Ramifications from the COVID-19 virus will likely continue from some time. The March 11 announcement that the novel coronavirus is officially a global pandemic triggered market reactions, additional health and safety precautions, and for the accounting world, the need for some additional financial reporting considerations. Below are some of the ways the COVID-19 virus affects financial statements.
The name of the novel coronavirus — coronavirus disease 2019 — suggests the COVID-19 virus might affect 2019 financial statements. Given that most of the financial ramifications have come in 2020, however, financial reporting prior to Dec. 31, 2019 will likely not be affected. Entities with fiscal year ends or quarterly reporting should anticipate some adjustments to reporting for the first quarter of 2020.
The announcement that the COVID-19 virus is a global pandemic officially marks it as a Type II subsequent event, meaning that it is not recognized in Dec. 31, 2019 financial statements, even if those financial statements have not yet been issued or made available for issuance. However, this does not mean that the impact of the pandemic can be ignored when preparing financial statements. The following are issues that may need to be addressed before year end financial statements are completed.
The evaluation of an entity’s ability to continue as a going concern is completed when the financial statements are issued or available for issuance. Therefore, the unrest could affect the going concern evaluation. The impact that the pandemic has already had should be included in the analysis. If you are an industry hard hit by the COVID-19 virus repercussions, you may experience more difficulty meeting your existing liabilities or covenant requirements. Additionally, expectations of the ongoing effect of the pandemic should be incorporated into the analysis. When conditions or events exist that raise substantial doubt about your entity’s ability to continue as a going concern, the significant amount of uncertainty may make it difficult for management to support that:
- It is probable that management’s plans will be effectively implemented; and
- That it is probable they will mitigate the conditions that raised substantial doubt about the entities ability to continue as a going concern.
Financial Statement Disclosures
The impact of the pandemic may cause certain disclosures to be more relevant to the financial statement users or may cause the need for subsequent event disclosures. Consider whether the following disclosures are complete in the financial statements:
Certain types of concentrations may be more relevant to the financial statement due to the impacts of the pandemic. For example, these may include concentrations in labor, financial assets, sources of supply, or customers that have been or will be impacted by the pandemic. If you hold investments in assets or industries affected by the COVID-19 virus (such as travel or oil), you may be required to make risk and uncertainty disclosures about the market volatility to which your organization may be exposed. You may also find your customers have more credit risk if they operate in one of the harder hit industries.
Many organizations have had to suspend parts of their operations because of the health protection measures enacted by state and federal governments. If you expect that your operations will be shutdown, be prepared to disclose those associated operational risks in your financial reporting.
Use of Estimates
The impact of the pandemic may result in a reasonably possibility that estimates will change by a material amount in the near term. Disclosure of changes in the condition, situation or circumstances that were used to develop the estimates that existed at the date of the finical statements should be included in the disclosures. The evaluation of the changes that should be disclosed is based on the conditions that exist when the financial statements are issued or available for issuance.
The pandemic may trigger an increase in subsequent event disclosures, for example, subsequent to year end entities may enter into contract modifications, new lending agreements, received capital contributions, experience shut downs of operations, or incur substantial losses on financial assets measured at fair value. In addition, the financial impacts of the pandemic may cause covenant violations on debt agreements or other arrangements that may require disclosure. For example, an entity may determine that due to the incurrence of losses because of a decrease in business subsequent to year end, it has violated its monthly debt coverage ratio financial covenant or the lender may have triggered a subjective acceleration (i.e. material adverse change) clause.
Examples of Disclosures
The following are some examples of some subsequent event disclosures that could be used to describe the general financial reporting impact for your organization:
On March 11, 2020, the World Health Organization declared the outbreak of a coronavirus (COVID-19) a pandemic. As a result, economic uncertainties have arisen which are likely to negatively impact net income. Other financial impact could occur though such potential impact is unknown at this time.
On March 11, 2020, the World Health Organization declared the outbreak of a coronavirus (COVID-19) a pandemic. The COVID-19 outbreak in the United States has resulted in reduced customer traffic and the temporary reduction of operating hours for our stores as well as temporary store closures where government mandated. At the current time, we are unable to quantify the potential effects of this pandemic on our future financial statements.
Potential Accounting Impacts
The nature of the pandemic and the related effects on the global economy can affect a variety of accounting estimates and computations. The following are some of the potential impacts to the financial statements that may need to be considered for inclusion in the disclosures discussed above for the Dec. 31, 2019 financial statements, and may need consideration when accounting for transactions in 2020:
Organizations might find they have changes to their impairment considerations for intangible and tangible assets due to the COVID-19 virus related disruptions. Goodwill, long-lived, realizability of deferred tax assets, inventory, right-of-use assets, contract assets and capitalized contract costs may be affected by your organization’s future performance expectations.
If your organization has adopted the changes to credit loss impairment, you may need to be looking at your accounting for certain financial instruments. The evaluation of the future expected economic conditions under the Current Expected Credit Loss (CECL) model might be affected by the current state of the financial markets. Entities still operating on the incurred loss model for credit loss impairment may need to re-evaluate the appropriate allowance for credit losses that have been incurred.
Companies that use inventory cost accounting, particularly organizations that operate in the manufacturing sector, may need to reevaluate their fixed asset overhead allocations. Mandatory plant shutdowns might prevent your organization from meeting its normal production levels or it may result in an excess of inventory because your organization cannot distribute its product on a normal schedule.
Some of your variable consideration metrics may be affected by the COVID-19 virus response. For example, if your contract contains bonuses based on time of completion, the likelihood that you will meet your bonus may change based on the extent your work is affected by the governmental health protection measures (quarantines, travel restrictions, etc.). Customer behavior may also change, which could affect the accounting you have in place for returns, rebates, and other similar type of estimates.
Collectability estimates may be affected to the extent your customers experience significant work stoppage or business disruptions. Depending on the extent a customer is affected, you may need to re-evaluate Step 1 of the ASC Topic 606 revenue recognition method.
The financial market disruption will have an impact on funded pension plans, and organizations with investment portfolios, including not-for-profit organizations with endowment funds. Changes in the value of the investments in your portfolio or plan may trigger contractual provisions, such as the requirement for additional contributions, or covenants.
Be prepared for significant changes in plan value for investments as well. If the financial markets do not stabilize in the near-term, the disruption could even change plan zone status due to the drop in market value.
Significant declines in the fair value of investments after year end may require a subsequent event disclosure be included in the financial statements.
Work with Your Provider
Your accounting provider can help you understand the ramifications of the COVID-19 virus on your financial statements and reporting. For more information, please contact us.