Financial Reporting and Compliance
Impact of COVID-19 on statutory accounts
In such unprecedented times, the filing of statutory accounts at Companies House is low on a long list of concerns faced by clients and business owners. Companies House have issued guidelines to assist business owners with the filing of accounts during this difficult period.
Companies House filing deadlines
Companies House have provided guidance on what to do if a company is unable to file its accounts on time. The advice is to act before the filing deadline.
However, if the company is unable to file on time because it has been affected by the coronavirus, it may make an application to extend the period allowed for filing. If an application for an extension has not been made and the company’s accounts are filed late, an automatic penalty will be applied.
To apply for an extension online you will need:
- the company number
- information as to why you need more time
- any documents that support the application.
On receipt of an application as a result of coronavirus, Companies House said it would grant a three month extension automatically. A further month delay is the maximum allowed under current rules.
Where an application is successful, the entity must file their accounts before the new due date or a late filing penalty will be imposed. It is also worth noting that an accepted application does not change the due dates for future accounts to be sent to Companies House.
Disclosing the effects of coronavirus in the financial statements
Companies that have 2019 and 2020 reporting dates will need to consider how the pandemic affects their businesses and consider disclosing the impact in their annual reports.
Where a company has a 31 December 2019 balance sheet date, the effects of coronavirus would generally not be considered as a condition that existed at the reporting date, as the virus itself was only discovered in January 2020.
Where a company has a 31 January 2020 reporting date or subsequent, the effects of the virus could be an adjusting or a non-adjusting event.
Where management concludes that the effect of the virus is a non-adjusting event, then no adjustments are made to the entity’s assets or liabilities.
However, such a non-adjusting event would need to be disclosed in the financial statements if it is considered material that non-disclosure would affect the ability of the user to make proper evaluations and/or decisions.
Where the virus is considered to be an adjusting event (as the virus was in existence at the balance sheet date), the directors need to consider the following issues:
- Are there assets which are likely to be impaired as a consequence of the virus?
- Does the entity need to make additional provisions as a result of the virus?
- Are employee benefits affected, such as defined benefit pension schemes and remuneration packages?
Implications of Going concern
The question to be answered is ‘Is the company a going concern’? Will the company be able to pay debts as they fall due?
The biggest worry to business owners will be the unknown certainty of whether their business will continue to pay staff and suppliers.
The pandemic may give rise to the going concern basis of accounting no longer being appropriate. Business owners will need to assess going concern for a minimum period of assessment of 12 months from the date of approval of the financial statements. It is likely that disclosure in the accounts will be required.
Clearly business owners face so much uncertainty over the coming weeks and months but our staff at Ward Goodman are here to assist you during this unprecedented time.
On 26th March 2020, the Financial Reporting Council (FRC) released detailed guidance for companies on Corporate Governance and Reporting :-
Guidance for companies on Corporate Governance and Reporting
Many companies are facing unprecedented uncertainty about their immediate prospects in an environment which may challenge or disrupt their usual management and governance processes.
In this paper, we highlight some key areas of focus for boards in maintaining strong corporate governance and provide high-level guidance on some of the most pervasive issues when preparing their annual report and other corporate reporting.
Our key messages to boards on corporate governance are to:
- develop and implement mitigating actions and processes to ensure that you continue to operate an effective control environment, addressing key reporting and other controls on which you have placed reliance historically but which may not prove effective in the current circumstances;
- consider how you will secure reliable and relevant information, on a continuing basis, in order to manage the future operations, including the flow of financial information from significant subsidiary, joint venture and associate entities; and
- pay attention to capital maintenance, ensuring that sufficient reserves are available when the dividend is paid, not just proposed; and sufficient resources remain to continue to meet the company’s needs.
Making forward-looking assessments and estimates when preparing financial statements and providing other corporate reports is particularly difficult currently. The following guidance is intended to help boards focus on areas of reporting of most interest to investors; and to encourage them to provide clarity on the use of key forward-looking judgements. The guidance covers:
- The need for narrative reporting to provide forward-looking information that is specific to the entity and which provides insights into the board’s assessment of business viability and the methods and assumptions underlying that assessment;
- Going concern and any associated material uncertainties, the basis of any significant judgements and the matters to consider when confirming the preparation of the financial statements on a going concern basis;
- The increased importance of providing information on significant judgements applied in the preparation of the financial statements, sources of estimation uncertainty and other assumptions made; and
- Judgement required in determining the appropriate reporting response to events after the reporting date and the extent to which qualitative or quantitative disclosures may be appropriate.
In these difficult times, the need for clear leadership, strong governance and effective decision making based on reliable information is stronger than ever.
The disruption to working practices and the changing resource demands will have led to the need for new forms of management and control. Such changes are inevitable, but boards are advised to consider the following matters and ensure plans are in place to address them.
The usual flows of management information through a group or company or from associates and joint ventures may have been disrupted. Boards must consider how they can maintain and/or complement this missing information as they plan their route through the current emergency towards reactivation of their full business activities. This flow of information will also be important for preparing the published financial statements.
Risk management and Internal controls systems
Relocation of staff and the inaccessibility of some business locations may lead to risk management processes and internal controls becoming unworkable or otherwise relaxed. Such changes may be unavoidable or considered necessary in the short-term to maintain some level of operations.
However, we urge boards to monitor such changes carefully, introducing alternative mitigating controls where necessary and practicable to support the operation of an effective control environment.
Dividends and capital maintenance
Many companies have already adjusted their approach to dividends and their shorter-term dividend policies to support their balance sheets and provide financial flexibility. For those companies that have proposed but not yet made a dividend (declared by the members in general meeting for a final dividend or by payment for an interim dividend), directors need to consider not only the position of the company when the dividend was proposed but also when it is made. Where the company is no longer able to pay a dividend, directors should halt any dividend and communicate as appropriate to the market.
The assessment of whether a dividend is appropriate should include consideration of current and likely operational and capital needs, contingency planning and the directors’ legal duties, both in statute and common law. Directors must ensure that the capital maintenance rules of Part 23 of the Companies Act 2006 are complied with, that they fulfil their duties under Section 172 of the same act and that due consideration is given to their fiduciary duties to ensure the company will be able to pay its debts as they fall due.
In some cases, it may be necessary to move funds around a group, using inter-company dividends from subsidiaries to their parent companies or capital contributions between companies. Once again directors must ensure that such transfers comply with statute and the common law duties of directors.
Investors have highlighted that their key information needs relate to the liquidity, viability and solvency of companies. Boards cannot predict the extent and duration of the COVID-19 pandemic nor its consequences for the global economy. It is however reasonable for investors to expect companies to be able to articulate their expectations of the possible impacts on their specific business in different scenarios.
Investors and other users of corporate reports want to understand a company’s resilience in the face of current uncertainty and to understand the key assumptions and judgements a board is making when assessing resilience and in preparing company financial statements.
Of particular importance is the availability of cash within a group of companies, the ability to transfer such resources around the group to where it is needed, given operational, regulatory and legal constraints, and the access to further cash through existing and potential financing facilities.
Strategic Report and Viability Statement
The Strategic Report should always be forward looking, and especially so during the current crisis. It should also be entity-specific – COVID-19 is affecting all businesses and individuals but the critical implications for individual companies may differ, as will their plans to mitigate some of the effects, their capacity to follow these plans and the level of resources available to withstand the effects that remain.
In setting out its principal risks and uncertainties, a company should consider the specific resources, assets and relationships that are most under threat and the steps being taken to protect them. The protection and retention of staff, and the associated corporate memory, may be crucial to a company’s ability to weather the current storm and to rebuild when the opportunity arises. All stakeholders, including investors, are concerned about companies’ workforces and seek an understanding of how they are being retained and supported.
Given the systemic uncertainties that currently exist, many boards will be less confident in stating that they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over a period of assessment (“the viability statement” as required for compliance with the UK Corporate Governance Code).
However, the FRC stresses the following points:
- Boards are required to have a “reasonable expectation” of the company’s viability over the period of assessment – during the current emergency and unprecedented pace of change, any reasonable level of expectation would naturally carry a much lower level of confidence;
- Being clear on the company’s specific circumstances and the degree of uncertainty about the future is important information; and
- When presenting a company’s viability statement, its board should draw attention to any qualifications or assumptions as necessary.
In describing any qualifications to the statement, a board should describe the limits of the predictions, the level of confidence with which they have been made and the uncertain future events that could prove critical to viability.
Similarly, the key assumptions made and the future scenarios considered should be explained. Many companies already use scenario and stress testing in developing their statements and this should continue as far as practicable. The use of reverse stress testing, to identify future scenarios that could lead to corporate failures, is also good practice.
At this time, the need for fuller disclosure is paramount.
Going concern and material uncertainties
IAS 1 requires financial statements to be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so.
The FRC thinks it is likely that more companies will disclose “material uncertainties” to going concern in current circumstances. This term may not be widely understood. It refers to uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern. In other words, if boards identify possible events or scenarios (other than those with a remote probability of occurring) that could lead to corporate failure, then these should be disclosed. When identifying such events or scenarios, boards may take account of realistically possible mitigating responses open to them. Events could lead to corporate failure because of the scale of their adverse impact on the company and its ability to avoid liquidation or because of their timing.
When assessing whether material uncertainties exist, boards should consider both the uncertainty and the likely success of any realistically possible response to mitigate this uncertainty.
These assessments are significantly more difficult currently given the uncertainties about the impact of COVID-19, the extent and duration of social distancing measures, the impact on the economy and asset prices generally. Boards should consider the potential impact of these matters on the company’s specific circumstances, paying attention to their current and potential cash resources, including access to existing and new financing facilities, revolving facilities, invoice discounting and reverse factoring. The company’s access to and use of such facilities should be disclosed appropriately.
Boards should also consider their access to government support measures that have been announced.
We encourage boards to consider the impact of different potential scenarios (e.g. consideration of different time periods for the continuation of social distancing) on their company’s revenues, costs (both fixed and variable) and cash flow requirements.
If a material uncertainty does exist, then the company should disclose it in terms that are as specific to the entity as possible. Users will wish to know how and when the uncertainty might crystallise and its impact on the resources, operational capacity, liquidity and solvency of the company.
If the board concludes that there is not a material uncertainty that meets the criteria for disclosure, but this conclusion required the application of significant judgement, then this judgement should be disclosed in accordance with paragraph 122 of IAS 1. The IFRS Interpretations Committee (then IFRIC) explained this requirement in an agenda decision set out in the July 2014 IFRIC Update. Providing such disclosures will help meet the information needs of financial statement users to understand fully the pressures on liquidity, viability and solvency.
Significant judgements and estimation uncertainty
Given the inherent uncertainties in making predictions, we have stressed above the need to disclose underlying assumptions applied when preparing a viability statement, and any significant judgements made when assessing whether there are material uncertainties to disclose.
Similarly, companies should disclose significant judgements made in applying accounting policies that have the greatest effect on the financial statements. The requirement to do so (IAS 1 paragraph 122) is normally distinguished from the requirement of IAS 1 paragraph 125 regarding sources of estimation uncertainty. However, at this time, we encourage companies to provide as much context as possible for the assumptions and predictions underlying the amounts recognised in the financial statements, irrespective of any narrow interpretation of the requirements. Such information will help users to understand the amounts presented.
Relevant judgements and assumptions might include the:
- availability and extent of support through government support measures that have been announced;
- availability, extent and timing of sources of cash, including compliance with banking covenants or reliance on those covenants being waived;
- duration of social distancing measures and their potential impacts.
In the absence of any consensus view of the future path of the COVID-19 pandemic and its impact on the economy, users cannot expect all companies to apply consistent assumptions when there is such uncertainty. This lack of consistency makes the need for full disclosure of judgements, assumptions and sensitive estimates significantly more important than usual.
Events after the reporting date
IAS 10 distinguishes between those events occurring after the balance sheet date that provide more information about the conditions that existed on the balance sheet date (“adjusting events”) and those that are indicative of conditions that arose after the balance sheet date (“non-adjusting events”). Amounts in the financial statements must be adjusted in response to adjusting events whilst only disclosures are required in response to material non-adjusting events.
There is a general consensus that the outbreak of COVID-19 in 2020 was a non-adjusting event for the vast majority of UK companies preparing financial statements for periods ended 31 December 2019. Companies will need to judge how much of the impact of COVID-19 should be considered to arise from non-adjusting events for subsequent reporting dates. This will be highly dependent on the reporting date, the specific circumstances of the company’s operations and the particular events under consideration.
In reaching this judgement, companies will need to focus on the importance of the conditions at the balance sheet date – does the event shine a brighter light on those conditions or did conditions change after the reporting date? If the judgement had a significant effect on the amounts in the financial statements, then this judgement should be disclosed and explained.
If an event is considered to be non-adjusting, then the nature of the event should be disclosed. Where an estimate of the financial effect on the company can be made, then this should be disclosed. Otherwise the fact that the financial effect cannot be estimated should be disclosed. The estimate does not need to be exact – a range of estimated effects is better than no quantitative information at all. In the absence of any quantitative estimate, a qualitative description should be provided.