Worldwide efforts to stop the spread of the coronavirus pandemic (COVID-19) have substantially affected the global financial markets, the international economy at the macro level, and the underlying businesses and organizations at the micro level. While things are advancing quickly, and there are still a lot of unknowns, the disruption and uncertainty caused by the COVID-19 pandemic is extensive (production and supply chain disruptions, loss of major customers, closures of locations, employee lay-offs, furloughs and work restrictions, decrease in the consumer spending, among others). These events will result in distinctive considerations in financial reporting that should be continuously and robustly assessed by entities and their financial statement users.
Why is it important?
The weakening in economic conditions related to COVID-19 and its likely effect on the operating results of entities could be seen as early as the first quarter of 2020. Therefore, entities should understand the financial reporting impact of the COVID-19 pandemic in their financial statements. In particular, business disruptions, losses of customers, closures, etc. may indicate a change in circumstances that could affect an entity’s future cash flow projections and other assumptions utilized when assessing if an asset may be impaired.
For reporting periods ending on or around December 31, 2019, Accounting Standards Codification Topic 855, Subsequent Events generally requires accounting for certain items, such as potential asset impairments that result from the development and spread of the pandemic, as Type 2/non-recognized events given that negative changes in business and economic conditions did not substantially develop or progress until, earliest, January 2020. However, for reporting periods ending after this date, entities should evaluate the impact that COVID-19 has on their operating and financial results used in asset impairment considerations based on the following timeline:
The adverse impact on entities caused by measures to stop the spread of the disease, such as temporary manufacturing plants or location closures, supply chain disruptions, travel and import/export restrictions, can all potentially be considered indicators of an impairment, depending on the type of asset. Furthermore, financial projections and key assumptions adversely affected by COVID-19, such as losses of major contracts and customers, could also be indicators of an impairment.
Determination of the valuation and future realization of assets is one of the more complex accounting issues entities may face as a result of COVID-19. Accounting standards provide for several impairment models depending on the nature of asset being assessed and there are distinctive accounting requirements. Some of the more common types of assets that entities should consider for impairment assessments are:
- Financing receivables (including accounts receivable and loans receivable),
- Inventory, goodwill and other intangible assets
- Property, plant, and equipment
- Investments in equity and debt securities (without readily determinable fair values),
- Equity method investments
- Deferred taxes.
Potential impairment triggers for the following assets:
- COVID-19 has already had a pervasive impact at both the macro and micro economic levels globally. Entities’ operations and the extent of the impact are both directly and indirectly affected and can vary widely based on several factor (i.e. industry, location, customer and supplier base, and the duration of the outbreak which remains uncertain) and may trigger the need for entities to evaluate the recoverability of its assets.
- The impact of the pandemic on present market conditions will create accounting and reporting implications and challenges for many entities particularly on the recoverability or realizability of many types of assets. In addition, entities should be aware of the various models that may need to be applied and the triggering events requiring impairment assessments of tangible, intangible, and financial assets as well as the resulting impact on income tax accounting.
- When assessing impairment, it is essential that entities determine the recoverable amounts of the assets by estimating expected future cash flows and expectations about variations in cash flows. The cash flow projections should reflect the entities’ best estimate of the macro and micro conditions that affect the industry and the entity specifically and that will be expected to exist over the remaining useful life of the asset.
- In determining the amount of impairment, entities may depend on fair value measurements. The purpose of a fair value measurement is to determine the price at which an orderly transaction would take place between market participants under the market conditions that existed at the measurement date. Given that the COVID-19 impact remains largely unknown, causes significant market volatility, and continues to evolve, entities should be cautious in applying the appropriate models and assumptions used in their fair value measurements.