EBITDA contribution of that location is expected to become negative. This would need to take into account any negotiation with landlords (discussed below). Other onerous contracts may also arise, for example ones which contain penalties for late or non-delivery, or contracts where the costs of fulfilling that contract have increased, e.g. by having to purchase alternative materials at a higher price due to supply chain issues.
- Lease accounting – where rent concessions have been received, for example rent-free periods, payment holidays, move to turnover linked rentals or reduced payment amounts, and ensuring this is accounted for properly. For more information on the impact on IFRS 16 reporters, click here.
- Whilst many companies will be having to restructure their businesses in response to this crisis, a restructuring provision can only be recognised if it meets the criteria for recognition. And this will usually mean that by the balance sheet date the business has a formal plan for the restructuring that has been announced, or implementation has begun. A provision can reflect the resulting direct expenditure, such as redundancy costs, consultancy fees or onerous contract provisions. Future operating losses or costs associated with ongoing activities, e.g. retraining staff or investing in new systems would not be covered.
- Dilapidation provisions may need to be revisited where locations may now close permanently.
- Staff costs such as bonus or incentive payment pots and holiday pay accruals may become a material figure as amounts are deferred or holidays carried over into the next financial year.
The UK Government has announced a range of measures to support businesses, the accounting and disclosure requirements of which will depend on the nature of the support received.
New accounting policy disclosures may be needed to explain the treatment of government grants and assistance.
Coronavirus Job Retention Scheme (CJRS)
The CJRS has been a lifeline for many businesses, covering wages for employees on temporary leave (“furlough”). The reimbursement to be received from the government each month should be matched with the associated payroll expense, and the grant should be recognised separately in the profit and loss account, for example as “other income”, rather than netted off staff costs.
For more information on the CJRS, head here.
Other schemes to help businesses access funding, such as the Coronavirus Business Interruption Loan Scheme (CBILS), often take places with third party banks, and so whilst they are loans rather than grants, they do often contain certain elements of company support embedded in the arrangement.
For example, where the government will make a Business Interruption Payment to cover the first 12 months of interest or fees, this element would be treated as a government grant, and the treatment would be the same as for the CJRS above – each month the interest expense would be matched by an equal amount of grant credit, shown separately in the income statement.
Typically, grants offered by the government such as the Small Business Grants Fund or the Retail, Hospitality and Leisure Grant Fund will meet the criteria to be accounted for as a government grant. That means they should be recognised when you’re reasonably certain the grant will be received.
Companies may be considering exceptional disclosures or using alternative performance measures, such as EBITDAC (earnings before interest, tax, depreciation, amortisation and coronavirus) to demonstrate their true underlying position.
Where a business has had to offer credits, refunds, extend the period over which goods can be returned, or run promotions which include free or discounted goods or services, it may be necessary to review the revenue recognition accounting policies to ensure they’re still relevant and appropriate in the current circumstances.
And the rest
Other areas of the financial statements that may be affected include: investment valuations, share-based payments, fair values of defined benefit pension assets and liabilities, and tax.
Given volatility in the currency markets, forex valuations will need to be reviewed – particularly where the company applies hedge accounting and is committed to significant amounts of forward contracts which are now surplus to requirements.
One of the words you’ll have no doubt heard throughout this pandemic is “uncertainty”. And for good reason, really, because it’s defined recent times.
Information disclosed will need to be sufficient to enable users of financial statements to understand the impact of COVID-19- on the entity’s financial position and performance.
As a number of areas of the financial statements are based on fair values, assumptions, key judgements and critical estimates, this uncertainty and the impact it has when making those judgements and estimates about the future will need to be disclosed. And we expect the level of narrative reporting to increase accordingly.
What about going concern?
Ah, the elephant in the room. And an elephant that deserves a whole article of its own. Click here to read about the impact of going concern considerations on a company’s audit and accounts.