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Covid-19 Impact on Financial Reporting

Written by 
Pei Pei

Covid-19 pandemic has affected the global economies and most of the entities, directly or indirectly, which in turn has significant implications on financial reporting.

This article highlights the impact of Covid-19 on financial reporting and provide a summary of key considerations to focus on the financial statement.

Basis of Preparation of Financial Statements

1. Assessment of Going Concern

Due to the pandemic, business entities are expected to deal with many uncertainties. The assessment on the entity’s ability to continue as a going concern basis need to be disclosed in the financial statements.

The disclosure should include

  • significant assumptions and judgements applied
  • conditions and events that raise the substantial doubt on the entity’s ability to continue as a going concern
  • entity’s plan to address the challenges and the progress made

If the entity has no real alternatives, but to liquidate or cease the business, it is no longer a going concern and the financial statements should have to prepared in other basis, such as “liquidation”.

2. Subsequent events disclosure (after reporting period)

The impact of Covid-19 on entities will change, but the uncertainties will remain for most of the entities.

Entities required to consider which events after the reporting date might be adjusting events and disclose the material non-adjusting event (nature of event and estimate of its financial effect).

Adjusting event  Non-adjusting event
Provide evidence of conditions that existed at the end of the reporting periodIndicative of conditions that arise after the end of reporting period
Reflected in adjustment to financial statement  Do not reflected in adjustment to financial statements, but disclosure required if material   Example: decline in fair value of investments, changes of asset, breaches of loan covenants, management restructuring plan, new government reliefs

Key Considerations on Financial Statement Areas

1. Impairment of non-financial assets

Economic disruption that caused by the pandemic may trigger the need for impairment testing. The disclosure is important to understand the degree of estimation uncertainty about the recoverable amount and sensitivity of the recoverable amount to possible changes.

Management may consider:

  • Determine CGUs performance and changes of consumption patterns
  • Cash flow projections adjusted to reflect the impact of Covid-19 (impact due to trade restriction, government shutdowns, change of growth rates, etc)
  • Discount rates applied in recent valuations been updated to reflect the risk environment
  • Disclose key assumption and major sources of estimation made by management on recoverable amounts

2. Fair value measurement

The fair value of an asset (or liability) should reflect market conditions at the measurement date.

Management may consider:

  • Assumption of market participants based on the market condition reflected in valuation
  • Include risk premiums due to the impact of Covid-19 (such as credit risk and liquidity risk, forecasting risk, foreign exchange risk and commodity price risk)
  • Disclose significant increases of unobservable inputs that result in a Level 3 categorisation
  • Disclose further key assumption and major sources of estimation made by management on valuation

3. Recoverability of deferred tax assets

The projection of future taxable profits that used to assess the recoverability of deferred tax assets may affected due to the changes of forecast cash flows, changes of company’s tax strategies and government measures in response to the pandemic.  

Management may consider:

  • Government measures (eg tax relief, additional tax deductions, reduced tax rate, etc)
  • Changes of company’s tax strategies and plans
  • Changes of company’s plan to repatriate or distribute profits of a subsidiary that will result the recognition of a deferred tax liability
  • Disclose key assumption and major sources of estimation made by management in recognising and measuring deferred tax assets

4. Recoverability of revenue-cycle assets

The Covid-19 has caused adverse impact on many company’s revenue cycles due to the decrease of customer demand, customer bad debt, trade restriction, etc.

Management may consider:

  • Assess both contract assets and receivables for impairment (ie using an expected credit loss model)
  • Estimated net realisable value for inventory adjusted based on the changes in customer demand and increase of labour cost (ie estimated selling prices and estimated costs to complete)
  • Capitalised contract costs, to consider the changes of expected customer renewals or expected timing for completion of project
  • Disclose key assumption and major sources of estimation made by management in measuring revenue related assets

5. Capitalisation of borrowing costs

There might be suspension of project due to trade restriction or disruption. Thereafter, the adjustment of interest expenses for renegotiation or modification of borrowing terms may affect the amount of eligible borrowings costs.

Management may consider:

  • Whether the interruption is for only short term or due to common external event
  • Ensure the amount to be capitalised if borrowing costs continue to be capitalised

6. Other areas

  • If there is no change of shares proportions, de-consolidation of subsidiary is allowed only when there was a loss of control over the subsidiary
  • If there is loan or financial instruments pegged to InterBank Offered Rates will be converted to an alternate benchmark and hedging done on the interest rate risk, to consider Phase 1 amendments to financial instruments standard and seek professional advice.
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