Impact of Covid-19 to Accounting: Non-Financial Obligations and Leases

This fifth installment of the series will discuss the impact of Covid-19 to non-financial obligations and leases. This article and other articles in the series summarize the impact based on several credible sources, i.e. the Big Four accounting firms, professional accountancy organization and IFAC (International Federation of Accountants). For further and detailed discussion, please refer to the original documents as cited in the sources at the end of this article for further reading, of which the links to access the full report are provided.

1. Non-financial obligations

Several aspects to be considered in relation to non-financial obligations are discussed below, which consist of provisions, employee benefits and current/ non-current liability classification.

a) Provisions

IAS 37 arranges accounting requirement on provisions. Provision is a liability of uncertain timing or amount, it is to be recognized in the statement of financial position if the following criteria are met: a present obligation has arisen as a result of obligating past event, the payment if probable, and the amount can be reliably estimated. Of particular importance during this Covid-19 situation is provisions in relation to restructuring. In IAS 37, a restructuring could result from sale or termination of a line of business, closure of business locations, changes in management structure, or fundamental re-organizations. The first two causes are the most likely factors that entities may consider in present circumstances. Restructuring by sale of an operation will only be recognized if the entity is committed to a sale, i.e. there is a binding sale agreement. Whereas, restructuring by closure or reorganization will only be recognized if a detailed form plan is in place and the entity has started to implement the plan, or announced its main features to those affected. Entities must also note that only direct expenditures related to restructuring can be included in the restructuring provisions account. In addition to restructuring, another relevant provision item could result from onerous (loss-making) contracts, where the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under the contract.  If such contracts are identified, then entities need to create (recognize) the related provision.

b) Employee benefits

The accounting standard that deals with employee benefits is IAS 19. Entities must evaluate whether there are any changes related with employee benefits and employer obligation arising from Covid-19 pandemic. In addition to legal obligation, entities must not overlook constructive obligation as well. Several employee benefits areas worth looking are sick leave, paid leave, possible employee termination, as well as the measurement of defined benefit obligation and plan assets for entities who have defined benefit pension plans.

c) Current/ non-current classification

When entities issuing non-current liabilities, it is common to have loan (debt) covenants that contain the conditions that must be satisfied or maintained by the borrower in relation to their loans, such example maintaining certain level of working capital. When there is a breach of contract, the loans that initially were due more than one year, hence classified as non-current, could become payable on demand thus classified as current liability. This classification is arranged in IAS 1 regarding financial statements presentation. Just recently, on January 2020, the IASB (International Accounting Standards Board) made a narrow-scope amendment on the standard to clarity this current/ non-current classification. To be specific, the amendment aims at helping entities to determine the classification if they have liabilities with uncertain settlement date. Initially, the effective date of this new amendment is set at January 2022, with permission of early application. However, given the Covid-19 pandemic, the Board has proposed to defer the effective date by one year to January 2023, as informed on the IFRS website.

2. Leases

The new standard on leases, IFRS 16, became effective on 1 January 2019. Countries adopting this standard could have later effective date, so there is a chance that they are preparing it for the first time and have some difficulties. Their hardship is then added on by the Covid-19 pandemic, so recently the IASB issued proposed amendments in relation to IFRS 16 on the Covid-19-related rent concessions to provide lessees with practical relief during this time without sacrificing the usefulness of their financial statements. In summary, this exposure draft proposes the treatment of whether rent concession is a lease modification.

Sources:

Deloitte 2020, IFRS in Focus: Accounting Considerations Related to the Coronavirus 2019 Disease, March

EY 2020, Applying IFRS: IFRS Accounting Considerations of the Coronavirus Outbreak, February

IFRS Foundation 2020, Covid-19-Related Rent Concessions: Proposed Amendment to IFRS 16, April

IFRS Foundation, IAS 1 Presentation of Financial Statements

IFRS Foundation, IAS 19 Employee Benefits

IFRS Foundation, IAS 37 Provisions, Contingent Liabilities and Contingent Assets

IFRS Foundation, IFRS 16 Leases

IFRS Foundation, IASB Proposes Deferring IAS 1 Amendments’ Effective Date due to Covid-19, 4 May, https://www.ifrs.org/news-and-events/2020/05/classification-of-liabilities-deferral-exposure-draft/

KPMG 2020, Quick Guide on COVID-19, https://home.kpmg/xx/en/home/insights/2020/03/covid-19-financial-reporting-resource-centre.html

PwC 2020, In Depth: A Look at Current Financial Reporting Issues – Accounting Implications of the Effects of Coronavirus, 17 March

(AL)