The coronavirus (COVID-19) outbreak — officially a pandemic as of March 11 — has rightly become the focus of massive public attention in recent weeks. In addition to concerns about the health of their workers, businesses may be concerned about how it will affect their financial results and the performance of their supply chain partners.
Though the full effects of the COVID-19 outbreak are yet unknown, the impact is already global. Every business is affected in some way.
As the outbreak continues to grow worldwide, U.S. companies, large and small, are devising contingency plans and reworking their goals and budgets to address potential risks. Likewise, investors and other stakeholders want to know how companies are responding to this emerging risk factor.
How (and when) should companies report the effects of this outbreak on their financial statements? Disclosure requirements largely depend on materiality — and whether failure to disclose this risk factor would make the financial statements misleading to investors.
Paul Gillis, a professor of management at Peking University who writes China Accounting Blog, believes the accounting implications of COVID-19 could be significant, depending on the nature of the business and its location. He said accounting standard-setters may need to provide further application guidance on subsequent events.
The outbreak has coincided with the deadline for calendar-year entities to prepare and file their annual reports. Gillis noted that the situation that led to the COVID-19 outbreak in China existed before December 31, 2019. Notably, on December 31, China had reported to the World Health Organization (WHO) that there was an outbreak of pneumonia from December 12 to December 29 in Wuhan, China. However, the WHO didn’t identify the virus as a novel coronavirus until January 7, 2020 — or declare the outbreak a public health emergency until January 30, 2020.
The effects of the outbreak are being felt around the globe, including here in the United States. Accounting Standards Codification (ASC) Topic 855, Subsequent Events, requires companies that follow U.S. Generally Accepted Accounting Principles (GAAP) to disclose events or transactions that occur after the balance sheet date but before financial statements are issued (or available to be issued).
Under GAAP, there are two types of subsequent events:
- Recognized subsequent events. These events provide additional evidence about conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements.
- Unrecognized subsequent events. These provide evidence about conditions that didn’t exist at the date of the balance sheet being reported on but arose after that date.
Moreover, ASC Topic 450, Contingencies, outlines the accounting and disclosure requirements for loss and gain contingencies. For example, this standard requires companies to accrue for potential lawsuits based on the probability that a claim will be made and loss will be incurred.
Possible financial effects
Under GAAP, U.S. companies may be required to factor COVID-19-related risks into their financial statements. Examples of balance sheet accounts that may be materially affected by the outbreak include:
Companies should consider the potential for impairment, as well as the need to adjust cash flow projections and other assumptions used to measure nonquoted financial instruments. Financial assets reported at fair value on the balance sheet may result in realized and unrealized losses.
Customers that are adversely affected by the outbreak may be unable to pay outstanding invoices. This situation could result in additional credit and liquidity risks, higher than usual bad debt, and even impairments and write-offs. Cash flows from operations may also be affected.
The outbreak may disrupt supply chains and productivity. Companies with reduced or idle production capacity may be unable to allocate overhead costs to inventory as they usually do. In addition, inventory that can’t be turned over because of travel restrictions may have to be evaluated for impairment. Finally, changes in prices and reduction in the level of demand will also have to be taken into consideration.
Pensions and other post-retirement plans.
Financial market volatility has affected the measurement of these accounts. Companies may have to revisit both the expected return on plan assets and the funded status of the plans.
Deferred tax assets.
If estimates of earnings of foreign subsidiaries change, companies may have to reconsider some of their tax strategies, or they may not be able to realize all deferred tax assets.
Goodwill and other indefinite-lived intangible assets.
Subsidiaries in areas heavily affected by COVID-19 may see their revenues or net income affected by the outbreak. This may trigger impairment testing for goodwill and other intangibles. The reassessment of key accounting estimates and projections may result in an immediate impairment. Additionally, impairment testing may have to be done more than once this year if management considers that evolving circumstances result in more than one triggering event.
There are many unknowns about the severity and duration of the COVID-19 pandemic. Disclosing and recognizing its financial effects may require management to exercise significant judgment. Contact your Sisterson representative to help navigate this potential crisis and its effects on your company’s financial statements. You can also reach us at email@example.com