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Checklist: implications of COVID-19 for the preparation of micro-entity accounts (FRS 105)

The coronavirus pandemic is having a major impact on businesses but the extent to which this affects the numbers in the financial statements will depend on the particular facts and circumstances of the entity. In this guide the Financial Reporting Faculty provides a checklist of some of the factors to consider when preparing your (or your client’s) accounts. This checklist is aimed at micro-entities preparing accounts in accordance with FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime.

This ICAEW Know-How guide was created by the Financial Reporting Faculty.

What are the conditions that existed at the balance sheet date?

The balance sheet must reflect the assets, liabilities and equity as at the end of the reporting period ie, as at the balance sheet date (FRS 105.4.1). For information that comes to light after the balance sheet date, but before the financial statements are authorised for issue, the entity will need to consider the extent to which such information should be reflected in the accounts (FRS 105.26.2).

Information which comes to light after the balance sheet date that provides evidence of conditions that existed at the balance sheet date should be reflected in amounts recognised in the accounts (see FRS 105.26.4 – adjusting events after the end of the reporting period). Information indicative of conditions that arose after the balance sheet date do not affect the measurement of amounts at the balance sheet date (see FRS 105.26.6 – non-adjusting events after the end of the reporting period), unless the business has ceased to be a going concern (see below). 

In a continually evolving situation, establishing what is adjusting and what is non-adjusting will involve a significant amount of judgement. 

More guidance is available in the faculty’s guide How to distinguish adjusting from non-adjusting post balance sheet events and the webinar recording 2020/21 Reporting: going concern and impairment

The considerations that follow below, other than going concern which is pervasive, relate to year or period ends that end in 2020.

Is the business a going concern?

An entity is a going concern unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When assessing whether the going concern basis of accounting is appropriate, the management must take into account all of the available information about the future which is at least, but not limited to, 12 months from the date when the financial statements are authorised for issue (FRS 105.3.3). The impact of COVID-19 must therefore be reflected in the going concern assessment for all accounts not yet authorised for issue.

More guidance is available in the faculty’s guide Coronavirus: Going concern considerations – a guide for FRS 105 preparers and the webinar recording 2020/21 Reporting: going concern and impairment.

ICAEW and ICAS have jointly published a guide aimed primarily at owners and directors of small and medium-sized business, to explain the importance of the going concern assessment and factors to consider when making this assessment COVID-19 and going concern – Guidance for Directors of SME Businesses.

To what extent are intangible and tangible assets impaired?

Whereas the assessment of going concern takes account of events and conditions that existed after the end of the reporting period, when assessing the recoverability of intangible and tangible assets (for example goodwill and/or property, plant and equipment), this assessment must be based on conditions and impairment indicators that existed at the balance sheet date.

COVID-19 means that many businesses are not able to operate as normal. This, combined with the negative impact on the economy more generally, are likely to be indicators of impairment to the extent these conditions existed at the balance sheet date. In such circumstances, the entity will need to assess the recoverable amounts of the assets affected (FRS 105.22.6). The implications for stock are considered separately below.

The recoverable amount of an asset is the higher of its fair value less cost to sell and its value in use (FRS 105.22.9). Value in use is the estimated future cash inflows and outflows expected to be derived from the asset, discounted to reflect the time value of money and the risks specific to the asset (FRS 105.22.14 and FRS 105.22.18).

When it is not possible to estimate the recoverable amount of an individual asset (for example, because the asset does not generate cash flows by itself), the micro-entity will need to estimate the recoverable amount of the cash generating unit to which the asset belongs in accordance with FRS 102 Section 27 Impairment of Assets (FRS 105.22.3).

For more information on testing cash generating units for impairment read the faculty’s factsheet FRS 102 Impairment of assets.

Any impairment loss will be recognised in profit or loss under the heading ‘Depreciation and other amounts written off assets’.

Note that even when assets are not considered to be impaired, residual values and useful economic lives may still require reassessment (FRS 105.22.8).

Watch the Bitesize Briefing  COVID-19 and impairment of assets and the webinar recording 2020/21 Reporting: going concern and impairment.

Will stock be sold for at least its carrying value

Stock (or inventories to use the FRS 105 term) must be measured at the lower of cost and estimated selling price less costs to complete and sell (FRS 105.10.3). Stock will need to be written down when the estimated selling price less costs to complete and sell is less than its carrying value (FRS 105.10.18) based on the conditions which existed at the balance sheet date. This will be particularly relevant when stocks have a short shelf life or when there is likely to be a long-term reduction in demand for the product. There may also be higher input costs and delivery charges affecting the estimated costs to complete and sell.

Is there evidence that debtors are not recoverable?

When there is evidence that debtors  are not recoverable as at the balance sheet date they must be written down immediately (FRS 105.9.18), for example there is evidence of significant financial difficulty of the debtor and/or a failure to pay debts when due. Adverse market or economic conditions can also be evidence of impairment. If debts have been renegotiated, reclassification or remeasurement may be required to reflect the new contract terms.

Have any existing contracts become onerous?

Some contracts that may have previously been considered profitable (or break-even) may now be considered onerous ie, when the unavoidable costs over the remainder of the contract exceed the expected benefits.  Examples might include operating leases for office space, restaurants or retail space. A provision will be required for any present obligation at the balance sheet date (FRS 105.16.13 and Example 2 in the Appendix to Section 16). Note that a provision for future operating losses is not permitted (FRS 105.16.14).

Are there any restructuring plans?

Many businesses will be reviewing their operations, for example reducing staffing levels, mothballing certain activities or selling some of the company’s assets. A restructuring provision must be recognised only to the extent that there is a constructive obligation at the balance sheet date ie, a detailed plan has been announced by the balance sheet date and there is a valid expectation that the restructuring will go ahead (FRS 105.16.15), as well as meeting the general recognition requirements for provisions (FRS 105.16.5).

Will any losses be covered by insurance policies?

Insurance recoveries should be recognised only when virtually certain (FRS 105.16.18). 

Have bank and other loans been renegotiated? Have covenants been breached?

Bank and other loans may require reclassification or remeasurement if terms have been breached or renegotiated at the balance sheet date eg, transfer from non-current to current liabilities or recalculation of implicit rates of interest.

Have contracts with employees been modified or terminated?

If contracts have been modified or terminated this may have implications for the amount recognised as employment costs. It may also have an impact on, for example, accrued bonus payments, pension liabilities and share-based payments. There may be additional holiday pay accruals for employees who have been permitted to carry forward statutory annual leave not taken due to COVID-19. 

What has been received by way of government assistance?

The government has introduced a range of initiatives to help businesses including the Coronavirus Job Retention Scheme, business rates holidays, grants for certain sectors and government-backed loan arrangements. Government grants may not be recognised until there is reasonable assurance that the entity will (a) comply with the conditions attaching to them and (b) the grants will be received (FRS 105.19.3). Grants related to revenue (as opposed to assets), for example the Coronavirus Job Retention Scheme, are recognised over the same period as the costs to which they relate (FRS 105.19.7). The grant receivable is presented as part of profit or loss, under a general heading such as ‘other income’.

More information is available in the Technical Advisory Service helpsheet Accounting for coronavirus government support schemes under FRS 105.

COVID-19-related rent concessions 

When rent concessions have been granted as a direct consequence of COVID-19, recent amendments to FRS 102 require a lessee (or lessor) to recognise any change in the operating lease payments (or income) on a systematic basis over the periods that the change is intended to compensate (subject to certain conditions). 
 
For more information on COVID-19-related rent concessions:

Are there implications for tax payable?

Some tax liabilities may have been deferred so their classification between current or non-current may need to be reconsidered.

What needs to be disclosed?

FRS 105 requires very limited disclosures and, provided these and other basic legal requirements are complied with, the accounts are presumed by law to give a true and fair view.

That is not to say that a micro-entity cannot choose to disclose additional information, including for example, in relation to post balance sheet events, any significant uncertainties that cast significant doubt upon the entity’s ability to continue as a going concern, or when the going concern basis of accounting has not been applied. However, if it does choose to include additional information, over and above that required by FRS 105 and the law, it must refer to the relevant requirements of Section 1A Small Entities of FRS 102 regarding that information (FRS 105.1.3). 

In these times of significant uncertainty it is likely to be useful to the users of the accounts to be transparent about risks faced and the assumptions used, and making disclosures which are as specific to the business as possible. 

Dividends and other distributions

Directors will need to consider whether they can lawfully pay dividends (eg under rules on distributable profits and capital maintenance) and, if they can, whether they ought to do so (eg taking into account possible reputational issues, particularly when the company has benefited from substantial government assistance). The law is complex. More information is available in the Introduction to the Law on Dividends.

Anything else?

This checklist is not intended to cover all eventualities, only areas likely to be of common concern. Each entity will need to consider its business, the transactions and contracts it has entered into, the environment in which it operates and what might be considered material to its users when determining the impact of COVID-19 on the financial statements.

Related resources

The hub includes:

ICAEW Financial Reporting Faculty’s is recognised internationally as a leading authority on financial reporting matters. The faculty is responsible for making submissions to standard setters and other external bodies on behalf of ICAEW, and provides extensive practical guidance to its members. Further resources can be found at icaew.com/financialreporting.

ICAEW members, affiliates or members of staff in an eligible firm with member firm access may also discuss their specific situation with the Technical Advisory Service (TAS). A limited telephone helpline is currently available (details here) but TAS can also be contacted on live web chat here or by email to technicalenquiries@icaew.com