Impact of Corona Virus Disease on Financial Reporting

Coronavirus (COVID-19) Impact on Financial Reporting: Accounting Year Ending March 31, 2020

COVID-19 has not only affected the health of people across the globe and it has also caused severe disturbances in the global economic environment which has a consequential impact on financial statements and reporting. While we are empathetic to the global concerns of health and safety of people, there is also a need to advise the preparers of financial statements to ensure that the potential impact of COVID-19 is suitably considered in preparing and reporting their financial statements for the year ended March 31, 2020.

Please note that this advisory is applicable for:-

• Entities to whom Ind AS is applicable and
• Entities to whom AS is applicable
• Companies to whom Companies, Accounting Standards Rules, 2006 is
  applicable and
• Non-corporate entities to whom AS issued by ICAI is applicable.

1. Inventory Measurement (Ind AS 2 and AS 2)

• In accordance with Ind AS 2, Inventories, and AS 2, Valuation of Inventories, it might be necessary to write down inventories to net realisable value due to reduced movement in inventory, declining in selling price, or inventory obsolescence due to lower than expected sales.
• The management may consider the written down of inventories to net realisable value item by item.
• Ind AS 2 and AS 2 also provide that the allocation of fixed production overheads to the costs of conversion is based on the normal production capacity. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognized as an expense in the period in which they are incurred.
• Entities should assess the significance of any write-downs and whether they require disclosure in accordance with Ind AS 2/AS 2 as well as paragraph 98 (a) of Ind AS 1, Presentation of Financial Statements, and paragraph 14(a) of AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.
• The normal production capacity is to be reviewed for allocating fixed production overheads for the year 2019-2020, because of adverse impact on the utilization of the production capacity due to the impact of coronavirus on the overall economy or the segment (s) in which the entity is operating.

2. Impairment of Non-Financial Assets (Ind AS 36 and AS 28)

• Ind AS 36, Impairment of Assets, and AS 28, Impairment of Assets, requires an entity to assess, at the end of each reporting period, whether there is any indication that non-financial assets may be impaired.
• Due to COVID 19, there might be the temporary ceasing of operations or an immediate decline in demand or prices resulting in a lowering of revenues and profitability and reduced economic activity. These are the factors that the management may consider as the indicators that may require impairment testing for the purpose of Ind AS 36 and AS 28.
• The management needs to consider whether:
• the contraction in economic activity due to the outbreak of COVID 19 is considered to be an impairment indicator at the reporting date, which results
  in an impairment assessment;
• assumptions used for impairment testing and to determine the recoverable amounts before the outbreak of COVID 19 requires any change
• the assumptions used to determine the discount rate to measure the recoverable amount require any adjustments
• the forecasts or budgets for future cash flows prepared by management should be updated to reflect the impact of COVID 19;
• market assumptions used to determine fair value for recoverable amounts needs reconsideration;
• reasonable assumptions are taken in estimating the value-in-use and fair value less costs of disposal and ensure that the impairment loss, if any, is estimated reliably.

3. Financial Instruments

Entities to whom Ind As is Applicable:-

• Financial Instruments within the scope of Ind AS 109 such as Loans, Trade Receivables, Other Receivables, Investment in Debt instruments, Financial Guarantees and Loan Commitments not measured at fair value through profit or loss, Contract Assets and Lease Receivables are subject to impairment loss recognition and measurement based on an approach called Expected Credit Loss (ECL).
• The widespread contraction in economic activity across the globe due to the rapid spread of COVID-19 is likely to have an impact on the quantification of ECL and classification of financial assets into 3 buckets for recognition and measurement of impairment losses. In this context, the following are important factors to be considered by the preparers.
• Recognition of 12 months ECL versus Lifetime ECL is based on the segregation of credit exposures into 3 buckets viz. Stage 1- those with no significant increase in credit risk, Stage -2 those with a significant increase in credit risk and Stage 3-
  Credit impaired. In the case of certain financial assets such as Trade Receivables
  where the simplified approach is applicable, this segregation of credit exposures into 3 buckets is not required.
• Measurement of ECL- Adverse impact on the business of borrowers or debtors may impact the following credit risk parameters:
• Risk of default (probability of default) i.e. the likelihood of default by the borrower may have increased significantly due to reduced economic activity;
• The estimated amount of the loss itself in the event of default (loss given default). The contraction in economic activity and its impact on consumers may have affected the value of collaterals and business cash flows adversely affecting the expected amount of loss;
• In this period of substantial business dislocation, borrowers may tend to fully utilise undrawn limits and loan commitments, which in turn would impact another credit risk parameter i.e. exposure at default.

• Entities may also need to consider the impact of any Prudential Regulatory actions to sustain the economy such as loan repayment holidays, reduction in interest rates etc.
• In respect of Ind AS 107, Financial Instruments Disclosures, entities may need to disclose the impact of COVID-19 on various credit-related aspects such as methods, assumptions, and information used in estimating ECL, policies, and procedures for valuing collaterals, etc.
• If the entity is unable to assess the impact of COVID-19 in estimating the impairment loss due to the inadequacy of information, the same should be disclosed appropriately.

• Non-Banking Financial Companies (NBFCs) and Asset Reconstruction Companies (ARCs) should also carefully consider the recent guidance provided by Reserve Bank of India (RBI) on the implementation of Ind AS (RBI/2019-20/170 DOR (NBFC).CC.PD.No.109/22.10.106/2019-20  Implementation of Indian Accounting Standards).

Entities to whom AS is Applicable:-

• In case of financial assets such as Loans, Trade Receivables, etc., entities shall be guided by the requirements of AS 4, Contingencies and Events Occurring After the Balance Sheet Date.
• In respect of financial assets within the scope of AS 13, Accounting for Investments, entities may have to carefully consider the requirements of making provisions for the decline in the value of investments, which is other than temporary.
• In respect of Banks and Insurance Entities, preparers need to consider the impact of COVID-19 on the classification of Loans and Advances into Standard, Substandard, Doubtful and Loss categories in addition to the Prudential Regulatory requirements of RBI and The Insurance Regulatory and Development Authority of India (IRDAI).

4. Fair Value Measurement:-

Entities to whom Ind As is Applicable:-

• Ind AS 113 recognises the fact that there are different ways in which fair value is determined i.e. it can be based on observable market price (quoted price in an active market – Level 1) or application of valuation techniques (Level 2 and Level 3) as of the reporting date.
• The current financial and capital market environment across the globe has got affected by the rapid spread of COVID-19 and may have developed the following features:-
• Significant volatility or indications of the significant decline in market prices of financial instruments like equity, bonds, and derivatives.
• Significant decrease in volume or level of activity.

• Preparers using valuation techniques may have to consider the impact of COVID-19 on various assumptions including discount rates, credit-spread/counter-party credit risk, etc.

Entities to whom AS is Applicable:-

•  In respect of financial assets within the scope of AS 13, entities have to carefully consider the impact of COVID-19 on the determination of fair value for the valuation of investments classified as Current Investments.

5. Leases :-

Entities to whom Ind As is Applicable (Ind As- 116):-

• Due to COVID-19, there may be changes in the terms of lease arrangements or lessor may give some concession to the lessee with respect to lease payments, rent-free holidays, etc. Such revised terms or concessions shall be considered while accounting for leases, which may lead to the application of accounting relating to the modification of leases. However, anticipated revisions should not be taken into account.
• Variable lease payments may be significantly impacted, especially those linked to revenues from the use of underlying asses due to contracted business activity.
• The discount rate used to determine the present value of new lease liabilities may need to incorporate any risk associated with COVID-19.
• If any compensation is given/declared by the Government to the lessor for providing concession to the lessee, it should be considered whether the same needs to be accounted for as lease modification as per Ind AS 116 or whether assistance received from Government is to be accounted as government grants under Ind AS 20.
• Entities will need to determine whether as a result of COVID -19, any lease arrangement has become onerous.

Entities to whom AS is Applicable (AS 19, AS 29):-

• Due to COVID-19 there can be changes in the terms of lease arrangements or lessor may give some concession to the lessee with regard to lease payments. Such revised terms or concessions shall be considered while accounting for leases. However, anticipated revision should not be taken into account.
• Discount rate used to determine the present value of minimum lease payments of new leases may need to incorporate any risk associated with COVID-19.
•  If any compensation is given/declared by the Government to the lessor for providing concession to the lessee, it should be considered whether the same needs to be accounted for appropriately as per AS 19. Whether any assistance received from the government is government grants under AS 12.
• Entities will need to determine whether as a result of COVID -19, any lease arrangement has become onerous. The same should be accounted for as per AS 29.

6. REVENUE :-

• Due to COVID-19, there could be a likely increase in sales returns, a decrease in volume discounts, higher price discounts, etc. Under Ind AS 115, these factors need to be considered in estimating the amount of revenue to recognised, i.e., measurement of variable consideration.
• Ind AS 115 also requires disclosure of information that allows users to understand the nature, amount, timing and uncertainty of cash flows arising from revenue.
• Therefore, entities may have to consider disclosure about the impact of COVID-19 on entities revenue.
• Entities to whom AS is applicable may have postponed recognition of revenue due to significant uncertainty of collection in view of the impact of COVID-19. AS 9, Revenue Recognition requires entities to disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties. 

7. Provisions, Contingent Liabilities, and Contingent Assets:-

Entities to whom Ind As is Applicable:-

• As a result of COVID -19, some contracts may become onerous for reasons such as an increase in the cost of material/labour, etc. Management should consider whether any of its contracts have become onerous. The same should be accounted for as per Ind AS 37.
• Ind AS 37 also requires assets dedicated to a contract to be tested for impairment before liability for an onerous contract is recognised.
• Additionally, there could be losses from the imposition of penalty due to delay in supply of goods, which may need to be considered under the guidance of Ind AS 115, Revenue from Contracts with Customers.
• If the management is unable to assess whether some of the executory contracts are onerous due to inadequacy of information, the same should be disclosed
• Management should disclose that it has assessed whether executory contracts are onerous due to the adverse impact of COVID -19. If, the management is unable to assess whether some of the executory contracts have become onerous due to the inadequacy of information, the same should be disclosed.
• Entities may have insurance policies that cover loss of profits due to business disruptions due to events like COVID-19. Entities claims on insurance companies can be recognised in accordance with Ind AS 37 only if the recovery is virtually certain i.e. the insurance entities have accepted the claims and the insurance entity will meet its obligations
• Due to COVID-19, there is a need for exercising judgment in making provisions for losses and claims. A provision may be accounted for only to the extent that there is a present obligation for which the outflow of economic benefits is probable and can be reliably estimated.
• Ind AS 37 does not permit provisions for future operating costs or future business recovery costs. However, Ind AS 37 requires that an entity should disclose the nature of the obligation and the expected timing of the outflow of economic benefits.

Entities to whom AS is Applicable:-[AS 29 Provisions, Contingent Liabilities & Contingent Assets]

•  As a result of COVID -19, some contracts may become onerous for reasons such as the imposition of penalty due to delay in supply of goods or an increase in the cost of material, labour, etc.
• Management should consider whether any of its contracts have become onerous. The same should be accounted for as per AS 29.
• Management should disclose that it has assessed whether executory contracts are onerous due to the adverse impact of COVID -19. If, the management is unable to assess whether some of the executory contracts have become onerous due to the inadequacy of information, the same should be disclosed.

8. Modifications or Termination of Contracts or Arrangements

It may also be noted that the entities may modify or terminate certain contracts which may be within the scope of other Ind ASs or ASs or Guidance notes highlighted below. Entities are advised to consider the specific requirements of these standards and guidance notes to account for these modifications or terminations.

Entities to Whom Ind AS is applicable	Entities to Whom AS is applicable
Ind AS 19, Employee Benefits	AS 15 Employee benefits (revised 2005)
Ind AS 109, Financial Instruments and Ind AS 32, Financial Instruments - Presentation	Guidance Note on Accounting for Derivative Contracts (Issued 2015)
Ind AS 104, Insurance Contracts For insurance companies this is routine; events like earthquake, huge floods, war situations, etc
Ind AS 115, Revenue from Contracts with Customers	AS 7 Construction Contracts (revised 2002) AS 9 Revenue Recognition) Guidance Note on Accounting for Real Estate Transactions (revised 2012)

9. Going Concern Assessment:-

• Management of the entity should assess the impact of COVID-19 and the measures taken on its ability to continue as a going concern.
• The impact of COVID-19 after the reporting date should also be considered and if, management after the reporting date either intends to liquidate the entity or to cease trading, or has.
• No realistic alternative but to do so, the financial statements should not be prepared on a going concern basis. Necessary disclosures as per Ind AS 1 shall also be made, such as material uncertainties that might cast significant doubt upon an entity's ability to continue as a going concern.

10. Income Taxes:-

Entities to whom Ind As is Applicable:-

•  COVID-19 could affect future profits and/or may also reduce the amount of deferred tax liabilities and/or create additional deductible temporary differences due to various factors (e.g., asset impairment).
• Entities with deferred tax assets should reassess forecasted profits and the recoverability of deferred tax assets in accordance with Ind AS 12, Income Taxes, considering the additional uncertainty arising from the COVID-19 and the steps being taken by the management to control it.
• Management might also consider whether the impact of the COVID-19 affects its plans to distribute profits from subsidiaries and whether it needs to reconsider the recognition of any deferred tax liability in connection with undistributed profits.

Entities to whom AS is Applicable: AS 22 Accounting for Taxes on Income

• COVID-19 could affect future profits and/or may also reduce the amount of deferred tax liabilities and/or create additional timing differences due to various factors.
• Entities with deferred tax assets should reassess forecast profits and the recoverability of deferred tax assets in accordance with AS 22, Accounting for Taxes on Income, considering the additional uncertainty arising from the COVID-19 and the steps being taken by the management to control it.

11. Consolidated Financial Statements

• Ind AS 110 prescribes that the financial statements of parent and subsidiaries used in the preparation of the consolidated financial statements are usually drawn upto the same date. It may be noted that in any case, the difference between the reporting dates should not be more than three months. 
• AS 21 prescribes that the financial statements of parent and subsidiaries used in preparation of the consolidated financial statements are usually drawn up to the same date. It may be noted that in any case, the difference between the reporting dates should not be more than six months.

12. Property Plant and Equipment (PPE)

• Ind AS 16 and AS 10 require that useful life and residual life of PPE needs revision in annual basis. Due to COVID-19, PPE can remain under-utilised or not utilised for a period of time. It may be noted that the standards require depreciation charge even if the PPE remains idle. Further, COVID-19 impact may have affected the expected useful life and residual life of PPE.
• The management may review the residual value and the useful life of an asset due to COVID 19 and, if expectations differ from previous estimates, it is appropriate to account for the change(s) as an accounting estimate in accordance with Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors and AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. 

13. Post Balance Events (Ind AS 10 and AS 4) :

• Entities must disclose significant recognition and measurement uncertainties that might have been created by the outbreak of the COVID -19 in measuring various assets and liabilities.
• They should also disclose how they have dealt with the impact of COVID -19 on the financial position and financial performance of the entity.

[This Article is Compiled on the basis of Advisory issued by the ICAI on Financial Reporting. We have simply summarised it and all credit of this article goes to the ICAI only]

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[Disclaimer:-This article is being furnished for informational purposes only. We make every effort to use reliable & comprehensive information, but we do not represent that the contents of the article are accurate or complete.]