The coronavirus (COVID-19) pandemic has developed rapidly in 2020, with a significant global impact. Measures taken to contain the virus have affected economic activity, which in turn has implications for financial reporting.
Measures to prevent transmission of the virus include limiting the movement of people, restricting flights and other travel, temporarily closing businesses and schools, and cancelling events. This will have an immediate impact on businesses such as tourism, transport, retail and entertainment. It will also begin to affect supply chains and the production of goods throughout the world, and lower economic activity is likely to result in reduced demand for many goods and services.
COVID-19 will impact many areas of accounting and reporting for all industries, as outlined in our publication.
In this Spotlight we provide our insight into the top issues that entities in the construction and engineering industry might face. While this Spotlight focuses on issues that are likely to be the most frequently encountered, many others are certain to arise. As the situation continues to evolve, so too will the consequential accounting issues. For these reasons, the following is not an exhaustive list of all relevant accounting considerations.
Construction and engineering entities often recognise their revenue over time in accordance with paragraph 35 of IFRS 15. Management will need to consider the assumptions that underpin their revenue accounting.
Potential issues include:
- Status of projects at the year end and subsequently. Are the projects continuing as normal in the current environment or have they been delayed, suspended or postponed? Are there force majeure clauses in contracts which have been triggered by COVID-19-related events? Are projects now operating at lower efficiency levels than previously, and how will this impact the overall outturn of the project?
- Measurement of progress through a contract. For example:
- If a ‘cost to cost’ method is used to measure progress and to determine how much revenue to recognise in the period, should expected cost increases resulting from delays, suspensions or postponements be built into the denominator of the ‘cost to cost’ calculation, or are they abnormal costs/inefficiencies that should be excluded? What would be a reasonable estimation process to determine the potential impact on costs?
- To what extent should any claims against the company from suppliers, or claims made by the company against their suppliers, be taken into account when considering cost forecasts and the overall outturn of projects
Contract modifications. Have there been modifications to contractual terms as a result of the COVID-19 situation? When were these modifications agreed with the customer (pre- or post-balance sheet date) and how should they be accounted for? Typically, modifications should not be accounted for until they are approved by both parties.
- For variations and claims with customers, the question arises to what extent any additional revenue can be taken into account due to delays, postponements or changes in scope? Entities should consider to what extent variations are enforceable under contractual terms that existed at the balance sheet date.
- Liquidated damages (or other penalties to the customer for delayed completion of projects) or other forms of variable consideration. Do assumptions about variable consideration (such as liquidated damages, milestones or other bonuses/penalties) need to be updated in revenue calculations?
- Given changes in expected outturn of projects, might there be onerous contract provisions required, including projects delivered in collaboration with other parties
- For entities recognising revenue over time in accordance with paragraph 35(c) of IFRS 15, would the right to payment for performance to date continue to be enforceable in the current environment?
- How do contractual terms, legislation and government actions differ from jurisdiction to jurisdiction, and might this drive different accounting outcomes in different territories?
Impairment considerations for goodwill, tangible fixed assets and investments in associates and joint venturesTemporarily ceasing operations or suffering an immediate decline in demand or prices and profitability are clearly events that might indicate that an impairment exists. However, reduced economic activity and lower revenues are likely to affect almost any entity, and they might also indicate impairment.
Management should consider various issues, including whether:
- COVID-19 and the measures taken to control it are likely to reduce future cash inflows, or increase operating and other costs, for the reasons described above;
- the assumptions and cash flow forecasts used to test for impairment should be updated to reflect the potential impact of COVID-19;
- budgets, forecasts and other assumptions from an earlier impairment testing date, that were used to determine the recoverable amount of an asset, should be revised to reflect the economic conditions
- at the balance sheet date, specifically to address increased risk and uncertainty; and
- the approach to determining discount rates might need to be revisited.
In addition to the above, it should be noted that additional disclosures are likely to be required to enable users of the financial statements to understand the assumptions used and the sensitivity of the calculation to reasonable changes in those assumptions.
Further details on these implications are discussed in In depth 2020-02: Accounting implications of the effects of the Coronavirus.
Decreases in pricing or volumes, due to issues such as price concessions, supply chain failures and work stoppages, could lead to potentially significant declines in cash flows, and they could therefore impact:
- the going concern assumption;
- liquidity risk disclosures; and
- debt covenants.
The impacts on these items will need to be carefully monitored. Further details on these implications are discussed in In depth 2020-02: Accounting implications of the effects of the Coronavirus.
Expected credit losses
IFRS 9 requires entities to use an expected credit loss (‘ECL’) model to measure impairment of most financial assets. The model requires consideration of both historical and current information, as well as reasonable and supportable forecasts of future conditions (including macroeconomic information). Contract assets are within the scope of the ECL model. Many companies in the industry use the simplified model for trade receivables and contract assets, and they measure the ECL at the lifetime expected credit losses.
Impact on employee compensation arrangements
Construction and engineering entities typically have a large workforce and significant defined benefit pension obligations. There might be an impact on holiday pay accruals if large portions of the workforce defer holiday in this period. Management should also consider whether any of the assumptions used to measure the employee benefits and share-based payments have been impacted by the current global economic situation.
For example, one of the inputs into the measurement of the defined benefit obligation is the yield on either high-quality corporate bonds or government bonds; this might have changed as a result of the current situation. Furthermore, IAS 19 requires plan assets of defined benefit plans to be measured at fair value in accordance with IFRS 13.
Downward pressure on financial markets might have had a significant impact on the values of pension assets and the funded position of such plans.
Further information on the impacts to employee benefits and share-based payments can be found in In depth 2020-02: Accounting implications of the effects of the Coronavirus.
Recoverability of deferred tax assets
Changes to forecasts of taxable income might impact the ability to recover deferred tax assets (for example, the ability to use loss carry-forwards prior to expiry). As such, some deferred tax assets might no longer qualify for recognition.
Governments around the world have reacted to the impact of COVID-19 with a variety of measures, including tax rebates and holidays and, in some cases, specific support for businesses, in order that those businesses are able to support their customers and/or retain their employees. Management should consider whether this type of assistance received from a government meets the definition of a government grant in IAS 20, ‘Government grants’. The guidance in IAS 20 should be applied to a government grant.
Interim reporting requirements
For entities that have a December year end, the 2020 interim reporting period will be the first reporting period when the impacts of the COVID-19 are reflected in the financial statements. For most entities, COVID-19 will affect the recognition and measurement of financial statement line items.
Interim reporting requirements need to be carefully considered in view of the impacts of COVID-19. IAS 34 requires significant events and transactions since the last annual reporting period to be explained and any updates to information that was disclosed in the annual financial statements to be included.
We would expect companies to provide additional information with regard to the impact of COVID-19 in interim financial statements, to the extent that these disclosures would include more than the required mandatory information as required by certain IFRSs, so as to assist users of the accounts to understand the impact of COVID-19.
Some regulators around the world have also issued guidance on what reporters should consider when issuing interim financial statements in accordance with IAS 34; for example, the European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, has issued the following guidance
COVID-19 has given rise to widespread challenges that have affected virtually every aspect of modern life. The economic implications of the virus will have a consequent impact on many aspects of accounting and financial reporting. We hope that this Spotlight will help you and your advisors as you navigate the key issues.