How the Coronavirus May Affect Financial Reporting
The coronavirus (COVID-19) outbreak, which the World Health Organization declared a pandemic on March 11, has prompted global health concerns. The financial markets and numerous sectors of the economy are suffering, and the long-term economic and business consequences are unknown. COVID-19 may affect your business and its financial statements for 2019 and 2020.
The duration and full effects of the COVID-19 outbreak are yet unknown, but the financial impacts are becoming evident. When preparing financial statements, consider whether this outbreak will have a material effect on your company’s:
- Supply chain, including potential effects on inventory and inventory valuation,
- Revenue recognition, especially if your contracts include variable consideration,
- Fair value measurements in a time of high market volatility,
- Financial assets, potential impairments and hedging strategies,
- Measurement of goodwill and other intangible assets (including those held by subsidiaries) in areas affected severely by COVID-19,
- Measurement and funded status of pension and other postretirement plans,
- Tax strategies and consideration of valuation allowances on deferred tax assets, and
- Liquidity and cash flow risks.
You will need to monitor your customers’ credit standing even more. A decline may affect a customer’s ability to pay its outstanding balance, and, in turn, require you to reevaluate the adequacy of your allowance for bad debts. Also, depreciation for an idled facility should still be recognized.
Then, consider how these items could impact loan covenants. If loan covenants are expected to be violated in 2020, a waiver is needed for the 2019 financial statement.
Disclosure requirements and best practices
Under U.S. Generally Accepted Accounting Principles (GAAP), companies must differentiate between two types of subsequent events (events occurring after the balance sheet date):
- Recognized subsequent events (Type I). These events provide additional evidence about conditions, such as bankruptcy or pending litigation, that existed at the balance sheet date. The effects of these events generally need to be recorded directly in the financial statements.
- Nonrecognized subsequent events (Type II). These provide evidence about conditions, such as a natural disaster, that didn’t exist at the balance sheet. Rather, they arose after that date but before the financial statements are issued (or available to be issued). Such events should be disclosed in the footnotes to prevent the financial statements from being misleading. Disclosures should include the nature of the event and an estimate of its financial effect (or disclosure that such an estimate can’t be made).
For 2019 financial statements, any COVID-19 related subsequent events are likely to be nonrecognized subsequent events (Type II).
Consider whether other disclosures are complete in the financial statements:
- Concentrations – labor, vendors or industries that create a larger impact
- Operations – were operations suspended by the government or voluntarily
- Estimates – are more difficult to determine and assumptions may have to change
Financial statements prepared under a special purpose framework (such as tax or cash-basis) are also required to include these disclosures.
Auditor and Accountant Reporting – Emphasis of Matter
An auditor, or accountant for compilations and reviews, may conclude that an event, such as COVID-19, has such a material impact on the entity that is would be appropriate to include an emphasis of matter paragraph in the auditor/accountant’s report and refer to the related footnote disclosure.
The consequences of COVID-19 may impact factors and cause a deterioration in an entity’s operating results and financial position. Accordingly, entities and their auditors/accountants my need to consider recent information related to their assessment of going concern.
There are many unknowns about the spread and severity of the COVID-19 outbreak. We can help navigate this potential crisis and evaluate its effects on your financial statements. Contact your M+N advisor or use this online form for the latest developments.