COVID-19 and financial statements after 31 December 2019

In addition to the first two contributions, we are providing answers to potential accounting questions in connection with financial statements and consolidated financial statements with reporting dates after 31 December 2019 on the basis of the practice statements published by the Institute of Public Auditors in Germany [Institut der Wirtschaftsprüfer e.V. (IDW)] on 25 March 2020:

What is the effect of the COVID-19 pandemic on overall accounting policies?

COVID-19 crisis as value-ehancing or value-justifying event  

For financial statements with a reporting date after December 31, 2019, it must generally be assumed that the current knowledge about the consequences of the coronavirus gained after the reporting date must be regarded as value-enhancing and taken into account in the accounting. In every case testing is required in how far value-justifying events are possible in relation to the general economic effects on the company. In general, it can be assumed that the further the reporting date after 31 December 2019, the less likely it is that a value justification should be assumed. As of March 31, 2020, it is regularly assumed that the pandemic must be taken into account in the financial statements.

Retrospective consideration of reorganisation measures In breach of the cut-off date principle, the prevailing opinion in Germany considers it permissible to take account of the accounting consequences of a restructuring measure implemented after the cut-off date in the financial statements as of that date. Conditions for such recognition are that no distributable (balance sheet) profit arises from the reorganisation measure, that the measure has become legally effective at the latest at the time of the completion of the preparation of the financial statements and that it is explained in the notes.

Valuation units

Some "anticipatory valuation units" may have to be reversed, in which future and highly probable forecast sales or procurement transactions were previously combined as items with corresponding hedging items. In the context of the COVID-19 crisis, the new developments may no longer permit to assume with a probability bordering on certainty that the expected transaction will actually take place or at the time previously assumed..

Also non-anticipative valuation units must also be reversed if a financial instrument included as a hedged item (in the case of a financial instrument with receivables character) or as a hedging instrument is to be classified as acutely exposed to default as a result of the effects of the corona pandemic. Commitments from government relief measures must be taken into account in the process of evaluating the possible reversal of such items, in particular for companies that have enjoyed a stable economic situation to date.

What is the effect of the COVID-19 pandemic on individual accounting items?

Intangible and tangible fixed assets

Where as a result of the COVID-19 crisis intangible fixed assets (e.g. software) or fixed assets (e.g. technical equipment, machinery) are temporarily not used or only used to a limited extent or where they are even subject to permanent restrictions on use (e.g. shutdown), the question arises as to whether unscheduled write-downs are necessary due to permanent impairment. A presumably permanent impairment in the value of depreciable fixed assets is assumed if the fair value on the balance sheet date is below the value resulting from scheduled depreciation for a considerable part of the remaining useful life. A considerable part is to be assumed if it exceeds half of the remaining useful life or a period of five years. If the reasons for a lower valuation existing after an unscheduled write-down no longer exist at a later reporting date, a write-up is required, expect for goodwill. Financial assets

In the event of an expected permanent impairment, financial assets must be written down; if the impairment is not expected to be permanent, there is an option to write down the asset.

A permanent value impairment of publicly traded securities (e.g. stocks of listed companies) is to be assumed if the fair value of the securities was either permanently more than 20 % below the last book value in the six months preceding the closing date, or if it was below the last book value for a period longer than one financial year and, in addition, the average of the daily closing prices of the security over the last twelve months was more than 10 % below the last book value. When testing the recoverability of investments or shares in unlisted companies using the dividend discount model or the discounted cash flow model it must be taken into account that the financial surpluses included in the calculation – in consideration of public support measures – are often likely to deteriorate compared to previous forecasts as a result of the effects of the corona pandemic. If this calculation results in a value that is below the previous carrying amount of the investment or shares, it must be assumed that the impairment is likely to be permanent. Where no write-downs were made since the impairment of financial assets was not expected to be permanent, the reasons for omitting such write-downs and the basis for concluding why the impairment is not expected to be permanent must be disclosed in the notes.

Inventories

When determining the production costs, the prohibition on recognising "idle-time costs" is to be taken into account. If facilities are temporarily shut down as a result of the COVID-19 crisis, if there are other restrictions on use that lead to considerable limitation of the capacity utilization, or if production processes are interrupted due to bottlenecks in supply chains, costs attributable to these periods are not reasonable and not due to production and may therefore not be included in the manufacturing costs, but represent expenses of the period in which they are incurred.

Furthermore, write-downs may result primarily from the complete loss of marketability, a lower turnover rate or increased storage costs as part of loss-free valuation. If the reasons for unscheduled depreciation no longer apply, a later reversal of the impairment loss is required.

Trade receivables

As a consequence of the COVID-19 pandemic, the general credit risk and the default risk of certain trade receivables will as a rule be higher. Where trade receivables are not settled by the debtor, not settled completely or not on time, corresponding specific bad debt allowances are to be set up or such receivables may sometimes even have to be written off. Furthermore, it should be checked whether the general bad debt allowances can be increased to the level of trade receivables for which specific bad debt allowances have been set up previously.

Deferred tax assets

For the possible recognition of deferred tax assets from temporary differences and from tax loss carryforwards in the balance sheet it must be probable that future taxable profit will be available against which the deductible temporary differences or unused tax losses can be utilised in the periods during which the differences are expected to diminish. Deferred taxes from the use of tax loss carryforwards are also subject to the limitation that they may only be used within the following five years. If future taxable income ceases to exist or is reduced as a result of the COVID-19 crisis and if therefore previously recognised deferred tax assets can no longer be realised, related value impairment is required.

Other provisions

If the presumption of equilibrium between the value of the benefit obligation and the value of the consideration claim can no longer be maintained at the expense of the balance sheet for sales or procurement transactions pending on the reporting date as a result of the corona pandemic, a provision for impending losses on the liabilities side must be recognized. If a pending sales transaction with positive contribution margins, which is loss-making at the bottom line, is concluded in times of the COVID-19 pandemic in order to improve capacity utilisation, a risk of loss arises which must be recognised as a provision for impending losses, including pro rata fixed costs.

The contracts underlying the pending transactions should be examined for so-called Material Adverse Effect (MAE) or Force Majeure clauses. If a contract contains such clauses the obligation of the reporting entity to accept or deliver would be suspended and for this reason the obligation to recognize a provision for impending losses on the liabilities side would no longer apply. At present, however, a court decision as to whether the coronavirus constitutes a case of "force majeure" and from what point in time and for which regions this is to be assumed in each case is still pending. If restructuring measures are adopted in response to the effects of the Corona pandemic, it must be considered whether the resulting obligations should already be taken into account in the financial statements in question in the form of a liability provision.

Liabilities

The COVID-19 crisis does not affect recognition of liabilities. If any covenants cannot be complied with as a result of the Corona pandemic and if noncompliance entitles the creditor to call in a loan prematurely, this does not affect the valuation of the liability. but the remaining terms to be disclosed are affected. If the repayment of loans is demanded, the going concern assumption may be affected.

What particularities arise from the COVID-19 crisis on consolidated accounting?

Due to the effects of the corona virus, it may be necessary to test for impairment the goodwill or disclosed hidden reserves arising from the capital consolidation of subsidiaries. If the value is not recoverable, an unscheduled write-down must be made. The same applies to shares in associated companies and joint ventures which were reported in accordance with the equity method If in the separate financial statements of the parent company an impairment loss is recognised for investments in subsidiaries, joint ventures or associated companies, such impairment loss is an indication that a value impairment of goodwill may also be required in the consolidated financial statements.

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Accounting questions in connction with public relief measures and the going concern assumption