It has been six months since the first case of COVID-19 was reported in New Zealand, and it seems that the country could continue to move in and out of various alert levels for the foreseeable future. The ongoing uncertainty will leave very few businesses unaffected by this brutal black swan. Some will suffer severe consequences, some will benefit, and for others, it will be business as usual.
Regardless of the financial implications for your organisation – good, bad, ugly or in-between – you will need to identify the areas in your financial statements that have been or will be affected to determine the disclosures that you need to include; many of these disclosures will focus on sources of estimation uncertainty and/or areas of significant judgement.
Over the last six months, our team of specialists has advised a broad range of Kiwi companies about a huge variety of financial reporting considerations affecting their businesses. While not an exhaustive list, this article outlines some of the more common considerations as well as those we will most likely continue to see going forward.
Going concern: can your business continue to operate?
Financial statements are prepared on the basis your business will continue to operate as a going concern - an assumption that’s rarely challenged annually. Our new normal means more businesses will need to challenge this assumption in their financial statements, or at least disclose that this assumption remains valid in today’s uncertain environment.
NZ IAS 1 contains guidance about the going concern assumption; it explicitly states that at each reporting date, management is required to assess the entity’s ability to continue as a going concern and consider all available information about the future (at least twelve months from the annual reporting approval date). A wide range of factors need to be analysed including:
- current and expected profitability
- debt repayment schedules
- potential sources of replacement financing
- the ability to continue providing services.
If management concludes that the entity may be liquidated either by choice or because it has no realistic alternative but to do so, the going concern assumption is not appropriate and the financial statements may have to be prepared on another basis, ie, using liquidation values. If there is material uncertainty about your business’s ability to continue as a going concern, you should include additional going concern disclosure in the notes to your financial statements.
Impairment: carrying value of assets
This needs to be considered for most assets that are not measured at fair value. For New Zealand businesses, this will generally include fixed assets, owned property, inventory, trade receivables and intangible assets such as goodwill.
A business is required to test its assets when indicators of impairment are present. A mandatory impairment test for goodwill and assets with indefinite useful lives must be also performed at least annually. Although some indicators of impairment are based on internal information (eg, damage to property, plant and equipment, and/or plans to remove the asset from use), others are triggered by events and circumstances external to the entity, and this of course includes COVID-19.
Examples of internal and external COVID-19 related indicators that might trigger a formal impairment assessment can include:
- impacts on supply chain
- the ability to operate your business at full or partial capacity under various alert level scenarios
- the extent and timing of various levels of Government assistance available to you
- the impact COVID-19 is having on your customers and their ability to pay
- macroeconomic forecasts for future economic activity.
If a formal impairment assessment is required, you will need to demonstrate that the carrying value of your assets (or cash generating unit) exceeds the assets’ recoverable amount. ‘Recoverable amount’ is based on the higher of the assets’ fair value less the costs of disposal or the value it contributes by being operated in your business. If the recoverable amount is less than the current carrying (book) value of your assets, the difference will need to be written off as an impairment charge.
Two particular asset classes, goodwill and financial assets (such as trade receivables), warrant a specific mention here:
Testing goodwill for impairment is an annual requirement; COVID-19 could impact goodwill through:
- a significant adverse change in legal factors or in the business climate (eg, an entity expects a decrease in its exports to a particular foreign market as a result of lengthy border restrictions)
- a loss of key personnel that is other than temporary
- the testing for write-down or impairment of a significant asset group
- the recognition of a goodwill impairment loss in an investee’s separate financial statements
- a significant decline in the entity’s share price which could result in the carrying amount of the entity’s net assets exceeding its market capitalisation.
Financial instruments and the measurement of expected credit losses
COVID-19 will have negative cash flow implications for many businesses. Under NZ IFRS 9, expected credit losses (ECLs) must be recognised for trade receivables and debt-type financial assets not measured at fair value through profit or loss (FVTPL) based on information about past events, current conditions and forecasts of future economic conditions. In other words, even possible future outcomes that may or may not come to pass should be factored into an entity’s ECLs on a probability-weighted basis. The negative economic outlook and cash flow difficulties experienced by customers as a result of COVID-19 must be factored into an entity’s forecasts of future conditions, which may result in an increase in its provision for ECLs to reflect:
- a greater probability of default across many borrowers, even those that currently do not exhibit significant increases in credit risk but may in the future
- a higher magnitude of loss given default, due to possible decreases in the value of collateral and other assets.
Fair value: measuring assets and liabilities at current market value
The fair value of an item (such as certain financial instruments, investment properties, and items of property, plant and equipment) must reflect market participant views and market data at the measurement date under current market conditions. There may be an increase in the amount of subjectivity involved in fair value measurements, especially those based on unobservable inputs. For example, a lack of market activity caused by COVID-19 may mean there are fewer observable transactions, or observable transactions occurred under a distressed market environment.
In some cases, greater use of unobservable inputs will be required because relevant observable inputs are no longer available.
Disclosure: additional information to include in your financial statements
Businesses will need to consider all of the factors in this article along with any others when determining the COVID-19 disclosures required for their financial statements. In New Zealand, some common disclosure themes have emerged:
- Transparent disclosure on a business’s going concern position; this might require increased disclosures where there are material uncertainties and/or significant judgements involved in the going concern assessment
- Disclosure of any significant judgements applied in the preparation of the financial statements; in New Zealand, this may include sources of estimation uncertainty and other key assumptions made in measuring the fair value of certain assets
- Where valuations have been completed by third parties, any restrictions on those valuations and how sensitive those valuations are to the underlying valuation assumptions used
- Judgements required to determine whether events subsequent to the end of the reporting period affect the carrying value of assets at the end of the period
How Grant Thornton can help
At Grant Thornton, our specialist advisors help New Zealand businesses to navigate the uncertainty of COVID-19, regardless of industry by:
- providing insight and benchmarking to deal with COVID-19 financial statement risk
- advising and/or drafting COVID-19 financial statement disclosures
- assisting with impairment assessment modelling
- providing advice about the tax considerations for Government assistance and relief.
If you need support or advice about what, how or why you need to include the effects of COVID-19 on your organisation in your financial statements, contact us today.