The first cases of the disease now known as COVID-19 were reported on Dec. 31, 2019, in Wuhan, China. The illness spread slowly at first but rapidly started to pick up speed. As the number of infections increased, world concern increased as well. On March 11, 2020, the World Health Organization (WHO) declared COVID-19 a pandemic, defined as a worldwide epidemic that crosses international boundaries and affects a large number of people.
The global response was immediate and, in many cases, drastic. In an effort to quell COVID-19’s spread, hard-hit nations issued quarantine and stay-at-home orders to their populations, and nonessential businesses were ordered to cease operations. The global economy went into a tailspin as consumer spending tumbled and organizations everywhere suspended operations.
This situation, unprecedented in world history, has brought unique challenges to the accounting industry. Faced with the task of issuing annual and quarterly reports during a period of massive uncertainty, accountants have found themselves with a long and confusing list of factors to consider. The accounting industry rose to this challenge, coming up with a series of standards that address accounting during a pandemic. During and after the crisis, when the challenges will shift into accounting during recession, these standards will help clarify the accounting role in the economy.
Although the pandemic guidelines are new, the accounting principles underlying them are not. Even in a global crisis, accountants will apply the tried-and-true methods they learned as students in accountancy programs such as the University of North Dakota’s master’s in accountancy online. A solid accounting education is the cornerstone of crisis management during and after the COVID-19 pandemic or future world health crises.
Items to Consider
Global consulting firm Deloitte, one of the big four accounting firms, put together a series of guidelines in March 2020 for accounting considerations related to COVID-19, both during and after the pandemic. The checklist is preceded by a discussion of material judgments and uncertainties. When authoring an accounting report, one of the first things to consider is materiality — whether certain issues are meaningful in the big picture and/or worth addressing. During a pandemic, significant and ongoing uncertainties exist that far exceed the norm. The question of materiality therefore takes on extra weight because things that might be unimportant in typical times have a potentially significant impact.
With that caveat, Deloitte comments on a number of factors:
Impairment of assets. Accountants must try to quantify financial damage to assets as a result of current or near-future events, such as a pandemic. Assets can include both tangible and non-tangible items. An example of a non-tangible asset is goodwill, which is basically the business’s good name and reputation. Impairment occurs in two main ways:
- As the result of an adverse market environment or economic environment in which the business operates.
- As a change in the way an asset is used or is expected to be used. For example, during a pandemic, an asset may become unexpectedly idle for an extended period. It may be discontinued or discarded (for instance, food going bad). It may also be reassigned to a different type of operation.
Valuation of inventories. Inventories are measured in part by their net realizable value (NRV). When a market disappears or is greatly reduced, as it may be during and after a pandemic, the NRV of inventory may tumble, at least temporarily. Additionally, if a business’s production levels fall dramatically (for instance, if production lines are shut down or reduced), fixed overhead costs will contribute more to the cost of items produced. These factors must be considered when valuing inventory for reporting purposes.
Allowance for expected credit losses (ECL). During a pandemic, borrowers (both corporate and individual) may have trouble meeting their payment responsibilities. Lenders must take this reality into account. A residential mortgage lender, for example, might reasonably expect that a skyrocketing unemployment rate would cause payment delays. Quantifying these losses is a bit of a guessing game and requires significant judgment on the part of the accountant. Deloitte suggests measuring ECL in a way that reflects several factors:
- A probability-based, unbiased assessment of a range of possible outcomes
- The time value of money
- Reasonable, supportable information about past events, current conditions and future economic forecasts. Such information should be readily available to the accountant (there is no need or requirement for undue effort or cost in gathering data).
Fair value measurements. Fair value in accounting is defined as “the estimated worth of a company’s assets and liabilities that are listed on a company’s financial statement.” Fair value should reflect market realities at the time a report is written. Since market realities during and after a pandemic are a dramatic departure from the norm, fair value assessments may be markedly different than usual as well. Accountants should pay particular attention to so-called “unobservable inputs,” subjective measures of worth often based on opinions and perceptions — which may be strongly influenced by pandemic events.
Onerous contracts provisions. Accountants need to keep an eye out for so-called onerous contracts, which occur when the cost of meeting one’s contractual obligations exceeds the benefits to be gained from the contract. During a pandemic, circumstances that could result in an onerous contract include penalties for late delivery or non-delivery of goods; increased costs from situations such as staff quarantine or the need to purchase raw materials at higher than normal prices; or a contractual obligation to provide services in reduced, nonprofitable ways.
Restructuring plans. Organizations impacted by a pandemic may be forced to consider restructuring, such as selling or closing parts of their business or downsizing operations, either temporarily or permanently. Such actions have accounting implications. If part of the business goes up for sale, in particular, this action has extensive accounting ramifications that the accountant will need to work into the report.
Breach of covenants. Global instability and cash-flow problems during a pandemic create an increased risk of contract breaches. Actual breaches must be reported; anticipated or likely breaches, if deemed material, should be included in the accounting report as well.
Going concern. Accounting reports are prepared on a “going concern” basis if the business intends to keep operating as usual for the foreseeable future. If a pandemic impacts a business so severely that there is doubt as to its future viability, the “going concern” basis may not be appropriate. The accountant will have to adjust his or her approach accordingly.
Liquidity risk management. During a pandemic, productivity disruptions and reduced sales can negatively impact a business’s working capital. Businesses may use a variety of creative financial techniques to lessen the impact. Examples might include later payment to suppliers or early settlement of trade receivables. Such arrangements are legal but may need to be disclosed in financial reports. Accountants should carefully evaluate each financial arrangement in light of reporting rules and regulations.
Events after the end of the reporting period. Although a reporting period may have ended, the world marches on, and post-period events may materially impact the reporting period. For example, management may take actions in response to a pandemic that completely change a business’s course overnight, or assets and liabilities may look very different between one week and the next. These types of changes should be acknowledged.
Other potential impacts. Deloitte touches on a number of other potential accounting impacts arising from COVID-19 or another future pandemic, including insurance claims for business interruption; employee termination benefits arising from a workforce reduction; modifications of existing contractual arrangements; and tax considerations arising from all pandemic changes as a whole.
After the Pandemic
When a pandemic passes, it can leave economic devastation in its wake. According to the International Monetary Fund (IMF), the COVID-19 pandemic is expected to trigger a global recession greater than any seen since the 1930s. The world will eventually recover, but doing so may take years — and accountants will be leading the charge to quantify the damage.
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COVID-19 timeline and pandemic definition – World Health Organization
Development of new accounting standards – Deloitte
Items to consider – Deloitte
Fair value definition – Investopedia
After the pandemic – Reuters