9 minute read 10 Aug 2020
Original weaving of rugs

Seven corporate reporting lessons from Asia’s experience with COVID-19

Authors

John King

EY Americas Vice Chair – Assurance

Advocate for audit quality and inclusive leadership. Track record of exceptional client service for large, multi-national organizations, as well as start-ups and rapid growth companies.

Tom Kornya

Senior Assurance Leader and Audit Partner

Change-maker. Business leader. Committed to unlocking the power of technology to drive audit innovation and deliver exceptional client service.

9 minute read 10 Aug 2020

Finance teams in the US and Canada may find it valuable to understand the way their peers in Asia, the first region to be hit by the pandemic, dealt with the challenges it presented.

CFOs and finance functions around the world are helping their organizations to navigate the COVID-19 crisis. However, different countries are at different stages of their crisis management journey. As a result, finance functions in some markets are only just confronting challenges that their peers in other regions have faced for some time.

The finance teams of some US-based multinationals are now studying the position of each of their markets on the COVID-19 curve. This is so that they can develop scenarios, based on experiences in the Asian markets, for those that are further down the curve. These scenarios relate to unemployment rates, consumer behaviors, likely demand, the impact of government incentives, the extent of travel restrictions and the ability of employees to return to physical workplaces.

Already, we have seen the COVID-19 pandemic weighing heavily on Asia’s growth this year. China, for example, suffered a 6.8% contraction in GDP during the first quarter due to declining retail activity and industrial output. Nevertheless, the impact of the pandemic does vary by market and by sector, and certain e-commerce businesses have in fact benefited from it.

So, what are the key observations for US and Canadian finance teams from their peers in Asia? From talking to colleagues in the region, we found that there are important takeaways in seven key areas:

Today and moving forward, US and Canadian finance professionals can benefit from lessons learned by their peers in Asia. In particular, they can learn how Asian finance teams have mitigated the impact of the crisis on their companies’ operations and how they plan to communicate that impact through financial reporting.

1. Cash and liquidity

Organizations in most sectors are currently suffering cash flow pressures as a result of COVID-19. In certain sectors, including aviation, hospitality and retail, these issues are particularly acute.

In Asia, finance teams have helped to ensure their organizations’ survival by monitoring their liquidity (in the short and medium term), as well as their possible recovery scenarios.

  • Teams are taking an agile approach to forecasting, performing short-term forecasts that are typically between one and three months in length, with a focus on the recoverability of their trade debtors, particularly where they operate in heavily impacted industries.
  • Budgets for the remainder of this year and next year are being rigorously reviewed, with a range of scenarios being developed for each business. Where possible, those budgets are being supported by economic modeling that shows the impact that different types of recoveries (V-shaped, U-shaped, etc.) would have on particular industries.
  • Finance teams are looking at where they can cut costs — for example, by delaying projects and reducing expenditure on advertising and marketing or by undertaking more comprehensive cost-out programs.
  • Companies in certain markets — particularly China and Japan — typically hold a lot of cash on their balance sheets, which will help them to withstand this difficult period. Nevertheless, shareholder dividends are being reduced, and listed entities are seeking additional capital.

2. Financial reporting

Since the 2019 financial year-end was pre-pandemic, the financial impact of COVID-19 has yet to fully manifest itself in corporate reporting in Asia. The quarterly and half-yearly reporting that takes place over the course of this year will offer more insight into the business and financial challenges that companies face and the accounting issues that are likely to arise.

We know from talking to colleagues that the key accounting issues that have already had to be addressed in quarterly reports for Q1 2020 include:

Asset impairment

The full impact of asset impairment on corporate balance sheets in Asia is unlikely to be known until the 2020 year-end. Still, updates around asset impairment are likely to feature in quarterly reporting as the year unfolds. Impairments may affect every sector that has a reduced capacity to generate income from its assets, such as aviation, hospitality, manufacturing, retail and real estate. Businesses across many sectors could also see some impairment of goodwill due to the negative or uncertain economic outlook.

A lack of visibility around cash flows will hinder finance teams’ ability to apply valuation models, such as discounted future cash flows. Having said that, the companies that have engaged to date appear to be doing their best to put forward a range of scenarios that reflect their best estimates of the likely impact of COVID-19 on their cash flows. We do not think that a single cash flow forecast will sufficiently address the level of uncertainty that currently exists in most organizations. The significant judgments and estimates to be made call for appropriate disclosure.

Contract modifications

Complicated issues with contract accounting are likely to arise as customers defer orders and construction contracts are put on hold. In South Korea, for example, companies are concerned about the possibility of export contracts being canceled due to the uncertainty in key markets, particularly the US and India. Finance teams can expect to consider contract modifications and whether existing contracts have effectively been extinguished, with new contracts being issued.

Credit losses

Businesses — especially financial institutions — are likely to suffer credit losses as the economic fallout from the pandemic continues. Increasingly, banks will be expected to make provisions for potential bad loans. In March, the International Accounting Standards Board issued guidance to companies on the measurement of expected credit losses, emphasizing that IFRS 9 Financial Instruments should not be applied mechanically and that prior assumptions may no longer hold true in the current environment. Given the level of judgment involved in applying IFRS 9 in the present circumstances, transparent disclosures in this area will be critical.

Leases

It is common for businesses in certain sectors, such as aviation and retail, to have significant lease obligations. If organizations cannot find ways to reduce these obligations — at least while their cash flow is diminished — they may simply have to exit from these leases, which may threaten the viability of the business. In China, retailers sought to address this issue by proactively negotiating rent waivers and discounts with their landlords, while in Singapore, the Government has stepped in to mandate certain rebates to be given by landlords to tenants. These can trigger complex lease modification and government grant accounting issues.

One-off items

A number of our clients are spending significant amounts restructuring their businesses as a result of COVID-19. Furthermore, some have adjusted their business structures to function within the constraints of social distancing. This may raise accounting issues around the timing of recognition of provisions and employee expenses.

Going concern

The ability of companies in Asia to continue as going concerns has been partly supported by government actions. In China, for example, the Government has provided support to businesses in certain sectors, and many of its largest businesses are state-owned. The Singapore Government has introduced many stimulus measures to mitigate the economic impact of the COVID-19 pandemic, such as wage subsidies for employers and low-interest, government-assisted bank loans for small and medium-sized businesses.

Despite these measures, the crisis will inevitably lead to corporate failures and render the going concern basis of accounting unfeasible. The risk will be greatest for those businesses that were already thinly capitalized before COVID-19 struck.

New revenue models

Some organizations will have developed new revenue models due to COVID-19. For example, they may have developed online subscription services. These services will need to be correctly accounted for to ensure they provide an accurate picture of the organization’s financial health at any given point in time.

3. Internal controls

The large-scale shift to remote working is making it harder for some companies to exercise their internal controls as they were initially designed. This is a challenge for South Korea, for example, which has recently implemented Sarbanes-Oxley-style controls. Companies in the US — particularly small and medium-sized companies that have limited resources — may also find it challenging to effectively apply controls, such as segregation of duties, in a remote environment.

4. Raising capital

In 2010, many companies refinanced themselves in the wake of the global financial crisis, so a lot of debt issued then is coming to maturity this year. Many South Korean CFOs are therefore looking at how they can refinance or recapitalize their businesses. The challenge for them — and for CFOs in other markets — is that notwithstanding the unprecedented loosening of monetary policies by many central banks, commercial banks may take a more conservative approach to lending as they start to incur or anticipate higher credit losses. In both Hong Kong and South Korea, companies have had to delay planned IPOs — closing another avenue for capital raising. Like their peers in Asia, US CFOs seem to be anticipating difficulties in this area. In fact, as the crisis has unfolded, we have seen some companies use credit lines to access cash they have no urgent need for but intend to hold in reserve.

5. Employee engagement

Employee welfare has been front of mind for organizations in Asia during the pandemic. Organizations have acted swiftly to enable remote working for staff, where possible. Nevertheless, plummeting revenues have threatened jobs and livelihoods. In many companies, executives have taken substantial pay cuts to help reduce payrolls and maintain staffing levels. Pay cuts have also been commonplace at other levels. In China, staff in various industries took pay cuts of up to 50% to enable their organizations to navigate the worst of the crisis.

6. Engagement with customers and suppliers

Finance teams in Asia are working alongside operational teams to engage with customers and suppliers. Payment terms are a means of providing support — they can be extended for stricken customers or sped up for struggling suppliers. The crisis also created opportunities for organizations to collaborate with their suppliers. For example, Chinese retailers worked with their vendors to launch online promotions of specific products. Now that the Chinese economy is recovering, organizations are proactively offering discounts to customers — a trend that is particularly evident in the hotel and property industries.

7. Communication with shareholders

Transparent financial reporting underpins effective communication between companies and their shareholders. Finance teams in Asia realize that quarterly and half-yearly reporting present opportunities to build trust with shareholders, especially around sensitive issues, such as dividends, asset impairment and going concern. Nevertheless, the rise in virtual annual general meetings requires finance teams to think carefully about how they enable effective shareholder engagement. For example, companies may need to provide further updates outside of formal reporting windows. In Singapore, which has just moved to half-yearly reporting for listed companies, some companies have retained quarterly announcements on a voluntary basis.

Now, next and beyond

It is clear that finance teams, both in the US and Canada, will have to continue to manage the impact of COVID-19 on their organizations for the foreseeable future. So, what should they be thinking about now, next and beyond?

Now
  • Focus on the “three Cs” — cash, costs and credit. Perform a comprehensive review of all cash flows, take control of expenses, undertake immediate renegotiations with suppliers and apply for government loans and aid where these are available and needed.
  • Study the patterns and trends in different markets for both the current and the previous quarters. Use scenario planning to anticipate different future situations and develop a response to them.
  • Use purpose to inform all organizational decision-making at this critical time.
  • Don’t lose sight of the long term. In a crisis, it’s easy to focus on short-term survival, but any decisions taken should also bear the future in mind.
Next
  • Revise the organization’s budgets, strategy and structure for the medium term. Where possible, ask for external benchmarks (e.g., economic reports) that help support the forecasts. Devise a plan that allows the organization to respond to evolving customer demand and emerging risks while remaining resilient.
  • Explore how the organization can use technology to transform its business. There will be opportunities to drive efficiency by automating processes and using data more effectively.
  • Capture the results of how COVID-19 is impacting the business so they can be used as a reference in the future.
  • Communicate clearly and openly with investors about what the organization is doing to improve liquidity, reduce costs and revise strategy.
Beyond
  • Think strategically about what the new normal will look like — for both your organization and its sector. How can your organization adapt its business model to thrive in a post-COVID-19 world?
  • Explore opportunities for the company to operate differently in the future. For example, will greater use of remote working and video conferencing allow the organization to reduce expensive office space and cut travel budgets?
  • Review your organization’s purpose. Will its current purpose — as it relates to customers, employees and shareholders — still be relevant in the future?

Above all, keep in mind the need for agility and flexibility; circumstances can change quickly, and CFOs will need to be prepared to change course if necessary.

The views reflected in this article are those of the author and do not necessarily reflect the views of the global EY organization or its member firms.

Summary

Finance functions in Asia had to respond to the challenges posed by COVID-19 before the rest of the world and their peers in the US and Canada can learn from their experience. These critical lessons cover seven key areas: cash and liquidity, financial reporting, internal controls, raising capital, employee engagement, engagement with customers and suppliers and communication with shareholders.

About this article

Authors

John King

EY Americas Vice Chair – Assurance

Advocate for audit quality and inclusive leadership. Track record of exceptional client service for large, multi-national organizations, as well as start-ups and rapid growth companies.

Tom Kornya

Senior Assurance Leader and Audit Partner

Change-maker. Business leader. Committed to unlocking the power of technology to drive audit innovation and deliver exceptional client service.