Covid-19’s impact on financial reporting – Going concern

in Industry Insights, 27.03.2020

Assessment of going concern in light of coronavirus

As promised in our earlier post, we’ll now explore Covid-19’s impacts on financial reporting – more specifically, management’s responsibility to assess its entity’s ability to continue as a going concern.

Assessments of whether the going concern assumption is appropriate consider events and conditions after the end of the reporting period. Due to significant events and changes in conditions since 31 December 2019, entities using the calendar year for fiscal purposes will need to reflect the impacts of these events and conditions in the going concern assessment.

Factors to consider in the going concern assessment

The impacts of current events and conditions on the going concern assessment will vary considerably from sector to sector. Entities in highly exposed sectors that are experiencing declining demand, falling sales and margin pressures – particularly travel, tourism, hospitality, entertainment, sports, retail and oil – will feel the impacts more significantly than others. Over time, impacts on the automotive sector, for example, may increase if consumers defer large purchases until the uncertainty recedes.

It will be critical to understand what impacts current events and conditions have on an entity’s operations and forecasted cash flows. The key, immediate question is whether an entity still maintains sufficient liquidity to continue meeting its obligations on time. Relevant considerations will also include whether:

  • an entity has sufficient cash and unused credit lines/borrowing facilities to meet short-term needs,
  • further management actions are needed to enable the entity to generate sufficient cash flow to meet its obligations when they fall due. Such actions could include:
      • negotiating with lenders to restructure and/or increase borrowing facilities,
      • restructuring operations to reduce operating costs,
      • deferring capital expenditures,
      • seeking financial support from shareholders,
      • accessing national and/or local government programs designed to support businesses.

In many cases, the budgets and forecasts initially used to support management’s going concern assessment may now be of limited relevance given rapidly changing economic and business circumstances and may require significant revision to reflect the current environment.

Management’s assessments may need to include:

  • updated forecasts and sensitivities as considered appropriate, taking into account risk factors identified and different possible outcomes;
  • a review of projected covenant compliance in different scenarios;
  • to management’s plans for future actions;
  • expanded disclosures.

If management identifies events or conditions that cast significant doubt on the entity’s ability to continue as a going concern, it will likely develop new action plan steps:

  • refinance or restructure existing debt facilities (including loans, leases and other payables) and obtain new sources of financing;
  • renegotiate financial covenants and/or seek waivers if there is a risk of non-compliance with covenants in loan agreements;
  • protect revenue, cut costs and manage working capital balances to generate sufficient operating cash flows to meet obligations as they fall due;
  • manage liquidity by deferring capital expenditures, dividends and other distributions; seeking financial support from shareholders; taking advantage of government assistance and making claims under business interruption insurance policies;
  • restructure operations to respond to supply chain and logistical disruptions and any significant changes in demand.

Management will assess whether the events or conditions, individually or collectively, cast significant doubt on the entity’s ability to continue as a going concern or, in severe cases, whether the going concern assumption is still appropriate as a basis for the preparation of the entity’s financial statements.

Does the company have a going concern issue?

Management may conclude that the consequences of the coronavirus outbreak have weakened operating results and/or financial position after the reporting date so severely that the going concern basis of preparation is no longer appropriate. In this case, the financial statements as at 31 December 2019 would need to be adjusted.

An entity requires disclosures if it identifies events and conditions that cast significant doubt on its ability to continue as a going concern and if these events constitute material uncertainties or management’s conclusion involved significant judgement, i.e. a “close call” scenario. Given the significance and widespread impact of Covid-19, particularly for entities in highly exposed sectors, now regulators are more likely to consider these types of disclosures necessary than they have in prior reporting periods.

Additional information

We expect that the additional information that accompanies financial statements (e.g. a management or activity report) will include further discussion on the risks associated with the outbreak and volatility in the oil markets. Management needs to consider whether the explanation of events used to clarify the impact on the entity complies with local regulatory requirements while aligning with regulator and user expectations.

You can find part one of this series here.

You can find part two of this series here.

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