Should the influence of the coronavirus be recognized in the 2019 financial statements?

The crisis caused by the coronavirus is coinciding with the peak season for preparing annual reports. The first signals of the spread of the coronavirus reached us on the last days of 2019. The virus itself reached Estonia in March 2020 – after the 31 December 2019 balance-sheet date and is having a significant impact on most companies. It raises the question of whether and how aspects related to the coronavirus be recognized in the 2019 financial statements and if so, how?

The recognition of events that occurred after the balance-sheet date but before the approval of the annual report depends on whether the event is

1. an adjusting event or
2. non-adjusting event.

An adjusting post-balance-sheet-date event is one that confirms circumstances that existed on the balance-sheet date. The influence of the adjusting events is recognized in the balance sheet and income statement for the year ended.

A non-adjusting post-balance-sheet-date event is one that does not reflect the conditions that existed on the balance-sheet date. The influence of the non-adjusting events is not recognized in the balance sheet and income statement for the year ended but disclosed in the notes to the financial statements, if material.

Considering the accrual-basis nature of the influence, the coronavirus crisis is a non-adjusting post-balance-sheet-date event for Estonian companies. That means that the impact of the coronavirus should be disclosed in the notes and not in the balance sheet for the year-ended 31 December 2019 and financial statements for the reporting period (income statement, cash flow statement etc.).

How does the coronavirus impact annual reports?

The objective of the financial statements is to provide information about the accounting entity’s financial position, results and cash flows so that they can be used to make business decisions. The management board is responsible for preparing the annual report. Several of the financial indicators documented in the financial statements are based on the management’s estimates, not on measurable data. Realistic estimates have a very important role in preparing reliable statements. In making accounting estimates, the management is obliged to take into consideration all known circumstances that could impact the data reported in the financial statements as a result of the estimate. The notes to the financial statements disclose material events occurring after the balance sheet date and the management’s estimate regarding their potential impact on financial indicators for subsequent periods.

Of course, it is very hard for the management board to assess how great the influence of the coronavirus will be on the company and financial indicators for future periods. Because of that, instead of giving detailed estimates, it is significantly more important for the management to assess whether the impact of the coronavirus could jeopardize the company’s ability to continue as a going concern.

If there is doubt regarding whether the company can continue to operate in the 12 months following the reporting date – 31 December 2019 – the following is disclosed in the report:

1. the main events and circumstances that may cause noteworthy doubt in the company’s ability to continue as a going concern;
2. the management’s plan for dealing with these events and circumstances.

The disclosure should make it clear that there is significant uncertainty regarding whether the company can continue as a going concern, as a result of which the company may not be capable of realizing its assets and fulfilling its obligations in the course of normal operating activity.

As it is for some patients in the medical sense, the impact of the virus on a company may be more serious and if the management estimates that it is likely the company will have to close in the coming 12 months, the requirements of ASBG 13, “Liquidation and Closing Reports” are to be followed when it comes to valuation of assets and liabilities and presentation of the financial statements. Put simply, this means that all assets and liabilities are revalued to net realizable value and accounted for as short-term. Comparative information for the previous period shall not be adjusted.

I would draw attention to the fact that when closing and starting liquidation proceedings, the financial year may be shorter or longer than 12 months but may not exceed 18 months. Thus, if it becomes evident in late June that the company is unlikely to be able to continue and it is decided to dissolve the company, the annual report shall be prepared for the period of 1 January 2019 to 30 June 2020.

How could the Estonian government help businesses?

I believe the state should consider temporarily relieving business operators of their administrative burden by extending the deadline for submitting annual reports by two months, which would mean a filing date 30 August 2020 for companies whose financial year is aligned with the calendar year. That would give entrepreneurs, CFOs, accountants and other personnel involved in preparing financial statements more time to better manage the crisis. It would also provide clarity regarding the effects of the coronavirus crisis and whether the relief measures are working and would help to make better estimates. The companies’ current financial indicators for taxes paid and taxable sales declared will remain publicly available in any case.

Nothing in this alert should be construed as expert advice. This alert is a generalized summary. Professional counselling should therefore be sought before any action is undertaken.