FRS 102 recognition issues under COVID-19

The impact of COVID-19 is being felt throughout the UK. Coronavirus will change the way business operates, even if only in the short-term. Detailed consideration for the financial statements of entities impacted by the coronavirus situation will be needed in many areas. Here are some in relation to the figures that make up the financial statements under FRS 102.

Impairment – financial asset

Section 11 of FRS 102 Basic Financial Instruments is applied when assessing whether financial assets (listed below) should be impaired.

trade and other receivables;
loans to directors, employees and shareholders; and
loans to connected entities.

COVID-19 factors could indicate that some or all of a debtor will not be recovered, or recovered later than originally expected. There could be debtors in significant financial difficulty and entering, or potentially entering, bankruptcy or some reorganisation.

Impairment – non-financial assets

All non-financial assets, dealt with in Section 27 Impairment of Assets, should be tested for impairment when there is an indication of impairment – i.e. something that indicates that an asset might be carried at more than it can be recovered for. There is no doubt that COVID-19 will have a significant impact on many entities when they assess whether non-financial assets are recoverable. There are already impairment indicators such as difficult trading conditions, decline in the economy and job losses. This means that careful consideration and a detailed impairment test will be required for many entities to determine whether goodwill, intangible assets, property, plant and equipment, investment property, investments in associates and joint ventures, and investments in subsidiaries are recoverable.

Fair value measurement

Items measured at fair value (e.g. investment property) require careful consideration. Fair value is determined based on market data at the measurement date (year end) under current market conditions. Shares prices are highly volatile. Based on the current position, one would expect significant declines in the fair values of shares, with a corresponding expense in profit or loss. Similarly, the fair values of investment property are likely to decline; and lessors may find that tenants are unable to pay.

Stock and WIP write-downs

The current circumstances could result in stocks being carried at an amount that exceeds the estimated selling price less costs to complete and sell. This might be because demand for the products has declined or the selling prices may have declined even if demand remains constant. In these circumstances, stock is written down to the lower of cost and estimated selling price less costs to complete and sell.

Recoverability of deferred tax assets

Where a decline in the trading and profitability of an entity is present that could result in deferred tax assets not being recoverable, reassessments of any recognised deferred tax assets will be necessary and then being written down to the extent that they are not recoverable. Section 29 Income Tax requires entities to recognise deferred tax assets only to the extent that it is probable that they will be recovered against the reversal of deferred tax liabilities or other future taxable profits.

Provisions and contingencies

Entities should consider, under Section 21, the impact of COVID-19 on the following:

(a) Provisions and contingent liabilities; an example of when this is relevant is legal cases. If anyone sues an entity as a result of COVID-19, the entity is required to determine whether a provision and related expense should be recognised or whether disclosure of a contingent liability is required.

(b) Onerous contracts; Onerous contracts could arise in many instances. An example of when an onerous contract could arise is when entities do not pass on increased costs to their customers and the costs exceed the revenue they earn. This is more likely to occur if margins are tight. Entities have already started incurring additional costs as a result of COVID-19 (e.g. increased costs for products, higher transport costs or additional cleaning costs for deep cleans and increased daily cleaning). Entities are required to recognise a liability (and an expense in profit or loss if a contract becomes onerous).

(c) Restructuring plans; entities that start to consider, or implement, restructuring plans should apply Section 21 to determine when to recognise a liability (and an expense in profit or loss), and how to measure it subsequently.

(d) Employee terminations; unfortunately, it seems likely that many entities will need to terminate the employment of some employees. Section 28 Employee Benefits should be considered when this occurs. It explains when termination benefits should be recognised as a liability (and expensed in profit or loss) as well as how these should be subsequently measured.

Breaches of loan covenants

If a loan is in default (for example, a payment is not made when due or a specified ratio is breached), this could result in the classification of the liability changing from non-current to current. Section 4 Statement of Financial Position states: ‘Unless an entity chooses to apply paragraph 1A(1) of Schedule 1 to the Regulations, an entity shall classify a creditor as due within one year when the entity does not have an unconditional right, at the end of the reporting period, to defer settlement of the creditor for at least 12 months after the reporting date. For example, this would be the case if the earliest date on which the lender, exercising all available options and rights, could require repayment or (as the case may be) payment was within 12 months after the reporting date.’

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