The economic impact of the COVID-19 pandemic will likely continue for some time causing uncertainty and volatility in financial markets, disruptions to supplies and distribution chains as well as directly affecting cash flows for many businesses. The pervasive impact of this pandemic also creates accounting and disclosure implications in financial statements for the year ended December 31, 2019 and beyond as we continue to battle the spread of the virus and its aftermath.
Since COVID-19 was not considered a pandemic until early 2020, the effects of the COVID-19 outbreak should not be considered in impairment of financial and non-financial assets when reporting on years ending on or before December 31, 2019. Forecasts, projections, and valuations for impairment calculations at December 31, 2019 should not incorporate COVID-19 outbreak issues in hindsight. However, if these estimates are expected to change significantly due to the factors brought on by COVID-19 subsequent to year end, additional disclosures should be considered.
For periods ending after December 31, 3019, the effects of COVID-19 should be considered in evaluating asset impairment. Intangible and tangible assets, goodwill, realizability of deferred tax assets, inventory, right-of-use assets, contract assets (allowance for doubtful accounts) and capitalized contract costs may be affected.
COVID-19 could impact the lower of cost or net realizable value of inventory. Companies whose supply chains have been disrupted, or whose sales have fallen because of the outbreak should evaluate whether they need to adjust the carrying value of their inventory. Unplanned work stoppages, labor or material shortages, or production bottlenecks could cause production levels to drop below normal capacity levels. If this happens, a company will need to consider the effects on its inventory costing.
The amount of revenue recognized, and the pattern of revenue recognition may be impacted by COVID-19. Variable consideration estimates might be impacted by updated analysis of the impact of discounts, refunds, price concessions, performance bonuses and penalties.
Companies may have a decline in cash inflows, and as such, may seek additional financing, revise repayment terms and interest rates of existing debt agreements, or request waivers if they no longer satisfy debt covenants. Such revisions may have an impact on the classification and measurement of financial liabilities presented on the balance sheet.
Companies that have business disruption insurance may be entitled to a certain amount of insurance proceeds to cover some or all costs. In addition, there may be government grants/incentives available to help support businesses. Accounting for any potential insurance recovery needs to be carefully evaluated. Anticipated reimbursements for business interruption (e.g., lost revenue) are considered a gain contingency and are subject to the guidance in ASC 450-30. This guidance requires that all contingencies must be resolved before such a reimbursement can be recognized in earnings. The contingencies would be considered resolved only if the proceeds have been received or if confirmation of the amount of the proceeds has been received from the insurer.
Equity Method Investments
Equity method investments (including investments in joint ventures) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment might not be recoverable in accordance with ASC 323, Investments — Equity Method and Joint Ventures. Companies should consider whether there are any changes in circumstances that might require an impairment assessment for equity method investments. If there has been a significant decline in the value of an investee, an investor would need to exercise judgment to determine whether the decline is other than temporary. An impairment loss is recognized for a loss in value of an investment that is other than a temporary decline. An investor also should consider whether its investment might be impaired when an investee recognizes an impairment loss and the investor recognizes a portion of that loss through its application of the equity method.
The pandemic may trigger an increase in subsequent event disclosures, for example, subsequent to year end entities may enter into contract modifications, new lending agreements, received capital contributions, experience shutdowns of operations, or incur substantial losses on financial assets measured at fair value. In addition, the financial impacts of the pandemic may cause covenant violations on debt agreements or other arrangements that may require disclosure. For example, a company may determine that due to the incurrence of losses because of a decrease in business subsequent to year end, it has violated a covenant.
ASC 205-40, Presentation of Financial Statements — Going Concern, requires management to evaluate an entity’s ability to continue as a going concern within one year after the date the financial statements are issued (or available to be issued, when applicable). Disclosures in the notes to the financial statements are required if management concludes that substantial doubt exists or that its plans alleviate that substantial doubt. Affected companies will need to consider the effects of the outbreak in their going concern evaluations. For example, prolonged plant closures or significant delays or the inability to collect from counter-parties whose businesses are severely affected by the outbreak may significantly affect a company’s operating cash flow and liquidity. Accordingly, management may need to update the cash flow projections it uses in its going concern evaluation.
ASC 450 requires disclosure of the nature of a contingency when there is at least a reasonable possibility that a loss has been incurred. For contingencies that meet the threshold for disclosure, but no liability has been recognized, companies must disclose an estimate of the possible loss or the range of possible losses or state that such an estimate cannot be made. If a company has recognized a liability, it has to disclose the amount only if not doing so would make the financial statements misleading. If there is at least a reasonable possibility that a loss in excess of the amount recognized exists, the company is required to disclose an estimate of the possible loss or range of losses or state that such an estimate cannot be made.
Certain types of concentrations may be more relevant to the financial statement due to the impacts of the pandemic. For example, these may include concentrations in labor, financial assets, sources of supply, or customers that have been or will be impacted by the pandemic. If your Company invests in assets or industries that are affected by COVID-19 it might be necessary to disclose the risk and uncertainty related to the volatility to which the Company may be exposed. Companies may also have customers that have more credit risk if they operate in one of the harder hit industries.
Many organizations have had to suspend parts of their operations because of the health protection measures enacted internally or by state and federal governments. Disclosures may be required or recommended if companies have or expect to shut down operations.
Use of Estimates
The impact of the pandemic may result in a reasonable possibility that estimates will change by a material amount in the near term. Changes in the condition, situation or circumstances that were used to develop the estimates that existed at the date of the finical statements should be included in the financial statement disclosures. The evaluation of the changes that should be disclosed is based on the conditions that exist when the financial statements are issued or available for issuance.
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