With the initial phase of lockdown now behind us, the focus has turned to the future, and the steps that companies and their advisers are taking to ensure that they are able to report on the pandemic at year end.

Directors will be exercising more judgement than usual when preparing the accounts. New accounting policies will be needed for new areas, such as government support. Greater uncertainty hovers over the recognition and measurement of assets and liabilities, and income and expenses.

Accountancy watchdog the Financial Reporting Council (FRC) is encouraging companies to provide full disclosure, detailed but specific to the company’s circumstances, says Alex Owen of the Corporate Reporting Review team. 

“Although IFRS distinguishes between accounting judgements and estimation uncertainty, in the current environment we’re encouraging companies to provide as much detail as possible to explain both the judgements and estimates underlying the amounts presented,” explains Owen.

Companies will also be considering whether the pandemic has triggered an impairment assessment and, if so, they will have to consider the impact on tangible and intangible assets. Factors such as the loss of key customers or suppliers or a reduction in business will need to be reflected in estimated future cash flows and assumptions around the discount rate to calculate the new values.

Investment property is likely to be one of the asset types most difficult to value in the current environment because of the lack of market data. Directors will be doing the best they can to value these properties, providing more detailed disclosures to back up their estimates.

The inventory situation may have changed a lot in the past few months and revaluations may be needed in several situations.

Many companies have lost customers, or customers are paying late or making partial payments, leading to concerns over debt recoverability. Companies that report under IFRS will be estimating the credit losses arising from the impact of the pandemic and showing the increase in provisions for expected non-recoverability. 

Meanwhile FRS 102 reporters will be considering whether there is objective evidence of debt impairment at the balance sheet date and whether this means they need to recognise an impairment loss.

Companies that trade with hard-hit sectors such as aviation or leisure will be adjusting their bad debt provisions to take into account the higher possibility of default or insolvency among their customers.

Companies will have checked contracts to see whether they could become onerous, and can recognise provisions for the lower cost or cancellation penalties against contracts defined as onerous in IAS 37. This will not apply if contracts have been cancelled without penalties or without obligation to fulfil their part of the contract.

Many businesses started lockdown by reviewing their bank covenants to ensure these were not breached – reviews that are continuing as business picks up. Directors have to be aware that any breach in covenant can change the classification of a liability from non-current to current, unless the lender issues a waiver.

Most of the adjustments put through to reflect the impact of COVID-19 on a business will have an impact on the distributable profits, which in turn affects dividends. “The risk of payment of illegal dividends is greater and that’s a worry for auditors,” says Katharine Bagshaw, ICAEW Manager, Auditing Standards.

And companies need to be careful in distinguishing between adjusting and non-adjusting post balance sheet events, says Marianne Mau, Technical Lead on Financial Reporting at ICAEW. 

“Information that sheds light on conditions that existed at the reporting date should be taken into account when measuring assets and liabilities,” says Mau. “To the extent information on COVID-19 is adjusting or non-adjusting will depend on individual facts and circumstances and, in particular, the reporting date. Details of material non-adjusting post balance sheet events should be disclosed in accounts.”

ICAEW’s guidance on going concern for SME directors, published in May, suggests companies start by adjusting expected cash flows for changes in circumstances specific to the industry and business and to reflect the broader economic environment.

Disclosure needs to be very clear, says Phil Fitz-Gerald, Director of the FRC’s Financial Reporting Lab. “Companies are starting to issue information on different scenarios that could arise and how they will respond. We also hope to find a lot of that information in the viability statement, as companies that follow the UK Corporate Governance Code and include a viability statement are encouraged to include the results of their stress and scenario testing.”

Directors will be considering any material uncertainties that cast doubt on the company’s ability to continue as a going concern and what possible mitigating measures will be open to them. “If it’s a close call as to whether there are material uncertainties, that itself is the sort of judgement that needs to be disclosed,” says PwC partner Peter Hogarth.

Directors of large companies are required to produce a s172 report, explaining how they have had to consider wider stakeholder needs.

This balancing of shareholder with stakeholder interests covers financial decisions such as dividend payments, executive pay and capital allocation, all of which will come under greater scrutiny this year. The pandemic will have shone a harsh light on dependencies, such as key suppliers being unable to produce or deliver goods, or significant price changes.

Auditors have their work cut out over the months ahead. Given the issues around assumptions and judgements in highly volatile trading conditions, they need to be much more robust with management – difficult if they are unable to talk face to face.

The scope of the work is likely to increase. Finance teams have been working from home and so auditors have to consider and test controls in three separate periods: those operating before the restrictions, during lockdown and after.

There’s a need to watch out for fraudulent financial reporting. “Auditors need to be aware of opportunities for burying bad news: Brexit is one, COVID-19 is another,” says Bagshaw. “Companies could put excessive provisions in place so next year’s results are improved when these are released.”

The extraordinary times do not mean there should be a relaxation in standards – far from it, says Steve Gale, Head of Audit at Crowe UK. “This is not a time to be going soft on companies. Rigour, challenge and scepticism need to be employed, and a questioning mind is vital. It’s about asking difficult questions, identifying pinch points and ensuring directors and management are realistic with their assumptions.”