On March 11, 2020, the World Health Organization declared a pandemic related to the COVID-19 outbreak. As entities continue to monitor the impact of COVID-19 on public health and overall commerce, they should also consider the financial reporting implications as a result of the outbreak. The significant disruptions to business activities precipitated by the COVID-19 outbreak have raised the prospect of a more widespread economic downturn. As a result, entities need to consider the effects of business disruptions on their operations.
The implications can be far-reaching and may affect all aspects of an entity’s business activities. Examples may include (not all-inclusive):
- Customers: Changes in demand, changes in pricing due to lower demand, requests for refunds, and increases in credit risk from payment delays or customer defaults
- Suppliers: Supply chain disruptions, including shortages of raw materials and components, significant risks associated with resourcing goods from nonaffected areas, and delays from cancelled passenger and cargo shipments and border closures
- Manufacturing & service delivery: Expected delays in goods production or service delivery, plant or office closures, delays or loss of business due to travel restrictions, and increased fulfillment costs
- People: Staffing shortages due to staff unable to work or quarantines, and increases in compensation costs and benefits
- Financial markets: Exposure to financial markets, including losses on investments and effects of potential limitations on liquidity, and effects of changes in commodity prices
Financial reporting implications
The initial reports about the effects of the COVID-19 outbreak in China began in late December 2019. The cascading effects of travel restrictions, plant closures, and business restrictions began in early January 2020 and have accelerated globally since then, with the most significant effects felt in the United States beginning in early March 2020. Given this timeline, the impact on financial reporting will depend on the reporting period of the financial statements.
The impact on financial reporting will depend on the reporting period of the financial statements.
2019 calendar year-end reporting entities
The main drivers of the impact on domestic businesses (resulting from the travel restrictions, plant closures and business restrictions) began in January 2020 for most entities. In this situation, calendar year-end entities will generally consider the impacts of COVID-19 as subsequent events.
Under U.S. GAAP, there are two types of subsequent events:
- Recognized subsequent events — Events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (commonly referred to as Type I subsequent events).
- Nonrecognized subsequent events — Events that provide evidence about conditions that didn’t exist at the date of the balance sheet but arose subsequent to that date (commonly referred to as Type II subsequent events).
Based on the timeline above, most calendar year-end entities will likely determine that the impact of the COVID-19 outbreak qualifies as a nonrecognized subsequent event and would be reflected in the financial statements for the period beginning Jan. 1, 2020. However, entities should consider the need to make subsequent event disclosures to help a financial statement user understand the anticipated impact of COVID-19 as of the date the financial statements are available to be issued. While conditions are continually changing, entities should disclose the most current information known as of the date the financial statements are issued or available to be issued.
Risks and uncertainties
Entities should also consider the need to disclose the known impacts of COVID-19 as part of their required disclosures on risks and uncertainties. U.S. GAAP requires disclosures about risks and uncertainties, including (1) significant estimates that could be subject to change; and (2) vulnerabilities due to concentrations, such as customers or suppliers, markets or geographic areas, and labor supply. Disclosure is required when there could be a “near-term significant impact” from these items; this threshold may be met in many situations as a result of the outbreak.
When determining balances reported in the financial statements, U.S. GAAP requires consideration of circumstances and events as of the balance sheet date, which includes the effects of recognized subsequent events, as described earlier. However, when evaluating potential going concern doubts, entities are required to consider all information that could have a bearing on the entity’s ability to meet its obligations as they come due within one year after the date the financial statements are issued. This not only includes information that’s known (or knowable) at the date the financial statements are available to be issued, but also require consideration of events that could occur even after the financial statements are issued. This means entities that have not yet issued their Dec. 31, 2019 financial statements need to consider the impact of COVID-19 when completing their going concern assessment.
Entities that have not yet issued their Dec. 31, 2019 financial statements need to consider the impact of COVID-19 when completing their going concern assessment.
For example, if the adverse effects of the COVID-19 outbreak and changing market conditions make it probable that a loan covenant violation will occur subsequent to the date the financial statements are available to be issued, and if the violation would affect the entity’s ability to pay its obligations as they come due, substantial doubt about the entity’s ability to continue as a going concern may exist. Consideration would then be given to management’s plans intended to mitigate these effects, including whether it’s probable the plans will be effectively implemented, and whether it’s probable the plans would be effective in mitigating the substantial doubt.
Fiscal year-end reporting entities and 2020 interim reporting
Entities with fiscal year-ends and entities that have interim reporting requirements for periods ending after Dec. 31, 2019 will have different implications resulting from the COVID-19 outbreak. Some of the more common considerations include the items below (not all-inclusive).
Asset impairments is one of the common accounting issues entities may face as a result of the COVID-19 outbreak. U.S. GAAP requires different impairment models depending on the type of asset being evaluated. Below are some of the more common types of assets that may require evaluation for impairment, including references to the U.S. GAAP guidance (not all-inclusive):
- Financing receivables (including accounts receivable & loans receivable) – ASC 310, Receivables or ASC 326 Financial Instruments – Credit Losses (if adopted)
- Marketable equity securities (without a readily determinable fair value) – ASC 321, Investments – Equity Securities
- Debt securities – ASC 320, Investments – Debt and Equity Securities or ASC 326, Financial Instruments – Credit Losses (if adopted)
- Equity method investments – ASC 323, Investments – Equity Method and Joint Ventures
- Inventory – ASC 330, Inventory
- Goodwill & other intangible assets – ASC 350, Intangibles – Goodwill and Other
- Property, plant, & equipment – ASC 360, Property, Plant, and Equipment
- Deferred taxes – ASC 740, Income Taxes
With respect to long-lived assets such as property, plant, and equipment and goodwill and other intangible assets, it’s often uncommon for calendar year-end entities to have impairment indicators in the first quarter, given the short time frame between the issuance of the annual financial statements and the first quarterly financial statements. However, in situations such as these where significant events arise during the first quarter, there can be impairment indicators that require impairment tests in the interim period.
Like calendar year-end reporting, entities with fiscal year-ends or with interim reporting requirements are required to consider events that are known or knowable as of the date the financial statements are available to be issued when performing going concern assessments. Given how quickly the situation is changing, entities will need to have processes in place to account for changes in the overall economy and how those changes may impact the entity’s future performance.
Business disruption insurance
Some entities may attempt to file claims for business disruption under relevant provisions in insurance contracts. Whether the policy will cover claims is a matter of legal interpretation, and entities should work with their legal counsel to determine if the impacts of COVID-19 would be covered. From a financial reporting perspective, recoveries are recognized in the financial statements to the extent of losses previously recognized once an entity concludes that an insurance recovery is probable. Any recoveries beyond losses previously recognized in the financial statements are gain contingencies and cannot be recognized until realized. Appropriately interpreting the concept of “losses recognized in the financial statements” is critical to determining when an insurance recovery can be recorded. For example, a claim for lost revenues doesn’t represent a loss recognized in the financial statements and any related recovery under this claim would be a gain contingency.
Other COVID-19 resources
- AICPA Coronavirus Resource Center
- SEC Coronavirus (COVID-19) Response Page
- Journal of Accountancy - How the coronavirus may affect financial reporting and auditing