6 minute read 23 Oct 2020
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How to prepare for year-end closing under COVID-19

6 minute read 23 Oct 2020

Finance teams can learn from the experience of their peers who have already filed 2020 interim or annual accounts.

In brief
  • A sample of 2020 filings shows that going concern, impairment, government support and rent concessions are the most significant COVID-19-related issues.
  • Companies need to be transparent about the impact of COVID-19 in annual reports and avoid introducing new or amending existing non-GAAP measures.
  • Accounts preparers should be aware of available reliefs and monitor updates to accounting standards.

As we approach the anniversary of the first confirmed case of COVID-19, it’s an appropriate time to reflect on the effect of the pandemic on the communication of financial performance and what this means for those preparing year-end accounts.

In doing so, it’s important to remember the context in which finance teams are working. There has been a significant difference in impact, timing and duration of the pandemic across geographical areas. However, all countries have been affected to some degree, and many are now responding to a second wave. Business impact has also varied dramatically, with the hospitality, aviation and retail sectors among the worst affected.

In response, governments across the globe have injected billions of dollars into their economies to provide some stability and prevent, or at least delay, high levels of unemployment. Similarly, regulators have offered relief to businesses, such as extending filing deadlines, while standard-setters have deferred the implementation dates of amendments to accounting standards and provided accounting exemptions such as on rent concessions.

There is still uncertainty about the duration, shape and depth of the economic effects of the pandemic. This makes the task of accounts preparers particularly difficult in undertaking going-concern assessments and measuring fair values of assets and liabilities, expected credit losses and impairment charges.

Working from home has become a necessary way of operating for many finance functions. However, for a large number of companies 2020 will be the first year-end closing process since the crisis started. This will put a significant burden on their internal controls and present challenges in gathering and analyzing data in time.

A sample of 330 Q1 and Q2 of 2020 filings – those with reporting dates around 31 March and 30 June – shows the main COVID-19 related issues that have been addressed. Of those referring to the implications of COVID-19 on corporate reporting:

  • 60% discussed (potential) impairments due to COVID-19
  • 20% reported that government support had impacted their organizations
  • 15% discussed threats to the going-concern status of the company
  • One in seven reported that the company had either provided or received rent concessions due to COVID-19

Not only did we see a significant increase in the reporting of COVID-19-related issues in Q2 compared with Q1, but the type of issues covered changed as well. There was a focus on impairment and going concern in Q1 and hardly any mention of government support or rent concessions, whereas, in Q2, mentions of government support and rent concessions rose dramatically.

So what lessons can be learned for those still preparing for 2020 annual reporting?

Establishing the best process to prepare accounts

Working from home has become an accepted and necessary way of operating during the pandemic for many finance functions around the world. However, for a large number of companies 2020 will be the first year-end closing process since the crisis started. This will put a significant burden on their internal controls, as these are generally designed for the office environment, and present challenges in gathering and analyzing data in time.

Coordination with external specialists, for example when performing impairment tests, assessing fair values and performing actuarial calculations and analyses, may also be more challenging.

As discussed above, some relief on 2019 annual and 2020 interim reporting deadlines has been provided by regulators including the US Securities and Exchange Commission and the European Securities and Markets Authority. It remains to be seen whether similar relief will be offered for 2020 annual reporting. Companies should thus consider the implications of COVID-19 when planning the year-end closing process, including whether to start earlier and liaise with service providers.

Not only did the sample filings show a significant increase in the reporting of COVID-19-related issues in Q2 2020 compared with Q1, but the number of mentions of government support and rent concessions rose dramatically.

COVID-19 and the content of company accounts

For many sectors and geographical areas, the economic fall-out of the crisis will not be restricted to Q2 and Q3 2020 but will run potentially into the first half of 2021 if not beyond. This means that companies need to carefully consider going-concern and impairment assessments in the next few quarters. They should update any assumptions used for developments in the timing, shape and duration of the pandemic and its consequences for the entity and its business relations.

Beyond going-concern and impairment assessments, COVID-19 has also raised questions on the appropriate accounting for other transactions and events including rent concessions, modifications of loans and sales contracts, government grants and loan guarantees, income tax changes and insurance recoveries. EY’s publication  Applying IFRS: Accounting considerations of the coronavirus  pandemic examines the effects of COVID-19 when preparing annual or interim financial statements. Given the attention that rent concessions has received, it warrants a few more words explaining the issue.

Questions raised by rent reliefs

Relief has been provided by some regulators on complex accounting topics such as rent holidays granted in response to the pandemic. While these and other rent concessions have been welcomed by those running struggling companies, they raise questions and challenges regarding the accounting treatment for both tenants (the lessees) and landlords (the lessors).

Accounting standards provide guidance on how to account for changes in lease payments. However, it can be difficult to assess whether rent concessions are lease modifications, and then apply the required accounting, due to the large volume of leases and the disruption caused by COVID-19.

To help preparers, the International Accounting Standards Board issued COVID-19-Related Rent Concessions - Amendment to IFRS 16 Leases in May 2020. The amendment allows lessees to account for COVID-19-related rent concessions as if they were not lease modifications. This “practical expedient” applies to rent concessions that reduce payments due on or before June 2021 as a direct consequence of COVID-19 under certain conditions.

The amendment provides welcome relief for lessees (it does not cover lessors), but there are still accounting issues that need to be considered. EY’s publication Applying IFRS: Accounting for COVID-19 related rent concessions looks in further detail at the requirements and how the amendment is applied. 

Communicating through the annual report

Regulators have indicated they expect to see listed companies explain the effects of COVID-19 on past performance and expectations for the future. This will be even more important and need to be more detailed in the annual report.

At the same time, regulators are reminding listed companies to comply with the guidelines for non-GAAP measures (also known as Alternative Performance Measures) and not introduce key performance indicators that try to portray what performance might have been in the absence of COVID-19 as that would be highly judgmental.

Companies should therefore:

  • Be factual and transparent when explaining the impact of COVID-19
  • Disclose such impact both qualitatively and quantitatively in the Management Commentary (Management Discussion & Analysis) section of the annual report rather than the financial statements
  • Avoid introducing new or amending existing non-GAAP measures

This is clearly an uncertain time for company finance functions and, indeed, for everybody else attempting to respond to an unprecedented health and economic crisis. The business impact has been huge and is ongoing.

Accurate and up-to-date financial information is crucial to maintaining trust and confidence in this period. The upcoming closing process will be more challenging this year and will require careful planning of resources in the finance function and in data gathering and analysis. Accounts preparers can learn from the experience of their peers, should be aware of the reliefs that are available and should monitor any updates to accounting standards.

Summary

This is an uncertain time for company finance teams as they respond to the business impact of COVID-19. But accounts preparers can learn from their counterparts who have already filed 2020 interim or annual reports. A sample of filings from Q1 and Q2 2020 shows the impact of the pandemic on accounting issues including going-concern and impairment assessments, government support and rent concessions. The closing process will be more challenging this year and will require careful planning of resources in the finance function and in data gathering and analysis.

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