How will COVID-19 impact financial reporting obligations?
The COVID-19 crisis will complicate many organisations’ ability to meet financial reporting obligations. Directors will need to disclose effects in their financial reports and directors of reporting entities will need to report in their operating and financial review (OFR).
The AICD has been heavily engaged in policy discussions with government and have put forward balanced solutions that recognise the need to provide Boards, and their management teams, with time and space to grapple with the challenges confronting them, while providing users with the necessary reporting to make informed decisions.
For further guidance on navigating financial reporting during COVID-19, see the AICD’s analysis here.
Has ASIC extended reporting deadlines?
ASIC has announced that it will extend the deadline to lodge financial reports by one month for both listed and unlisted entities with balance dates from 31 December 2019 to 7 July 2020. The 7 July 2020 date accommodates entities that use a provision in the Corporations act enabling their financial year to be changed plus or minus 7 days each year.
ASIC has advised that, where possible, entities should continue to lodge within the statutory deadlines having regard to the information needs of shareholders, creditors and other users of their financial reports, or to meet borrowing covenants or other obligations.
Importantly, listed entities will be required to inform the market when they rely on the extended period for lodgement. ASIC also indicates there will be an expectation for those entities to explain the reasons for relying on the extension period.
ASX listed entities required to lodge their Appendix 4E under ASX Listing Rules 4.3A and 4.3B by 31 August 2020 (for 30 June 2020 year ends) that do not have audited accounts by that date, will need to lodge unaudited accounts with its Appendix 4E.
What about ACNC Annual information statements?
The ACNC has now advised that entities with an AIS due date between 12 March 2020 and 30 August 2020, will now have an extension until 31 August 2020.
Do directors need to disclose the effect of COVID-19 on their business in their audited financial report?
Directors of reporting entities should disclose the effects of COVID-19 if it will have a significant effect on the entity and if it is “material”, that is “if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements”. Part of that consideration might be the likely size of the effect of COVID-19, however the nature of the virus is relevant: if users reasonably expect that COVID-19 and its consequences will impact your entity it could be material even if you assume the financial impact is negligible.
If a reporting entity assesses that there is no financial impact, then the assumptions that lead to that assessment should also be disclosed. So, for example, the entity would need to explain why COVID-19 would not have any effect on demand for its goods and services.
Material financial impact should be measured by looking at the effects on a range of operations, including:
- reduced demand for products or services;
- increased costs;
- workforce shortages affecting production of goods or services;
- changes to indirect costs because of effects on customers, suppliers or financiers leading to issues with supply chains or reduced revenues;
- asset impairment and changes in fair value of assets or value of inventory or stock;
- ability to service debt;
- impairment of financial assets.
Some initial guidance has already been provided by the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB) (see AICD summary here). ASIC has provided some guidance in question 3 of its FAQ (available here).
How do I assess going concern for my financial reports?
The Australian Accounting Standards requires an entity’s Board to assess whether it is a going concern when preparing financial accounts. An entity may be assessed as a going concern unless the Board intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. If the Board determine that the company can continue in operation for the foreseeable future, and at least the next 12 months, then they can prepare their accounts on a going concern basis. The entity’s auditor is separately required by Australian Auditing Standards to review the directors’ going concern assumption and to determine if in the auditor’s judgment, there are events or conditions which cast significant doubt on the company’s ability to continue as a going concern. The directors’ judgment is not whether an entity is a going concern today, but rather a continuing going concern.
Where uncertainty exists, directors may be able to deal with the going concern assessment by making a going concern statement with a material uncertainty around COVID-19 related issues, which will require some detailed disclosure of what those uncertainties are. An auditor, who agreed with that assessment, would then issue an emphasis of matter paragraph in their opinion detailing the COVID-19 material uncertainties set out by directors. There may even be an increase in qualified opinions as auditors disagree with judgments made by entities around future prospects or going concern.
The Australian Accounting Standards Board (AASB) and the Auditing and Assurance Board (AUASB) have published a joint guidance on assessing going concern and solvency declarations entitled “The Impact of COVID-19 on Going Concern and Related Assessments”. The guidance is available here.
The guidance sets out an overview of going concern and the obligations and responsibilities of directors and auditors, as summarised above. The most important section of the guidance is a list of indicators that management should consider when trying to assess going concern, such as unavailability of resources or breaching loan covenants. There is a specific section on indicators for NFPs including factors like an inability to hold fundraising events. An appendix to the guidance provides an additional useful list of indicators.
The guidance then sets out mitigating strategies that directors and managers might consider when issues are raised in relation to going concern, including government stimulus or support, sale of liquid assets and capital raising. Special cases, such as how to make going concern assessments where entities have gone into hibernation due to government shutdowns are also discussed. As the guidance notes, just because an entity is in hibernation it does not necessarily mean that it is not a going concern.
On specific disclosure around going concern, the guidance talks about different categories of disclosure and matters that boards should consider disclosing. This includes circumstances where no issues are identified, where issues are identified but resolved, where there is a material uncertainty and where the entity is assessed as no longer being a going concern.
Much of the guidance covers the auditor’s responsibilities in reviewing the going concern assessment and reporting on it; it asks auditors to pay particular concern to this as an issue. This is useful reading for directors and it should form the basis for discussions between directors and auditors over the auditor’s role and the professional scepticism they are asked to bring. It assists preparers of financial statements if they also think of the perspective of the auditor when pulling them together.
What do I do about my solvency declaration?
Annual financial reports (and half-yearly reports for listed companies) must contain a director’s declaration that the entity is solvent; that is whether, in the directors' opinion, there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable. For audited financial reports this statement will be subject to independent audit. If an entity does not submit a financial report to ASIC, they must pass a solvency resolution at least once a year and notify ASIC if it is negative.
Normally, a company that passed a negative solvency resolution would immediately call in the administrators. However, this practice has been complicated by the Federal Government’s decision to temporarily suspend the duty to prevent insolvent trading and to raise some of the thresholds by which a creditor can apply to have a company wound up. Under the temporary safe harbour, a company may potentially continue to trade while insolvent, without the directors breaching their duty. Indeed, ASIC has confirmed that a company may be insolvent while remaining a going concern.
Directors can look to ASIC’s FAQ for specific information on what to do around solvency declarations during COVID-19 – see here.
What about the case where directors could be unsure of an entity’s solvency given market uncertainties? ASIC has confirmed that in those circumstances directors can make qualified declarations as to solvency and disclose their material uncertainty. ASIC’s Regulatory Guide 22 - Directors’ Statement as to Solvency, provides some assistance on this point. The FAQs provide more information.
The interaction between the going concern assessment and solvency declaration are discussed in the AASB-AUASB publication referred to above.
In practice of course, directors may be very reluctant to qualify their solvency declaration given the practical, commercial, and legal implications that could follow. For example, a qualified solvency declaration may lead to a qualified audit opinion, which in turn leads to a breach of debt covenants. It is also possible that the disclosure of the entity’s precarious state of solvency in published financial reports may precipitate its decline. This seems unavoidable.