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The upheaval to society and the economy caused by COVID-19 has resulted in many new arrangements for Australian businesses.
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Financial reporting for COVID-19-related changes
29 May 2020
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In anticipation of the 30 June 2020 financial year-end, we’ve highlighted the financial reporting implications of the more common changes businesses are experiencing. These include the impact of COVID-19 on going concern status, the implementation of the JobKeeper scheme, an altered rental market, and cash-flow shortfalls affecting loans and financing arrangements.
Going concern
While going concern is inherently a company-specific assessment, directors should be prepared to include some narrative in financial statements explaining why the entity is a going concern. This might include discussion of operating, investing and financing impacts the company has already experienced; the near-term opportunities; and risks and consequences in terms of the need to raise future capital or extend financing arrangements where liquidity and working capital are under pressure.
Consequential impairment of assets and collectibility of receivables should also be considered. Robust disclosure would address how COVID-19 conditions have affected the company’s core operations in terms of ability to serve customers, temporarily or permanently closed stores, laid off staff, curtailed investment activities as well as the current status and plans to bring operations back online.
Ask your auditors if they expect to include some mention of going concern pressures in the audit report and manage your board and stakeholders early.
JobKeeper
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The JobKeeper scheme provides up to $70 billion to Australian businesses as support payments to keep employees from being made redundant. JobKeeper receipts are accounted for as government grants under AASB 120 Accounting for Government Grants and Disclosure of Government Assistance. These can be presented either as other income or as a reduction of the related employee costs. The presentation approach you choose should be applied consistently to all similar grants.
If you have capitalised the employee expenses to which the JobKeeper payments relate under another accounting standard (e.g. as part of property, plant and equipment under construction), then receipts under the scheme should be accounted for as government grants related to assets under AASB 120. You can present the payments either as:
• deferred income in the balance sheet and amortised over the useful life of the related asset, or
• as a reduction of the carrying amount of the assets resulting in a reduced depreciation expense.
Other stimulus payments such as business assistance grants would be similarly assessed.
Changes to lease arrangements
COVID-19-related disruption has resulted in many businesses being forced to either withhold rental payments, negotiate rental concessions with landlords or take advantage of the concession measures for small and medium-sized entities (SMEs) set out in the government’s rental code of conduct.
Generally, changes to a contractual lease arrangement that are legally effective or agreed to by the lessor may require remeasurement of lease balances. The IASB has provided a practical accommodation for COVID-19-related lease contract amendments agreed with lessors. Provided certain criteria are met, lessees can elect to account for all rent concessions in relation to rental payments due before 30 June 2021 immediately in profit and loss (P&L). No adjustment or remeasurement of existing lease balances is required. If adopted, application of the concession is required consistently for all lease contracts with similar characteristics.
We’ve explained the financial reporting consequences of some of the most common rental arrangements in Table 1.
Table 1. Financial reporting impact of changes to common rental arrangements
|
Type of change to rent |
How it will affect your financials as a lessee |
|
Lessee unilaterally withholds payment without landlord consent in breach of the rental contract. |
Continue to accrue for unpaid rent contractually due. Lease amortisation expense in the P&L will not change. Any accrual should not be derecognised before either: • the landlord has consented to a waiver of the contractual obligation, or • the lessee is eligible to claim concessions under the government SME commercial leasing code of conduct. |
|
Landlord agrees to defer current rental payments due, with future repayments increased in compensation. |
If the future repayments are adjusted inclusive of the time value of money, then no lease modification will have taken place. Lease amortisation expense in the P&L will continue to be recognised except for some minor interest accretion if material. A corresponding increase in lease liability will be recognised representing future repayments incurred. |
|
Lessee obtains contractual rental holiday or rental concession for the next few months without any obligation to make good in the future. |
Lessee can take advantage of the IASB concession to recognise the benefit of the holiday as a reduced lease expense through P&L in the current period. Making this election avoids any requirement to undertake a complex “modification” and potential remeasurement of the net present value (NPV) of lease liabilities. |
Changes to loans and financing arrangements
Given cash-flow constraints, many businesses have been required to renegotiate loan arrangements and seek covenant waivers. Generally, banks have been willing to support businesses through cash-flow shortfalls but have not yet offered further concessions or interest waivers. Some common scenarios relating to banking arrangements are included in Table 2.
Table 2. Financial reporting impact of changes to banking arrangements
|
Type of change to loan |
How it will affect your financials as a lessee |
|
Borrower has a covenant breach during the period and seeks a waiver from the bank. |
Timing for the grant of a loan waiver is critical. If a waiver isn’t obtained by year-end, even if before the financial statements are completed, the entire loan must be classified as current. This is because the lender has the contractual right, as of balance date, to call the loan due to breach of covenant. Even a timely covenant breach waiver might not be sufficient for non-current classification depending on the terms. For example, it might impose further conditions over the next 12 months that could cause the loan to be called. Cross events of default clauses should carefully be considered as each breach needs to be cured by balance date for the related debt to be classified as non-current. |
|
Lender agrees to a deferral of principal repayments for a short period. Interest continues to accrue on the outstanding balance and still must be paid. Additional interest set to compensate lender for repayment deferrals. |
There will be no remeasurement of the liability in the borrower’s balance sheet at the date of change to an interest-only basis unless the NPV of the loan has materially changed. An increased interest expense would be recognised prospectively as a result of the loan balance remaining unchanged until repayments of principal restart. |
|
Lender agrees to capitalise both interest and principal repayments for a short period. Interest continues to accrue on the outstanding balance. |
There will be no remeasurement of the liability in the borrower’s balance sheet as the NPV of the loan has not changed. An increased interest expense would be recognised prospectively as a result of the loan balance increasing until interest and principal payments restart. |
The topics discussed are only an illustration of some of the challenges companies will face when preparing financial reports over the next few months. Other areas of challenge include hedge arrangements, impairment, expected credit losses on receivables and revenue recognition. Finance teams should ensure they consider these well in advance of year-end to ensure they meet their legal obligations and can give a transparent account of COVID-19’s impact on their business to manage stakeholder expectations.
John Ratna, Akuntina Novriani, David Waters, PwC Australia
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