The implications of COVID-19 and the measures taken to control it may have a significant impact on the financial statements of an entity. Below, are some of the key considerations for directors of medium and large organisations when preparing the next set of financial statements.
Is my business a going concern?
Some industries and sectors will be harder hit by the lock down situation than others. If your business has been forced to shut or you have seen a large decrease in demand you will need to carefully consider whether or not your business is a going concern. In making this decision you should think about your customers, suppliers, the impact of the government measures, and those of finance providers.
If you are uncertain about the future to the extent that there is significant doubt, it is likely that your financial statements will need to include an additional note explaining the uncertainty and how you feel the business will be able to continue.
If the situation is thought to be worse than this and it is likely that you will liquidate or cease to trade, the business will not be deemed a going concern and a different basis of preparation for the financial statements will be required as well as the note set out above.
Everything has changed since the year end
You may also find that there are events which have taken place after the date to which your financial statements will be prepared which are having a large impact on the way in which the business is now operating. This may be changes to the financing arrangements or closures of specific lines of business.
Depending on the nature of the event these too may need to be included within your financial statements either as a note or as a change to the financials.
It is our view that for financial statements prepared up to a date of 31 December 2019 or before, the impacts of Covid-19 would be a non adjusting event and result in an explanatory note being added to the financial statements. However if the date to which your financial statements are prepared is 31 January 2020 or after the impact of covid-19 may, depending on the circumstances, be an adjusting event with accounting entries and an explanatory note being presented.
The value of the assets in the business has changed
Assets are generally held within the financial statements at cost or open market value. The current economic environment is likely to be very different to that at the date of your last financial statements and therefore the values at which the assets are presented may need to change. Where the values for last year are higher than what is considered reasonable at the date of the financial statements, the reduction in value will need to be recognised and a note included to explain this.
What is the impact on stock?
Stock is held within the financial statement at the lower of cost and the selling price of an item less, the costs to sell it. If there ceases to be demand for the product, it becomes obsolete as a newer version is available or the stock has a short life then there may be a reduction in the value of the stock to below its original cost.
The valuation of work in progress at the reporting date will also need to be reviewed to ensure that it reflects the cost of the future work to be undertaken as well as the final valuation of the end product and the likelihood of its future sale. This may again result in a reduction to the value at the end of the reporting period.
Dividends and other distributions
The Companies Act 2006 requires dividends to be paid out of distributable profits. This means that they are paid out of the retained earnings shown in the balance sheet plus the profits made for the current year. Where this years’ business performance looks very different to the performance of previous year, and you do not have a large balance of retained earnings it is important to ensure that the dividends that you pay remain legal. As a director you have fiduciary duties which include the safeguarding of the company’s assets and taking reasonable steps to ensure that the company can meet its debts as they fall due. Directors must make sure that the company remains solvent following the payment of a proposed dividend by considering the financial position presented at the balance sheet date of the latest management accounts and the future cash needs of the business, which given the current environment may have drastically changed since any dividend was proposed. It is worth highlighting that the directors who approve a dividend and/or the shareholder in receipt of the dividend may become liable to repay the full dividend, or a proportion of it, should it be found to be illegal. Director’s should carefully consider the decision to pay a dividend and may find taking a higher level of salary at this moment in time, a less risky strategy than receiving a dividend.
Breach of covenants
It is recommended that you check the covenants attached to any loan arrangement. If there is a breach of terms during the financial period or another form of default that has not been remedied by the reporting date, disclosure of this fact is required within the financial statements.
If however you renegotiate terms with the finance provider ahead of the period end no disclosure is required other than that for all loan arrangements.
The companies act requires medium and large companies to include disclosures covering their credit, liquidity, currency and other price risk within their financial statements. These are likely to have changed in comparison to the prior period and there may also be additional disclosures surrounding liquidity that are now required as many organisations will be impacted by abnormal cash flow patterns.
Employee benefits and share-based payments
A review of employee bonus schemes and share based payments should take place focusing on the terms and conditions attached to them. It may be that, given the change in economic environment, the terms are no longer appropriate and this may have a negative impact on key employees whom we need to engage when times are hard. From an accounting perspective the assumptions and judgements in place for measuring such schemes should also be reviewed as yields on high-quality bonds and risk-free interest rates in some currencies may have changed.
Accounting Estimates and Judgements
FRS 102 requires disclosure of significant accounting policies, judgements and estimates. Those already disclosed may now need to be reviewed as it is likely given the uncertainty that further disclosures of judgements may also be required.
The strategic report includes a specific requirement to set out the principal risks and uncertainties facing the business. It is likely that most organisations will require some level of disclosure of the impacts of Covid-19 within their strategic report as the document should be forward looking. The level of disclosure will depend on the level of impact and the adjustments and notes within the financial statements. Some examples of the things which may be currently relevant are the protection and retention of staff, closure of premises, halting of production, solvency and liquidity risks and covenant headroom.
We can help
If you would like to discuss the impact of Covid-19 on your financial statements please get in touch with your usual Albert Goodman contact