As every year we make a summary of aspects to be taken into account at year-end, we are living a unique situation that will have an impact on the year to be closed
Possible Covid effects at year-end 2020
During the year that has just ended, we have experienced a situation unprecedented in recent times, the beginning of a pandemic with major repercussions in the health and economic spheres, which we are still experiencing. For example, the International Monetary Fund, in April 2020, already predicted a contraction of the world economy by 3%, the World Bank has warned that the commodity market is in shock, significant falls in revenues and profits are expected and company managements are starting to implement cost containment policies.
All entities, whether non-profit, S.A., S.L., Cooperatives, small, medium or large companies, international or national, have been affected by Covid, and we must be able to explain in the financial statements of each one of them in an adequate manner, both quantitatively and qualitatively, making the appropriate explanations in the different sections of the financial report.
The purpose of this summary is to help you to think about some of the impairment losses that may exist, independently of the corresponding analysis to be made by each entity.
Impairment of non-financial assets (fixed assets, goodwill, inventories)
The calculation of impairment linked to non-financial assets has always been one of the workhorses of many companies. In this section, and taking into account the current situation, the hypotheses we were using for the projection of cash flows for the calculation of recoverable value will probably be affected, possibly implying a short-term reduction in these. As always, we must provide sufficient and appropriate information to understand these changes, explaining the change in the key assumptions and their impact.
We should also take into account possible impairments on inventories, both for obsolescence and realisable values, and also pay special attention to goodwill.
Impairment linked to financial assets
This section deals with the same point as the previous section on updating the assumptions that support the present value of future cash flows of financial assets measured at cost.
Apart from financial instruments at cost or available for sale, this section also includes customers, where there may be an increase in risk, either due to an increase in their credit risk or the loss of guarantees, and a more detailed study should be carried out at year-end. It should be remembered that, as with all provisions, they are reversible as they are made on the basis of certain assumptions at a certain date.
Likewise, reclassifications from short-term to long-term accounts may occur due to renegotiations, in which case the corresponding restatements should be made to these amounts.
Other points that are not as general in the business area as the customer section are hedging instruments, in this case we may find that they were hedging highly probable transactions and in the current situation they may no longer be hedging instruments.
Risk and uncertainties
Risks and uncertainties are more difficult to assess due to the high degree of uncertainty that exists in the markets, so it is necessary to focus on each of these and try to assess them in the most reasonable way. For example, liquidity risk will be one of the key risks, and sufficient funding must be available to safeguard against the risks of default or decline in the company’s business, credit risk may increase due to the current environment, and the company must analyse whether it will recover the amounts owed to it, as well as market risks (currency, price or interest rate).
As mentioned above, the estimates made to date and their assumptions may be affected, in which case the estimates corresponding to the useful life of assets should be revised.
We may also encounter reclassifications of available-for-sale assets to fixed assets, with a corresponding effect on the depreciation charge and vice versa.
Investment property and its income can clearly be affected by this situation and in many more cases than the legislation allows for the possibility of applying rebates or deferrals. In those cases where we have applied rebates to rental income, we will have to study the consequences for VAT, personal income tax and corporate income tax.
There are different consultations on the treatment of deferrals and forgiveness of rent in operating leases (consultations: no. 3 of BOICAC 87 and no. 11 of BOICAC 96, as well as the update of the IAS on lease income IFRS 16).
In these cases it is worth remembering the current regulations, which specify that if the conditions are substantially different in debt refinancing operations, we may consider the derecognition and subsequent recognition of the financial liabilities affected by the operation.
We must also pay special attention to the possible breach of covenants and their impact on the classification of short-term debt.
And we must correctly record loans received with guarantees granted by the State or other guarantees (ICO loans).
We should review the projections used for the activation of deferred tax assets and check compliance with the conditions for the activation of deductions and allowances.
We shall analyse whether there are existing obligations at year-end that should be recorded, evaluating them and explaining the value judgements adopted for their evaluation. There may be onerous contracts at year-end, as well as including an analysis to ensure that there are no breaches of commitments acquired, such as, for example, the commitment to maintain the workforce in companies under ERTE.
It should be remembered that it is not possible to provide for expected future losses.
ERTEs have had and continue to have a great impact on companies, leading to the registration of public aid and certain limitations on the distribution of dividends (art.5.2, RDL 8/2020, of 12 May). Likewise, special attention should be paid to commitments to employees (bonuses, prizes according to the collective agreement, etc.), to the registration of time off, to deferrals of registered holidays, etc.
Many entities are encountering public subsidies. We must study their nature in order to register them, the time of their recognition and study the certainty of compliance with the conditions.
In the case of ERTEs, as explained in the current consultations, we should record the corresponding subsidy for the amount covered by the Public Administration corresponding to the employer’s contribution (BOICAC no. 122 consultation no. 1).
On the other hand, there are some entities with public tenders in which a balanced budget has been requested. In these cases, we must study compliance with the conditions and assumptions made for the study of this balance, and in these cases the subsequent events are of great importance for the verification of their collection and acceptance.
Extraordinary income and expenses
In many cases, some companies record income and expenses related to the effects of Covid under extraordinary items, and the nature of these items and their classification should be analysed.
Going concern principle
The going concern principle is one of those that should be analysed, providing sufficient information in the notes to the financial statements, analysing: negative working capital, significant accumulated losses, losses for the year, non-positive future estimates, cash flow tensions, debt deferrals, etc.
The company must analyse the current situation and the measures to be applied in the future, updating budgets and forecasts, with a study of the different scenarios, applying the measures corresponding to each of them, adapting the plans and analysing that they are achievable.
In this regard, we should remember the suspension of the cause of dissolution due to losses, as well as the postponements in the filing of the insolvency application established in articles 13 and 6 of Law 3/2020, of 18 September. Whereby it is indicated that the losses generated in the current financial year will not be taken into account for the calculation of the cause for dissolution due to losses.
As we have already mentioned, we are still in the midst of the pandemic and we will be experiencing constant changes, for this reason, we must pay special attention to the events after the closing that could affect us and to the high level of regulations that the government is publishing.
We are at your disposal to analyse any of these sections or others that may affect your company and, as always, we recommend that you carry out the accounting close with sufficient time to consider those provisions, estimates, etc. that our daily routine does not allow us to outline.
For this new year, perhaps we should adopt the mantra “hope for the best, but prepare for the worst”.