We have not yet recovered from how our world virtually changed overnight. From a colourful world of abundance and wealth, we suddenly find ourselves in a world where we have to avoid personal contact, cannot move freely and fear for our and our family’s health. Despite all the big fears and smaller ones, many see the new situation as an opportunity. Suddenly we all communicate via modern technology, organise video- and teleconferences, scan, e-mail and find out that it might actually not be necessary to keep binders full of papers.
Experience shows that one method to avoid depression (or panic) is to set and maintain a stable routine, even under the different and limiting conditions. And such a routine may very well include a proper preparation of financial statements and their audit.
We do not yet know how COVID-19 will affect our lives. And we are still learning to assess its impacts on the financial statements. The reporting entity’s management has to assess the impact of COVID-19 on the business activities of the entity, and subsequently on the accounting books. In relevant cases, it also has to propose appropriate entries or changes in valuation.
Some business areas have not (yet) experienced the negative impact of the pandemic, with sales and profits even growing faster than usual. Examples include segments of the food industry, ordinary retail, transportation, packaging and medical material. For now, agriculture has been operating as usual, putting aside the weather. On the other hand, negative effects of the pandemic may be visible in the automotive industry, hotel and tourism industry, and in most services and transportation tied to industrial products (regardless of whether the private or the public sector is concerned). Accounting can easily and accurately reflect the positive effects. However, it is necessary to keep an eye on the negative ones, as they represent risks related to the preparation of financial statements.
Areas and Risks to be Assessed by the Reporting Entity’s Management Primarily Involve the Following:
Is the reporting entity dependent on the supplies from affected areas, whether from Europe, China, Korea or the USA? Does the entity face the risk of being dependant on one suppliers with its registered office or an establishment in these areas? Are the goods transported through these areas or from them? Do exemptions have to be arranged for transport by truck or are supplies delayed due to closed borders? Or have the suppliers temporarily or permanently suspended production, which subsequently poses a threat to your own production or your business?
The reporting entity’s ability to continue as a going concern in the near future will have to be assessed.
Are your customers still operating as usual despite the prohibition of certain activities, or do you sell your goods to car manufacturers, hotels, restaurants or other companies that had to suspend their operations? Are your customers in delay with payments for the delivered goods or provided services? Are your sales dropping or coming to a halt? Are the demand cut-offs negatively affecting your cash flow or liquidity?
It will be necessary to assess the impact on receivables and provisions against receivables, or, in case of unsaleable inventories (or inventories with a limited useful life, expiration etc.), provisions against inventories and write-off of inventories. In this case as well, the management should assess the accounting entity’s ability to continue as a going concern in the near future.
The cut-offs of demand and sales affect fixed assets, which suddenly do not bring the same economic benefits as in the recent past. Inventories may be hard to sell, or only at a significant discount. Receivables from partners who suspended or ceased production are becoming irrecoverable. These and similar factors affect the value of assets in the financial statements, and therefore it is worth considering reporting a temporary impairment through provisions.
Many reporting entities are also facing difficulties with meeting loan covenants or even loan repayments; however, it seems that as per the government decisions, repayments will be postponed for some time.
If the situation is leading to (or has already led to) the need to suspend or reduce business activities, and therefore some employees will be made redundant, the reporting entity creates reserves for future expenses related to redundancy payments in the event of discontinued operations.
If the reporting entity does not use all the leased premises, it will consider creating a reserve for onerous contracts.
The most important assessment of the reporting entity concerns the continuation of the entity as a going concern in the foreseeable future. The assessment and comments on the impact of COVID-19 is a key part of the notes to the financial statements where in the part “Post Balance Sheet Events” the reporting entity is required to describe the concrete impacts, their assessment by the management and a conclusion regarding the going concern. The auditor will also thoroughly explore the impacts of COVID-19 on the reporting entity and the adequacy of the disclosed assumptions.
Recommendations of the Chamber of Auditors of the Czech Republic
Recently, the Chamber of Auditors of the Czech Republic (hereinafter the “Chamber”) has issued recommendations for dealing with the impacts of COVID on the financial statements for the year ended 31 December 2019. In the disclosed text, the Chamber states that when assessing the impact of COVID-19 on the financial statements, the date of the preparation of the statements (the balance sheet date) is of utmost importance.
When it comes to the financial statements for the year ended 31 December 2019, the current emergency situation, caused by the measures adopted in order to stop the spread of COVID-19, is generally understood as a non-adjusting event, which generally should have no influence on the valuation of the assets and liabilities reported in the financial statements (with the exception of a situation when as a result of a non‑adjusting event, the going concern assumption is not appropriate), because the current development does not provide any information on the situation existing as of 31 December 2019. This means that the reporting entity does not re-assess, for example, the amount of the provisions or reserves in relation to the changes in the business environment induced by COVID‑19.
The key question is the assessment of the influence of the subsequent events on the ability of the reporting entity to continue as a going concern in the foreseeable future (i.e. at least 12 months after the post balance sheet date). On 11 March 2020, the World Health Organisation declared a COVID‑19 pandemic and on 12 March 2020, the Czech government declared an emergency state.
The financial statements for the year ended 31 December 2019 prepared in the period between 1 January 2020 and 11 March 2020.
The influence of COVID‑19 will be assessed individually. The management of the reporting entity will assess whether the concrete impacts of COVID-19 represent an adjusting or a non-adjusting event. This assessment will differ depending on the sphere of business activity, the individual supplier-costumer relations, etc.
The financial statements for the year ended 31 December 2019 prepared in the period after 11 March 2020
The influence of COVID‑19 on the financial statements prepared in the period after 11 March 2020 will have to always be assessed as an adjusting event that can affect the reporting and valuation of assets and liabilities as of 31 December 2019. It will mainly influence the assessment of the impact on provisions against fixed assets, inventory, receivables and recognition of reserve, classification of long‑term and short‑term items.
In its recommendation, the Chamber states that the current situation is very changeable and that it is difficult for everyone involved to anticipate the future impacts not only on the local markets, but also on global business relationships. In practice, there can be many reasons why the existence of the reporting entity may be threatened, for example a long‑term halt in production or another business activity, lack of future cash resources to cover debts, failure to comply with the provisions of a loan contract or other type of contract, unavailability of supply of material and goods, collapse of supplier or customer markets, shortage of qualified staff, violation of contractual relations, impairment of assets or collapse of the sphere. All of these and many other aspects may considerably affect the overall financial and economic situation of the reporting entity. In addition, their influence can also significantly change at a very short notice.
Disclosing the Impact of COVID‑19 in the Notes to the Financial Statements
In spite of the complicated nature of the current situation, the management of the reporting entity is required to perform all of the above assessments and describe them in the notes to the financial statements in the part devoted to the subsequent events. Adjusting events have to be taken into account directly in the reporting or valuation of the affected assets or liabilities and this impact must be described in the respective part of the notes.
The recommendation of the Chamber gives examples of what to do when describing the subsequent events in relation to the going concern basis in these basic situations:
Should you need assistance with assessing the impacts of COVID‑19 in the financial statements, we will be glad to provide you with an expert consultation.
For the full text of the recommendation, see the website of the Chamber of Auditors of the Czech Republic.