4 minute read 16 Dec 2020
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What COVID-19 disclosures to expect in 2020 financial statements

By Pieter Dekker

Associate Partner, Ernst & Young Accountants LLP (The Netherlands)

Develops insights on applying IFRS with a focus on income taxes, currency translation, hyperinflation, and EU developments. Enjoys photography and cooking for friends and family.

4 minute read 16 Dec 2020

An EY survey of recent financial statements shows a wide range of COVID-19 related disclosures.

In brief
  • Many companies have faced COVID-19-related disruption due to interrupted operations, dwindling demand, the cost of mitigating actions and financing challenges.
  • COVID-19 disclosures can be grouped into clusters covering: going concern; recoverability of assets; income statements; and financial instruments.

COVID-19 has affected both countries and companies unevenly. Some businesses have even benefited from the pandemic as existing trends, such as online shopping, have accelerated or because spending patterns shifted towards consumption at home. However, most companies have seen their businesses disrupted by the interruption of operations, dwindling demand, the cost of mitigating actions, and challenges around financing.

The EY organization surveyed disclosures in the IFRS financial statements of more than 120 companies that published their annual financial statements as of 30 June 2020. COVID-19 disclosures in these financial statements can largely be grouped into four clusters covering: going concern; recoverability of assets; income statements; and financial instruments.

Disclosures in the first cluster involve going concern, viability, liquidity, and financing. They address the immediate question of whether a company is at risk of a sudden stop because its business is no longer viable or as a result of difficulties in financing operations. These going concern assessments may consider a worst-case scenario modelled over several years and address the ability of the entity to meet financial obligations, taking into account any mitigating actions it would expect to take.

Surprisingly, the EY research indicates that the use of COVID-19-adjusted APMs in the financial statements has been limited. This is most likely due to the regulators’ call for caution before using APMs to disclose the impact of COVID-19. 

The next cluster of disclosures deals with the recoverability of assets, which includes impairment testing of assets and goodwill, provisions for expected credit losses, the valuation of inventory and recoverability of deferred tax assets. These disclosures provide information about the impact of COVID-19 on the companies’ performance, but they are also forward-looking.

In particular, the disclosures in this cluster around impairment testing triggers, scenario analyses, key assumptions and sensitivities can provide deep insights that help investors understand how new developments may affect an entity. For example, an airline disclosed that part of its fleet is expected to be grounded for the foreseeable future and it was tested for impairment separately. This was followed by a detailed sensitivity analysis in which the airline outlined its recovery plan.

The third cluster of disclosures covers income statements and involves issues such as revenue recognition, cost of sales and alternative performance measures (APMs). Disclosures around revenue are quite varied as they address issues such as rebates, variable consideration and revenue reversal, but also the disclosure of revenue in both pre-COVID-19 and COVID-19 reporting periods.

Costs of sales are affected in various ways: there are incremental costs as a result of prevention measures taken; abnormal and unproductive production costs (e.g. operations well below capacity); and costs of spoilage where finished goods had to be destroyed.

Surprisingly, the EY research indicates that the use of COVID-19-adjusted APMs in the financial statements has been limited. This is likely due to the regulators’ call for caution before using APMs to disclose the impact of COVID-19.

The final cluster of disclosures concerns financial instruments, which includes loan modifications, loan covenants, hedge accounting, expected credit losses, liquidity, concentrations of risks and related judgments and estimates. Financial institutions provide the most extensive disclosures about these issues, but the pandemic has impacted most companies beyond their ordinary worst-case forecasts for 2020 and so disclosures have been seen more widely.

For example, an entity disclosed that its forward exchange contracts were no longer highly effective and that hedge accounting on these items had been discontinued, as foreign revenue was lower than expected. Another entity also referred to the general processes that it undertakes for expected credit losses (ECLs) in a “normal” environment with additional specific areas that have been considered this year and explained how its assessment of the ECL rate changed in various overdue categories.

 

More information on disclosures can be found in the EY publication Applying IFRS Disclosure of COVID-19 impact, which provides a useful starting point for companies that are looking to prepare and publish their financial statements in the coming months. It covers not just the four clusters discussed above, but also picks up on issues such as government grants, stimulus measures and lease modifications.

Summary

An EY survey of more than 120 companies shows the extent of COVID-19 disclosures in the financial statements. It examines disclosures involving going concern, recoverability of assets, income statements (including alternative performance measures or APMs) and financial instruments. The survey demonstrates that the use of COVID-19-adjusted APMs in the financial statements has been limited and that disclosures involving financial instruments have been seen in a wider group of organizations.

About this article

By Pieter Dekker

Associate Partner, Ernst & Young Accountants LLP (The Netherlands)

Develops insights on applying IFRS with a focus on income taxes, currency translation, hyperinflation, and EU developments. Enjoys photography and cooking for friends and family.