Covid impact on the financial statements of businesses

The pace at which the coronavirus outbreak has engulfed countries across the world, including India, is beyond anybody’s imagination; and the impact, unprecedented. Over 200 countries have witnessed the impact of the extraordinary event.

It will be prudent to expect that the impact on businesses will reflect in the results from operations over the next few quarters. Most businesses will need to re-assess their forecasts for the next 12-24 months, and for many, the business model may need to be relooked at — the impact will definitely flow down to their financial statements.

Some critical areas that need attention will include:

Continuing as going concern: Businesses, especially start-ups and companies with low operating margins (for example airlines, retail etc) will need to assess the ability to continue as going concerns for the next 12-18 months.

Companies will need to consider the impact of events as per the balance sheet date, and make necessary adjustments and disclosures in their financial statements.

Adverse impact on liquidity: There may be short-to-medium term shortage of goods — forcing the companies to buy raw materials/products at higher prices in cash. Apart from profitability, the liquidity of the companies may be impacted adversely, thereby putting additional stress on the operations. Businesses may need to review the key contractual terms with their customers and suppliers.

Impairment of tangible/intangible assets and businesses: Many businesses have global operations; the impact on some of them could be more than just temporary. Companies will need to carry out a detailed impairment assessment for each of the cash-generating units (CGUs). Businesses will also need to test the carrying values of intangibles, for example intangibles recognised in public private partnership contracts (airports, infrastructure contracts) or goodwill on acquisition.

Inventories: Overall slowdown and disruption will require companies to rethink the carrying value of inventories — the fall in net realisable values is expected considering the increased discounts, high sales returns, obsolescence etc. Further, companies may not be permitted to allocate the fixed overheads to reduced production — the excess may have to be recognised in the profit and loss account.

Carrying value of financial instruments: Expected credit loss is likely to significantly increase on receivables from customers as well on the carrying value of investments, due to a significant increase in credit risk.

Revenue recognition: Contract modifications (price changes, delivery schedules, penalties, sales returns, discounts, etc) are likely to impact the timing and amount of revenue recognition. Uncertainty around collectability of revenue may also lead to revenue reversals and deferral.

Lease commitments and other obligations: Companies in some sectors such as aviation and retail may need to review their lease commitments and other obligations. Businesses will also need to review any exposure on account of onerous contracts; this is more relevant for businesses in mining, metals and consumer retail. There could also be potential obligations on account of severance costs and inventory lock-ups.

Hedging strategy for exposure to market risks: Companies that have significant exposure to future sales/receivables and existing forward contracts may find their investments out of money. Amounts recognised in other comprehensive income may have to be transferred to the profit and loss account, in case of ineffective hedges. Companies that have unhedged foreign currency debt may have a significant exposure on cash outflow. Similarly, exposures on interest rates and commodities may also increase for a lot of businesses.

Breach of bank covenants: Companies with a significant impact on future cash flows may need to re-negotiate their arrangements with banks and financial institutions. There could be an impact on their bank covenants and hence impact on the current/non-current classification of the obligations.

Increased disclosures: Year-end/period-end reporting would require enhanced disclosures in the financial statements. There are likely to be many new as well as changes to existing assumptions and estimates made by companies as they prepare the financial statements. Adequate disclosures with respect to the impact of these will need to be included in the financial statements.

Way forward for the finance teams: Whilst the primary focus of the companies should be on the well-being of people, there is also a fiduciary responsibility of the finance functions towards the investors and shareholders. As the event unwinds over the next few weeks/months and businesses get back to normal operations, it will be critical for them to be ready with the remediation plan.

Businesses and finance teams should take a complete stock of the impact on business operations, key processes and financial statements. Timely engagement with key stakeholders including customers, suppliers, investors, bankers and auditors will help avoid surprises.

The writer is Managing Director, Financial Reporting & Transaction Advisory, Protiviti Member Firm for India

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