We explore some of the key areas below and distinguish between periods ending on or before 31 December 2019 and those ending in 2020.
Periods ending on or before 31 December 2019 – accounting implications
As at 31 December 2019, only a few cases of an unknown virus were reported to the World Health Organisation. Accordingly, the identification and emergence of Coronavirus since that date is regarded as a non-adjusting event, as it did not reflect events and conditions that existed at 31 December 2019.
No adjustment is required to the carrying amounts of assets and liabilities in the balance sheets prepared as at 31 December 2019, or earlier periods, as a consequence of the Coronavirus issue that subsequently emerged.
However, companies will need to ensure transparent disclosure is made in the financial statements for any material non-adjusting events arising between the end of the reporting period and the date the financial statements are approved, for example material impairments of assets in the subsequent reporting period and covenant breaches.
Preparers should also refer to the narrative reporting, going concern and dividend and distributions sections below, as Coronavirus is likely to have a bearing on directors’ considerations in these areas.
Periods ending in 2020 – accounting implications
The technical consensus is that for companies with 2020 reporting dates the financial effect of Coronavirus on the financial statements will be an adjusting event as the existence of the virus was known. As such, the financial impact of the virus in the post-balance sheet period provides further evidence to allow directors to evaluate the correct accounting treatment for all affected balances and obligations as at the reporting date.
Directors should consider the implications on the carrying amount of assets and liabilities as well as evaluate contractual obligations, particularly potential liabilities which may need to now be provided for at the reporting date. The most sensitive will include key estimates and judgements over:
- assets measured at fair value (e.g. investment property or own-use assets carried at valuation)
- impairment provisions for tangible fixed assets, intangible assets including goodwill, and investments in subsidiaries, associates and joint ventures
- impairment provisions for trade receivables and inventory
- potential losses on long-term contracts
- potential onerous leases
- assessment of recoverability of deferred tax assets
- the classification of borrowings as current rather than long-term where covenants are breached
- evaluation of commitments entered into at the reporting date
Directors should also consider the requirement to include financial statement disclosures of material non-adjusting events. We address this below.
For medium and large companies, the strategic report should disclose the principal risks and uncertainties for the business that derive from the effects of Coronavirus. Where mitigating actions can be taken, these should be disclosed with the risks. The extent of the risks and magnitude of impact will depend on the specific circumstances of the business. Risks should be reviewed and updated as further information comes to light, up to the date of approval of the financial statements. Directors should ensure that risks disclosed are consistent with the risks disclosed on going concern.
Where Coronavirus has influenced reported results, the narrative reporting on financial position and financial performance will be expected to draw out the effects.
For small companies, that are not required by law to prepare strategic reports, voluntary additional reporting may be required for the directors’ report to meet the objectives of meaningful, fair and balanced disclosure. Small companies, like other companies, can be expected to disclose material non-adjusting events in the financial statements as well as ensuring going concern disclosures reflect the risk to the business.
Going concern basis of preparation
The going concern basis of preparation is a pervasive concept and there is no distinction in its application to differing period ends.
In complying with accounting requirements, and those of the Companies Act 2006, the presumption is that the financial statements have been prepared on a going concern basis. The wider economic consequences and day-to-day operational impacts arising from Coronavirus may cast significant doubt over the company’s ability to continue as a going concern.
Up to the date of the approval of the financial statements, management are required to make an assessment of the entity’s ability to continue as a going concern which should cover a period of at least, but not limited to, twelve-months from that date. Robust and up-to-date forecasts will be required.
When management is aware of material uncertainties related to events or conditions that cast signiﬁcant doubt upon the entity’s ability to continue as a going concern, the company is required to disclose those uncertainties in the basis of preparation section of the financial statements. Disclosure would also be expected to be extended to the narrative reporting.
If the impact of Coronavirus means the company is not a going concern, and prior to the approval of the financial statements, the directors intend or have no alternative to cease trading, then the financial statements must be prepared on a ‘basis other than going concern’. Accordingly, adjustments may be necessary to the carrying amounts of assets and liabilities, and their classification for the financial statements to be prepared on a basis other than going concern.
Dividend and distributions: capital maintenance and directors’ fiduciary duties
For some businesses, the impact of Coronavirus on reported results and results after the balance sheet date will have significant implications for decisions on dividends and distributions.
The Companies Act 2006 requires that any dividend may only be paid out of distributable profits as shown in the company’s most recent relevant accounts drawn up in accordance with applicable UK law and accounting standards. Accordingly, irrespective of the level of surplus cash, a dividend cannot be paid without the existence of distributable profits.
Further, under common law, no distribution may lawfully be made out of capital. Therefore, a company will need to consider losses suffered subsequent to its balance sheet date of the relevant accounts which may have eroded its profits available for distribution. Companies will need to consider this both at the time of proposing the distribution and when it is ‘made’ which is usually when it is paid or when it was approved by the shareholders.
Finally, directors are subject to fiduciary and other duties in the exercise of the powers conferred on them including the obligation on directors to safeguard the company’s assets and take reasonable steps to ensure that the company is in a position to settle its debts as they fall due. Directors must therefore specifically consider whether the company will still be solvent following a proposed distribution. Directors should consider both the immediate cash flow implications of a distribution and the continuing ability of the company to pay its debts as they fall due. In reaching their decision, they must take into account any change in the financial position of the company after the balance sheet date of the relevant accounts and the future cash needs of the company.
If you would like to discuss any of the above, please contact your usual Blick Rothenberg contact or one of the Partners or Directors to the right.
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