The Impact of COVID-19 on Financial Statement Disclosures
April 20, 2020
The novel coronavirus (COVID-19) was officially declared a public health emergency by the World Health Organization (WHO) on January 30, 2020. The result has been a dramatic shift in daily lives and in business operations, although the effects can vary across industries with some feeling its effects more deeply. As businesses settle into this new version of normal and uncertainty, the impact of this pandemic is beginning to unfold in financial results. As entities prepare to issue their 2019 or 2020 financial statements, here are two changes you may see in financial statement disclosures relating to the impact of COVID-19:
- Subsequent event – Subsequent events disclosures are for significant events after the date of the balance sheet and fall into two categories: recognized and non-recognized subsequent event. Based on the facts and circumstances that existed at calendar year-end, the majority of 2019 year-end financials will have a non-recognized subsequent event disclosure. Accounts, balances, or estimates are not adjusted for the impact of the non-recognized subsequent event, however, there would be an additional disclosure describing the nature of the events and an estimate of the financial impact (or a statement stating that such an estimate cannot be made at the time). The description of the events should be adequately tailored to the entity to describe the real impact of COVID-19. Likely areas of disclosure of the effects could include: reduced demand for goods or services, supply chain disruption, government related restrictions, or workforce reductions or changes.
- Going concern – Before the financials are issued, management is required to evaluate the entity’s ability to continue as a going concern for at least one year after the date the financials are issued. In other terms, management is required to determine if the entity will still be in business one year after the date the financials are issued. Some areas of likely consideration to include in management’s analysis are the same items discussed above for subsequent events, however, the financial impact should be estimated and measured. Have supply chain disruptions, reduced demand for goods and services, government restrictions, or workforce reductions and changes affected cash flows of the entity? Is the entity able to pay its debts as they become due? If management determines that substantial doubt exists, disclosure in the financial statements is required. Although the type of disclosures can vary depending on the severity.
Keep in mind that these changes are primarily for calendar year-end 2019 financial statements that have not yet been issued. For financial statements that have a fiscal year ending in 2020, the impact of COVID-19 will likely have a much bigger impact on financial results and figures. For 2020 financial statements, consider the impact on the following accounting areas and financial statement disclosures:
- Debt covenants and modifications – Due to COVID-19, entities may need to amend the terms of their debt arrangements or restructure agreements due to liquidity concerns or debt covenants requiring balances to remain above a certain amount for total assets, total liabilities, net income, cash flows, etc. Additionally, modifications may be made to access additional capital. Consideration should be made to whether a debt covenant waiver should be obtained from the lender, if possible violations exist. ASC 470, Debt, describes certain situations that may apply if the debtor has modified, extinguished, or agreed to a troubled-debt restructuring.
- Revenue recognition and receivables – Even though your entity may still be operating, it is likely that your customer base has been experiencing an impact of COVID-19 or financial difficulty. Under ASC Topic 606, Revenue from Contracts with Customers, which was effective for 2019 private company financial statements, revenue can only be recognized when it is probable that the entity will collect substantially all of the consideration to which it is entitled. In essence, if collectability of revenue is uncertain, an entity will only be able to recognize revenue that is probable of collection upon initial recognition of the contract. Estimates for the allowance for doubtful accounts, discounts, returns and refunds, will have to be carefully considered and updated to reflect present conditions.
- Risks and uncertainties – Additional disclosures regarding the use of estimates in the financial statements, the nature of the entity’s operations, or concentrations in the entity’s operations. Significant estimates may be impacted by business closures, decline in sales of goods and services, or supply chain interruptions. Concentrations make the entity more susceptible to loss or risk due to lack of diversification. Concentrations can exist due to suppliers, customers, products, etc. When it is possible that events will occur to negatively affect these concentrations, consider a disclosure to help inform the user of the potential area of risk or uncertainty.
These are just a few of the more prominent changes affecting upcoming financial statements and disclosures. As the year progresses and as the full effects of COVID-19’s impact on business operations become more well-known, there may be other areas of the financial statements and disclosures affected including but not limited to: fair value estimates, investments and investment balances, goodwill and intangible assets including testing for impairment, leases and lease modifications, inventory, and deferred tax assets. In these unique situations, it remains important to adequately inform the users of the financial statements about the effects, the possible effects, and the unknown effects of COVID-19 on the financial statements.