Pandemic Math

Most companies around the world are being profoundly affected by Covid-19, and the impact on financial reporting and control is significant.

Increased uncertainty and a new world of risk have left many chief financial officers scratching their heads as to how to evaluate the Covid-19 fallout. Is goodwill impaired? How have employee benefits been affected? What is the impact on revenue cycle reporting?

Companies are struggling to provide the answers, says Reinhard Dotzlaw, Global IFRS leader at KPMG. “The current environment is making the normal process of preparing financial statements very challenging. We’ve got increased uncertainty on the recovery outlook. We’ve got dramatic volatility in the stock markets and significant fluctuations in foreign exchange rates and commodity prices. This poses significant challenges for management for making estimates.”

While financial accounting might appear to be a highly structured, rules-based exercise, there’s a lot of room for judgement. “Estimates are pervasive throughout financial statements,” Dotzlaw says, “particularly when it comes to forecasting future cash flows and [assessing things such as] receivables, loans and nonfinancial assets like goodwill and intangibles.”

This means much more work for the finance department of companies reporting in this level of uncertainty, he adds. “Under IFRS, given the economic downturn, there’s the potential for a lot more impairment triggers, and companies will need to evaluate those triggers carefully to determine if they need to do recoverability tests. Companies will also need to revise, review and reassess the various assumptions underlying those tests, as well as model multiple scenarios and probability weight them to come up with a recoverability amount.”

According to Iarla Hughes, CFO of Manx Telecom, a UK-based telecommunications conglomerate, Covid creates unprecedented challenges when it comes to applying accounting standards that were designed for much less volatile times. “In terms of trying to estimate the economic impact of Covid-19, there is no playbook for us,” he says. “You couldn’t draw back in history to say this is how you deal with it.” Furthermore, he adds, “at the beginning, there wasn’t a huge amount of guidance in terms of what you do from a US GAAP or an IFRS perspective—how you validate the estimates required for your financial records in terms of provisions, potential revaluations of intangible assets, goodwill and bad-debt assessments.. In terms of the financial impact of Covid, all of those assessments were relatively new.”

As to how CFOs can provide a clearer picture of their companies’ overall economic position going forward, it’s easy for any organization to just present a set of numbers on a piece of paper in black and white, he adds, but what’s critical in these times is for shareholders to understand the context of how those numbers were achieved. “For me and for our organization, the most important thing is to make sure that there is a narrative, and it’s clearly explained how we’ve arrived at certain positions,” Hughes adds.

Dotzlaw says companies can expect their auditors and their audit committees to continue to go deep into the judgements made by their finance chiefs. “From an audit committee perspective,” he says, “what I’ve seen is that they’re focused on management’s response to this changing risk landscape and making sure they’re comfortable with the conclusions management has drawn.” At the same time, he adds, analysts and other financial statement users expect more clarity around key management judgements and estimates. “What we, as a profession, are encouraging companies to do is to go beyond the bare minimum in terms of the disclosure requirements,” says Dotzlaw. “So what we’re doing differently is, in those areas where there is a significant amount of judgement involved and a significant amount of estimation, we’re doing audit-level work to get to the bottom of things, and be comfortable with the judgements and assumptions that support for those estimates.”

More specifically, he says, auditors are more interested in how the company intends to survive in the coming months and what possible risks the future holds. “The key to this,” explains Dotzlaw, “is to explain how the strategy and the targets of the company may have been modified to address the effects of the pandemic, and the measures that they have taken to mitigate the impacts. As auditors, we’re focusing on the key assumptions that were made by management, where the uncertainty lies, and if there’s a range of reasonable possible outcomes, what are they?”

When it comes to comparing companies, things get even trickier, says Manx Telecom’s Hughes. “The biggest challenge I see, especially for the equity markets,” he says, “is ensuring that companies are taking a relatively consistent approach in what they’re doing; what provisions they’re putting in. I think it’s going to be very, very difficult to decipher what’s really happening from the outside looking in if you don’t have that consistency.”

Therefore, the main message to the accounting bodies when it comes to accounting during the pandemic, he says, is to make sure that they continue to strive toward consistency in how companies are allowed to apply the standards: “When it comes to accounting in the Covid-19 environment, there’s still a lot of room for interpretation.”

Over the past several weeks, the FASB and IASB have been working on ways to provide additional guidance and relief to preparers around certain standards that posed specific practical difficulties in the Covid environment. In early mid-March, the FASB ceased to deliberate on projects on their technical agenda. “Given the situation,” says Shayne Kuhanek, technical director at FASB, “obviously folks had other things to worry about. So we refocused all of our efforts on finishing a couple of projects that were very important to the capital markets and that were almost done, and then turned our attention to Covid-19.”

As he explains, the board is taking a three-pronged approach of deferring dates, providing practical interpretations of the guidance already released and helping develop reasonable applications of GAAP to account for Payment Protection Plan loans. “The Board understood that the economy had a shutdown, and businesses were really just trying to focus on survival at this point, so we deferred the effective dates for two standards [Revenue from Contracts with Customers (Topic 606) and Leases for Certain Entities (Topic 842)], which would shift the focus away from implementation to managing the company.”

“We also explained how to interpret certain standards,” he says. “As an example, in the case of hedging, we said, ‘Here’s when the pandemic happened in the cases of hedging, here’s what you can consider to be rare, here’s how you would account for your hedge under this situation in a pandemic,’ and laid it out in very plain English.” Furthermore, he adds, “working with our capital market partners and the AICPA, we developed guidance around the small-business loans provided by the government that companies didn’t necessarily have to pay back, which didn’t exist in our current GAAP literature.”