Impact of COVID-19 on the Financial Reporting Ecosystem

financial reporting ecosystem - COVID-19 - Taxscan

The COVID-19 pandemic is affecting major economic and financial markets and almost all industries. The virus has hit not just people, but businesses and financial markets too – the extent of which is yet unstipulated. The financial reporting ecosystem is not spared either and the professional accountants are vying to understand better what the implications of Covid019 are on financial reporting. The pandemic is posing enormous challenges for preparers of the financial statements and for auditors too.

Globally, the health and safety of people are of precedence. But, supporting businesses and their employees is in many countries mandatory. Many governments have already come forward to provide both financial and non-financial assistance to disrupted sectors and majorly impacted organizations.

Today, transparency is paramount. There is a vital need for trustworthy information to reclaim trust in ambiguous times, and part of that will be delivered through financial reporting. While the impact on financial reporting may take a back seat when it comes to the consequence of the outbreak, there is an important and challenging role that accountants are undergoing while preparing these financial statements.

Considering the present scenario, the current accounting, and auditing standards will inexorably incur questions from the preparers. The existing audit and accounting requirements are still there, however, some regulators have provided restructured guidelines allowing relaxation of deadlines. Companies will also be on the lookout for additional regulatory updates and keep monitoring the existing and potential effects that the COVID-19 will have on their financial reporting.

Profits and Value

When preparing financial statements, businesses will need to assess a company’s ability to generate profit and create sustainable value. In the present settings, the management will need to deliberate the existing and expected effects of the outbreak on the undertakings in its account. It is possible that these tumultuous times can cast doubt on the company’s capability to operate in profit. In this case, the company should prepare the financial statements considering these uncertainties too. However, substantial judgment and constant updates to the analysis may be necessary given the progressing nature of the outbreak.

With traditional financial reporting activities providing an indication of only the financial value being created in the short term, there have been wider calls for some time to extend the breadth of reporting, to give a more holistic reflection of the true value-creation activities of organizations, and provide more transparency and insight on how these lead to sustaining this value creation.

Assessing Impairments

In addition to this, at the end of each reporting period, companies will be required to evaluate whether there is any impairment for non-financial assets. The adverse impact on companies caused by measures to stop the spread of the disease, such as brief closure of manufacturing plants or import/export restrictions, can be deliberated as an impairment indicator.

Now, when the companies are gauging impairment, they are required to calculate the recoverable amounts of the assets. This calculation requires an evaluation of probable future cash flows and prospects about disparities in cash flows. The predicted cash flows should echo the management’s best calculation of the economic conditions that will exist over the remaining useful life of the asset. The more the current environment is uncertain, the more important it is for the company to provide exhaustive disclosure of the assumptions taken, the evidence on which they are based, and the influence of a change in key assumptions.

Modifying Contracts

Changes in economic activity caused by the pandemic will cause many businesses to renegotiate the terms of existing contracts and arrangements. Organizations affected by the pandemic may experience cash flow challenges as a result of disrupted operations, higher operating costs, or lost revenues. They may need to get additional funding, modify the terms of debt agreements, or get waivers if they cannot fulfill the debt contracts. Here, they will need to contemplate whether these changes to existing contractual arrangements are a substantial modification or possibly a contract extinguishment.

This will impact lenders too. Financial institutions like banks and insurance companies are already being asked to help borrowers by relaxing cash-flow obligations. These will incur contract modifications and will entail institutions to think about the dimensions of their loan portfolio and estimated credit losses.

Fair Value Measurements

In addition to this, companies will be required to measure some of their assets and liabilities at fair value. This is a date-specific exit price approximation based on expectations that market players would make under current conditions. When making assessments and judgments for computing fair value, the company should consider the conditions and resultant assumptions that were known to the market players. The fair value measurement impact would depend on the evaluation of whether the harshness of the pandemic at the reporting date would have obstructed the players’ valuation assumptions at that time.

Clearly with staff absences and time needed for managing cash flow and other disruptions there may be problems with the ability of companies to prepare financial statements with all the internal controls in place. The performance of widespread impairment reviews will be an accounting resource issue for many companies. The impact of the virus outbreak will raise in many cases more areas of judgment for the accounting staff, audit committee and directors to deal with than previously.

 The pandemic will raise more queries to deal with for the accounting staff and audit committee than before. This is where the role of the finance professional as ‘value communicator’ comes to the fore. Professional accountants have an extraordinary opportunity to champion the adoption of wider reporting frameworks, that communicate the value created more fairly, how this value created is being protected, including the extent to which the organization’s business model is robust for the longer term.

Organizations must duly consider their unique circumstances and risk exposures when analyzing how recent events may affect their financial reporting. Specifically, financial reporting and related financial statement disclosures need to convey all material current or potential effects of the COVID-19 pandemic. Opportune and appropriate disclosures about the impending effect on the financial position, performance, and viability of the company, as well as measures taken to manage the risks, are important to sustain trust. Financial reporting remains an important tool in the communication between businesses and their stakeholders in this tempestuous time.

Md. Sajid Khan is a Head of International Development, Association of Chartered Certified Accountants (ACCA).