2020/21 Reporting Season: questions and consequences
Six business questions and their accounting consequences.
1. What lines of business are currently not viable?
A particularly challenging question for the 2020/2021 Reporting Season is whether lines of business remain viable under current circumstances. That assessment may have been deferred while conditions were uncertain, but events can move quickly when decisions do have to be made about viability. Businesses may have locations, products or lines of business that they conclude no longer have a future.
While continued uncertainty makes forecasting the future particularly difficult, many businesses will have been more actively managing cash flows during the pandemic. At the heart of good financial management is a close understanding of the drivers and timing of cash flows into and out of the business. That means identifying the levers the business has for controlling cash flows and who has influence over them. Robust information about cash flows can help support forecasting.
Having this information to hand could also help with key tasks necessary for the annual accounts. Directors will need to assess whether the business is a going concern and assets may need to be reviewed for impairment. Having robust cash flow information to hand could help with that exercise and may mean surprises can be avoided.
Understand cash flows and be ready to use them in going concern and impairment reviews
A strong understanding of the drivers of cash coming into and going out of the business can help produce more robust cash flow forecasts. This information will be valuable when it comes to completing going concern assessments and any asset impairment reviews that may be necessary.
- COVID-19 and going concern – Guidance for directors of SME businesses
- UK GAAP: Going concern considerations – a guide for FRS 102 preparers
- UK GAAP: Going concern considerations – a guide for FRS 105 preparers
- COVID-19 and impairment of assets
- IFRS: Applying IAS 36 Impairment of assets
- UK GAAP: FRS 102 Impairment of assets
Understand any refinancing, ownership changes or balance sheet restructuring
COVID-related stress or Brexit preparations may have led to changes in ownership or control. New sources of finance or breaches of trigger points in financing agreements may lead to different terms and conditions. Assets may have been sold or refinanced or new liabilities assumed. These factors could have implications for recognition or classification of assets or liabilities on the balance sheet, and for disclosures. The company may have grown or contracted.
Requirements applying to different sizes of company
- IFRS: IFRS 9 – Financial instruments
- IFRS: Debt for equity swaps
- UK GAAP: Financial instruments
- UK GAAP: Debt for equity swaps
Identify discontinued operations and assets held for sale
Special accounting requirements apply to assets held for sale. Operations that are identified as ‘discontinued’ require separate classification and special disclosures. Decisions to withdraw from lines of business or ownership changes in the group may result in operations being discontinued and/or in assets being identified for sale.
Reflect in operating segments
An increased risk of viability issues in individual lines of business mean that segmental disclosures will be particularly relevant this year. That may lead to increased scrutiny of the process for identifying segments and of allocation between segments. Increased granularity of management information due to the crisis or restructuring may result in changes to segments.
2. What government financial support has been received?
In 2020, Governments have created a range of financial support measures for businesses including loans, tax relief and cash grants. Businesses may have accessed financial support to pay wages or sustain operations through the crisis.
While many businesses will have clear visibility about the support accessed and the conditions that apply to it, it quickly becomes more complicated. Conditions for some schemes have changed over time. Understanding whether scheme rules have been complied with, and making decisions about disclosures, may therefore require records of what was accessed when. In larger businesses or group situations, multiple individuals may have been involved in receiving support; information about this will need to be collated, in good time before reporting and audit.
ICAEW has created a range of specialist resources to help members with the accounting, classification and disclosure of government financial support, repayment terms including loan interest, compliance conditions or expectations, e.g. dividend or bonus restrictions and risk of fraud and breach of conditions:
Identify, classify and disclosure government assistance received
With a range of different support that may have been received keeping track of the schemes may be a challenge. Benefits received may be spread between different ledger codes and may not be individually visible in accounting records. This information may therefore need to be tracked separately and assembled from across a group. It will be needed for required disclosures and to ensure benefits are classified appropriately in the accounts.
- At a glance: identifying government financial support taken
- Accounting for coronavirus government support schemes (bitesize briefing)
- IFRS: Government grants and disclosure of government assistance
- UK GAAP: General accounting for government grants
- UK GAAP: Accounting for coronavirus government support schemes under FRS 102
- UK GAAP: Accounting for coronavirus government support schemes under FRS 105
Understand repayment terms
Understanding the terms that apply to government-backed loan schemes, and how they may have changed over time, is important to ensure that appropriate disclosures can be given and borrowing classified appropriately as current or non-current. For schemes where interest and/or fees are subsidised by the government, businesses may need to identify a comparable commercial rate of interest so they can assess the value of the benefit received.
- COVID Corporate Financing Facility (CCFF)
- Coronavirus Large Business Interruption Loan Scheme (CLBILS)
- Coronavirus Business Interruption Loan Scheme (CBILS)
- Bounce Back Loan Scheme (BBLS)
- Future Fund
Comply with conditions or deal with expectations, e.g. dividend or bonus restrictions
With several different schemes available and with conditions potentially changing over time, appropriate controls are important to ensuring that scheme terms have not been breached. This may require collating information and seeking representations from across a group. Scheme terms may restrict dividend payments or remuneration.
Consider risk of fraud and breach of conditions
The pandemic has increased both opportunities and incentives for fraud, with government support schemes being a point of risk. ICAEW’s code of ethics sets out how professional accountants should respond if they encounter non-compliance with laws or regulations (referred to as NOCLAR).
- Code of ethics: non-compliance with laws and regulation
- Accountants face up to exceptional challenges (interview)
- Accountants must be wary of COVID-support fraud (interview)
For further guidance for preparers of financial statements on the coronavirus outbreak, visit the financial reporting hub and for more information on the government financial support schemes visit the coronavirus hub.
- Key considerations when preparing 2020 IFRS and UK GAAP accounts (factsheets)
- How to improve disclosures when preparing accounts
3. What assets are being used less?
Many businesses will have assets that have been used less than expected during the pandemic. Examples include properties, vehicles, plant and equipment. Inventories may not have been drawn down. As a result, some assets may be obsolete or their value to the business may be reduced. Equally, ‘moth-balled’ assets might now last longer than previously expected as wear and tear or other consequences of use have been less.
Closures may have provided the opportunity for overhaul or refurbishment or lines of business may have been terminated or wound down, leaving unneeded assets. Equally, in the future the business may need less capacity in certain assets – for example aeroplanes. Businesses may have assessed their asset portfolios to determine whether capital allocation needs to be adjusted. Equally, other businesses may not yet have revised assumptions and may find they have impairments to recognise when they do so.
Consider impact on depreciation and useful lives
Assets that have not been used during the pandemic might now have a longer remaining service life. Some assets may have been overhauled or enhanced during the period of lockdown. Equally some assets may not have been serviced to schedule, potentially reducing their service life or resale value. The residual value and useful life of property, plant and equipment is expected to be reviewed at least each year-end and the current circumstances mean that previous estimates may need to be revisited.
- IFRS: Property, plant and equipment (IAS 16)
- UK GAAP: Property, plant and equipment under UK GAAP (FRS 102)
Consider assets being held at valuation
Businesses may have property, plant or equipment that they have opted to hold at revaluation rather than cost. COVID-19 may pose difficulties in this case. Revaluations are expected to be carried out regularly, so that the carrying amount of the asset doesn’t differ materially from its fair value. However, assessing fair values might be difficult under current conditions and values may be depressed.
Assess whether there is asset impairment
Under both UK and international financial reporting standards, the principle exists that assets should be stated at no more than their recoverable amount in an entity’s balance sheet; the recoverable amount is the higher of the amount that the entity could generate from either using or selling the asset. Businesses must consider at each reporting date whether indicators exist which might suggest assets’ carrying value exceeds their recoverable amount. When such indicators exist, an impairment review must be carried out and the assets’ recoverable amount calculated.
Typical impairment indicators include elements of a business being closed, reduced demand for products, customers facing financial difficulty and supply chain issues. Market capitalisation being below the carrying amount of the net assets of an entity is a further indicator specifically referred to in financial reporting standards that might be relevant for listed entities.
Assessing impairment may not always be possible at the level of an individual asset. Measuring ‘value in use’ requires cash flows from the asset to be assessed and many assets do not generate cash flows by themselves. Consequently, both IFRS and UK GAAP allow assets to be grouped together to be assessed as a single ‘cash generating unit’.
An important aspect to consider is whether COVID-19 is an adjusting or non-adjusting post balance sheet event for the business, as impairment reviews must be based on conditions that existed at the reporting date This in itself is a complex area of judgement for some and is an area on which the ICAEW Financial Reporting Faculty has published guidance (see below).
Applying accounting requirements on impairment of assets in times of such uncertainty will only add to the challenge. ICAEW has created a range of specialist resources to help members with considering the impact on depreciation and useful lives, assets being held at valuation, impairment assessments and inventory obsolescence and valuation.
- COVID-19 and impairment of assets (bitesize briefing)
- Applying IAS 36, Impairment of assets (factsheet)
- Applying FRS 102, Impairment of assets (factsheet)
ICAEW is also running a series of interviews on the 2020/21 Reporting Season:
Consider inventory obsolescence and valuation
The impairment requirements also apply to inventory. Businesses may be holding inventory that is now life expired or no longer needed in the business.
- UK GAAP: Accounting for inventories (FRS 102)
For further guidance for preparers of financial statements on the COVID-19 outbreak, visit the financial reporting hub.
4. Which contract obligations might you not honour?
With COVID-19 disrupting operations in many ways, businesses may not be performing under their contracts or may be seeking to vary or exit from them. At the same time, contract obligations might have become onerous – rather than providing beneficial access to something necessary to the business, contracts may tie businesses to continuing to pay for capacity they no longer need.
Moreover, under normal circumstances businesses might expect legal action to follow from any breach of contract. In the current situation many businesses may find that they have contracts they have not complied with, either due to voluntary decisions or because they have not been able to comply. There may be disagreements with customers or other parties. Some disputes may end in legal action. Equally, the implications of state sanctioned closures and the widespread impact of lockdown may mean some contracts are renegotiated or voluntarily set aside. Situations may not be clear-cut or outcomes still uncertain.
This situation will be a challenge for accounting, as assets and liabilities are synonymous with contractual rights and obligations. Where a business is unable or unwilling to perform under a contract, assets may no longer exist or might be impaired.
For example, some businesses may have contracts that have previously been considered profitable (or break-even) and may now be considered onerous e.g. operating leases for aircraft, restaurants or retail space. Some businesses may have leases where there have been COVID-19 related rent concessions. Some may have or will be reviewing their scale of operations and workforce.
ICAEW has created a range of specialist resources to help members with considering the accounting for revenue recognition under customer contracts, leases and supplier contracts, financial instruments and contingent liabilities:
- UK GAAP: Accounting for provisions and contingencies (FRS 102)
- UK GAAP: Accounting considerations and requirements for redundancy payments (FRS 102)
ICAEW is also running a series of interviews on the 2020/21 Reporting Season:
Consider revenue recognition under customer contracts
Businesses may have recognised contract assets for work performed to date, subject to revenue recognition rules. However, there may be contracts that the business is no longer going to complete or where profitability is affected by the pandemic.
- Accounting and auditing revenue under COVID-19 (webcast)
- Contract modifications (webcast)
- IFRS: Accounting for revenue (IFRS 15)
- UK GAAP: Accounting for revenue (FRS 102)
Review leases and supplier contracts
The business may have leased assets that it is no longer using, or it may be paying a different amount of rent. Property tenants in closed industries may not have been making contractual rent payments. The IASB has issued a modification to IFRS 16 Leases to take account of COVID-19 related rent concessions.
- IFRS: Accounting for the application of IFRS 16 leases for COVID-19 related rent concessions
- IFRS: Accounting for leases with COVID-19 related rent concessions (IFRS 16)
Review financial instruments
Financing may have been re-negotiated with lenders or payments may have been restructured, with consequential implications for financial contracts. Businesses may have breached financial covenants or triggers in contracts.
- IFRS: Accounting for financial instruments under IFRS 9 (webcast, financial services)
- UK GAAP: Accounting for financial instruments (FRS 102)
Consider recoverability of debtors
If a business has stopped performing under a contract or there is the prospect of it doing so, questions may arise about whether any outstanding receivables associated with that contract can be recovered in full. Equally some customers might be in financial difficulty and unable to pay invoices when they fall due.
5. What contract rights might you not enforce?
Equally there may be contractual rights that a business has chosen not to enforce, perhaps voluntarily to preserve a relationship or because prospects of recovery are poor. In some cases, businesses may have delayed enforcement while they waited to see what happens or because options were restricted by legislation. A business may have assets it no longer expects to recover in full.
Similar assets are affected to question 4 above dealing with contract obligations. The resources linked in the section above are therefore also relevant here. For example, some businesses may be considering how to recognise revenue under customer contracts, implications for leased assets and financial instruments as well as the recoverability of debtors.
6. Why do the accounts matter?
In normal circumstances the preparation of annual accounts might sometimes be viewed as a largely mechanical exercise, which is not expected to have any specific implications. Preparers and auditors of annual accounts may have little or no contact with the individuals using this information. This year may be different. The business may find it has breached borrowing covenants or that it will be relying on financial information to secure additional financing or reassure customers about solvency. There may be little headroom to pay dividends or meet remuneration targets – the accounts may therefore be under greater scrutiny.
Preparing the annual accounts provides an opportunity to communicate with finance providers, customers and rating agencies. Equally, the calculation of realised profits and incentive scheme targets is linked to preparation of the annual accounts.
ICAEW has created a range of specialist resources to help understand why accounts matters, how to improve accounting disclosures, reporting of key ratios and alternative performance measures, and a summary of the various laws that directors need to consider in determining whether they can lawfully, or ought to, pay a dividend.
- Do financial statements matter?
- Who does what in the financial reporting system
- UK GAAP: How to improve disclosures when preparing accounts (FRS 102)
Consider key ratios and alternative performance measures
KPIs might be particularly close to threshold levels this year and may therefore merit additional scrutiny. Similarly, assessing alternative performance measures may require more difficult judgment. Some assumptions previously used may no longer hold true.
Consider bank covenants
Bank covenants include metrics calculated from the financial statements. Publication of the annual accounts may crystallise a covenant breach with related consequences. Businesses should ensure that they’re aware of covenants across the business, how they’re calculated, and any sensitivities.
Consider credit ratings and access to credit
Credit ratings are based on financial performance and position. The publication of annual accounts will typically cause the credit worthiness of the business to be reassessed and downgrades or upgrades may follow. The criteria that ratings agencies use is published online, and rated businesses will wish to familiarise themselves with these.
Consider regulatory licences
Regulated businesses may have prudential requirements to meet – for example regulatory capital for banks or ABTA licences for travel agents. Businesses with a defined benefit pension scheme will have a pensions levy to pay. Some businesses may have their revenue regulated and the pandemic may have implications for this.
Understand dividend capacity
Directors should consider whether they should pay dividends as these can only be paid from realised profits. This is an accounting measure, based on the annual accounts. Dividend capacity could therefore depend on preparation of the annual accounts.
Be aware of remuneration
Incentive schemes may rely on the accounts. Employees may review performance reported in the accounts when reviewing their own bonus expectations.
- ICAEW library: Directors' remuneration
ICAEW is also running a series of interviews on the 2020/21 Reporting Season:
- Impact of COVID-19 on narrative reporting (interview)
- FRC sets out 20/21 company reporting expectations (interview)
- Opportunities for the development of investor information despite the uncertainty (interview)
ICAEW members, affiliates, students and staff in eligible firms with member firm access can also access core accounting and tax content provided by Bloomsbury and can also discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or e-mail email@example.com
The ICAEW Financial Reporting Faculty has created a wealth of financial reporting help including a general guide for preparers, a summary of reflections for financial reporting and Brexit, and specialist factsheets on topics such as impairment of assets, pointers on going concern considerations, improving disclosures or other general financial reporting resources.
The Faculty has created three checklists highlighting the key factors to consider when planning and preparing accounts in the light of COVID-19. They suggest that careful consideration will need to be given to the deferral of filing deadlines, the recoverability of assets, conditions that existed at and post the balance sheet date, the measurement and classification of liabilities, treatments for the various government grants/loans and directors’ going concern assessments:
IFAC has also issued a summary of COVID-19 financial reporting considerations and in the UK, the Financial Reporting Council (FRC) has also issued guidance on a range of implications. To find further help visit the external resources section of the financial reporting hub.
The Financial Reporting Faculty is constantly reviewing the need for guidance to help members focus on what is important and achieve consistency of accounting practice given COVID-19. We would love to hear about financial reporting issues you are facing that we may not have yet covered. If you have insight and ideas for guidance or policy input to standard setters and regulators, please let us know by emailing the Financial Reporting Faculty.