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Impact of covid-19 on non-financial  assests

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The COVID-19 outbreak has developed rapidly in 2020, with a significant number of infections.  Measures taken to contain the virus have affected economic activity, which in turn has implications for financial reporting. Measures to prevent transmission of the virus include limiting the movement of people, restricting flights and other travel, temporarily closing businesses and schools, and cancelling events.  This will have an immediate impact on businesses such as tourism, transport, retail and entertainment. It will also begin to affect supply chains and the production of goods throughout the world and lower economic activity is likely to result in reduced demand for many goods and services.  Financial services entities such as banks that lend to affected entities, insurers that provide protection to affected individuals and businesses, and funds or other investors that invest in affected entities are also likely to be affected. Management should carefully consider the impact of the COVID-19 on both interim and annual financial statements.  The impact could be significant for many businesses.

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The impairment requirements in IAS 36 apply to the following types of assets: Goodwill Intangible assets Property, plant and equipment Right-of-use assets Associates and joint ventures accounted for using the equity method Investment properties measured using the cost model Cost to obtain or fulfil a contract recognised under IFRS 15  Revenue from Contracts with Customers.

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IAS 36 – WHEN THE IMPAIRMENT IMPLICATIONS OF COVID-19 SHOULD BE RECOGNISED

Determining when the effects of COVID-19 should be reflected in the impairment calculations in accordance with IAS 36 will depend on:   The period end of the financial statements (i.e. the balance sheet date); and   The sector and geography in which the entity operates. The effects of COVID-19 are generally a ‘non-adjusting’ subsequent event as at 31 December 2019. Significant government action and intervention began to take place on 30 January 2020 when the World Health  Organisation  declared coronavirus to be a global health emergency, which generally triggers the recognition of the broad economic effects of the outbreak in financial statements.  However, 30 January 2020 should not be seen as a ‘rule’ for when entities should begin  recognising  the effects of the outbreak. For example, a manufacturer with a 31 December 2019 year-end that imports significant amounts of inventory from the Wuhan region of China could have experienced disruption arising from the outbreak prior to 30 January 2020 (because there were significant effects in late 2019), and therefore this uncertainty would have been considered as at the 31 December 2019 year-end in the entity’s application of various accounting policies, including impairment. This is because, on the basis of information known at 31 December 2019, one of the reasonably possible scenarios may have been significant effects from COVID-19 .

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Furthermore, the effects of the outbreak are evolving and changing on a day-to-day basis, such that it may be difficult in a practical sense for entities to ‘cut-off’ the information that is relevant as at a particular period end.  While it is not appropriate to use hindsight, it will be appropriate to assess whether the various scenarios that are used for the purposes of IAS 36 at each reporting date incorporate reasonable and supportable assumptions at that date about the range of economic conditions that are forecast to exist in future. Below is an illustrated timeline:

30 January 2020 WHO announcement of coronavirus as a public health emergency 29 February 2020  Financial year end March 2020  Government takes action that affects the future of the entity operations. Information available up until 29 February 2020 must be considered, including making estimates of the outcome of uncertain future events ( e.g  how much sales may decrease by) Determine whether information obtained subsequent to period end relates to conditions that existed as at period end

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IAS 36 requires assets within its scope to be tested for impairment  when indicators of impairment exist at the end of a reporting period (IAS 36.9).  Many of the indicators of impairment noted in IAS 36.12(a)-(h) may exist due to the effects of COVID-19, including declines in quoted asset values, operational disruptions to supply chains, and decreases in revenue and profitability.  Many entities will have to perform impairment calculations in accordance with IAS 36, and these calculations may need to be significantly more detailed than have been prepared at previous period ends. IAS 36 requires goodwill, intangible assets with indefinite useful lives and intangible assets not yet available for use (e.g.  capitalised  research costs on incomplete intangible assets) to be tested at least annually for impairment and at the end of each reporting date whether there is any indication of impairment (IAS 36.9-10).  Consequently, entities that prepare interim financial statements may need to prepare impairment calculations on these assets more regularly as indicators of impairment may exist at multiple reporting dates despite the minimum requirement (i.e. an annual test) having been carried out already.

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For example, an entity with a 31 December 2020 year-end may have tested its goodwill and indefinite life intangible assets for impairment as at 31 December 2020.  Despite this, the entity may need to test the same assets for impairment again prior to 31 December 2021 (the next mandatory testing date), because indicators of impairment may exist at an interim reporting date.  As a result of COVID-19, almost all entities that prepare interim financial statements would be expected to be required to carry out an impairment test at the next reporting date in 2020 (whether this is 31 March for quarterly reporters or 30 June for entities that only publish half year interim financial statements).

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An asset or CGU is impaired if its carrying amount exceeds its recoverable amount.  The recoverable amount is the higher of an asset’s fair value less costs of disposal (FVLCD) and value in use (VIU). Impairment losses are recognised in profit or loss.  Value in use (VIU)  VIU is determined by  estimating future cash flows from the use and ultimate disposal of the asset, and discounting these to their present value using a pre-tax discount rate that reflects current market rates and the risks specific to the asset.  The discount rate does not reflect risks for which future cash flows have already been adjusted because this would result in the risks being ‘double counted’.  This means that when calculating VIU for a CGU, the entity will either apply risk adjustments to The cash flows (for example by assigning probability weightings to various possible cash flow scenarios),  or The discount rate.

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Discount rates are not entity specific; they reflect the current market assessment of the time value of money and the risks specific to the assets (IAS 36.55).  The rate is meant to be representative of what market investors would require when choosing an equally risky investment, resulting in the use of a rate which is estimated based on the rate implicit in current market transactions for similar assets, or from the weighted average cost of capital of a listed entity that has a single asset (or portfolio of assets) similar in terms of service potential and risk to the asset (or CGU) under review (IAS 36.56); and  This may be especially important to note given the increased uncertainty in cash flow projections affected by COVID-19.  However, an appropriate discount rate in a VIU calculation with multiple scenarios may still increase compared to previous impairment calculations, as market investors may require higher returns in order to accept risks that are not wholly entity-specific (e.g. risks related to a particular industry sector).  Additionally, entities may have previously used a single, best estimate cash flow projection in their DCF models. Such an approach may have been appropriate when the variability in future cash flows was low or the risks inherent in the cash flows could be appropriately captured in the discount rate used. Given the high level of uncertainty that COVID-19 creates, entities may be required to consider multiple scenarios in a DCF model, each of which are probability weighted.

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When determining VIU, it is important that the estimates of future cash flows are realistic.   Ordinarily, past performance is likely to be a useful starting point for the estimation of projected future cash flows.   However, in the current environment, models of the future will need to incorporate unprecedented shocks, as decreases in asset values, decline in demand for goods and services and supply chain disruptions may be dissimilar to any previously encountered scenario.   This will make forecasting particularly difficult, which may mean that additional disclosure of the key judgements made and estimates used may be required. Most governments had mandated social distancing rules and varying degrees of ‘lock down’ by the end of March 2020, so these actions will be factored into cash flow forecasts for impairment models for entities with 31 March 2020 reporting dates.  However, the requirement not to use hindsight in impairment models may be more difficult to implement for entities with January or February 2020 reporting dates, because information regarding the effects of COVID-19 was changing rapidly and governments took actions at different times.  Therefore, deciding whether information subsequent to reporting date relates to conditions that existed at reporting date (and therefore should be built into impairment models), or whether it relates to post balance date events is not straight-forward.

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IAS 36 – DETERMINING THE RECOVERABLE AMOUNT

To measure impairment,  the recoverable amount of an asset or CGU is compared to the asset’s (or the CGU’s) carrying value amount.  The recoverable amount is the higher of:   Fair value less costs of disposal (FVLCOD); and   Value in use (VIU).  Recoverable amount is a ‘higher of’ test and it applies regardless of how management intends to use an asset.  For example, if the carrying value of a CGU is higher than its VIU and management has no realistic intention of disposing of the CGU, if its FVLCOD is higher than its carrying value, the CGU is not impaired. This approach therefore prevents management from making provisions for future operating losses. VIU calculations will always require a discount rate to be used and, if FVLCOD is estimated using a discounted cash flow (‘DCF’) model, then discount rate considerations will be applicable to both.

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Scenario
I - positive
case
- base case
3 - negative
case
4 - worst case
Probability
Weighting
Key Assumptions
Operations at sit down restaurants are halted
for 4 weeks, take-out and delivery options are
popular With consumers and result in a net
reduction in revenue Of for the year.
Operations at sit down restaurants are halted
for 8 weeks, take-out and delivery options only
compensate for a portion of lost revenue and
result in a net reduction in revenue of for
the year.
Operations at sit down restaurants are halted
for 12 weeks, take-out and delivery options
only compensate for a portion of lost revenue,
resulting in a net reduction in revenue of
for the year.
Operations at sit down restaurants are halted
for 20 weeks, take-out and delivery options are
not popular With consumers and operational
and supply chain disruptions require most take
out options to cease operations, resulting in a
net reduction in revenue of for the year.
Discount
Rate
Used*
single
rate is applied to each
unting' of the risks,
p ehted
the rate æfQts the risk to the
for which Applying a to each
refl«ted in the cash
flows the

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Fair value’ is defined in IFRS 13, Fair Value Measurement as ‘The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ’Depending on an entity’s period end, the price it would receive at that specific point in time may be significantly lower than prices or estimates of prices it may have received at previous dates due to the implications of COVID-19 on global asset prices, availability of capital and risk appetites of market participants. These decreases in value at a point in time may appear to be a ‘distress sale’ requiring adjustment in the fair value estimation.  However, other than in extreme cases, such decreases in value would not be attributable to factors that would be adjusted for (e.g. a lack of current information, declines in trading).  Significant decreases in prices at one point in time are a consequence of fair value measurement, which is a current amount as at the period end.  Similarly, the fact that there may have been a significant reduction in trading volumes for a particular asset listed on a public market does not mean that it is appropriate to disregard the ‘level 1’ quoted price.As noted in the previous section, many FVLCOD estimates may be carried out using a DCF model.  In these cases, the model used is likely to incorporate significant unobservable inputs (e.g. financial forecasts developed using the entity’s own data – IFRS 13.B36(e)), which require specific disclosures (IFRS 13.91-99).

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Whereas FVLCOD is not an entity-specific measure, VIU is entity-specific to the extent that the cash flows included in the model reflect the expected cash flows to be derived from the asset/CGU.  This reflects management’s intentions (e.g. how it expects to deploy the asset or CGU to generate cash flows). The effects of COVID-19 may significantly impact DCF models used, as noted in the earlier sections, however, several points should be considered in VIU calculations:  The expected effect and endurance of operational disruptions (i.e. the slope and severity of the ‘V- curve’ as noted earlier), which will be affected by the jurisdiction and sector in which the entity operates. Note that the ‘V curve’ above has been used for illustrative purposes; depending on information available at a reporting date, and the economic and other forecasts at that time, the curve may be different, such as ‘U’ or ‘W’ in shape;  The availability of necessary resources to ‘ramp up’ operations once the entity expects to be able to increase (or resume) operations (e.g. employees, raw materials, etc.);  The survival rate of competitors; The demand for its goods and services during and following the harshest effects of the outbreak(e.g. a medical supply firm vs. a tour operator); and  VIU calculations are based on assets in their current condition. That is to say, future  restructuringsto  which the entity is not yet committed or improvements to assets may not be considered (IAS 36.44).  Therefore, if an entity is considering a significant overhaul to its operations to redeploy assets given the outbreak, these cash inflows and outflows may not be considered unless an entity is committed to such a restructuring (e.g. the plan has started to be implemented and the main features have been announced to those affected).

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Right-of-use assets (lessees) Businesses (lessees) that have received rent concessions from landlords need to consider whether this is an indicator of impairment at reporting date, and if so, either test the ROU asset for impairment individually (usually only possible where the ROU asset generates independent cash flows, such as via a sub-lease), or as part of a CGU. IFRS 16 may also result in the recognition of more corporate ROU assets, e.g. leased corporate head office, which must be allocated appropriately to CGUs for impairment testing purposes.  It is clear to see that covid-19 has had a ripple effect on the international accounting standards let alone the economy as a whole. It caused many businesses not to comply with laws and regulations to combat the many losses made however there were many businesses that pulled through regardless of the circumstances whilst some unfortunately could not.

https:// www.pwc.com /m1/en/publications/covid-19/in-depth-look-at-current-financial-reporting-issues.pdf https:// www.bdo.global /en-gb/home

Impairment loss
ias36

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 https:// www.pwc.com /m1/en/publications/covid-19/in-depth-look-at-current-financial-reporting-issues.pdf https:// www.bdo.global /en-gb/home

Impairment loss ias36

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