Expected effects of the Covid-19 pandemic on the IFRS financial statements for the financial year 2020

4.1.1 Intangible assets including goodwill and property, plant and equipment

The rules for recognising impairment of an asset according to IAS 36 have to be applied on all kinds of intangible assets (IAS 38 and IFRS 3), on property, plant, and equipment (IAS 16), including the right-of-use assets resulting from leases (IFRS 16)18, and on investment property (IAS 40) measured at cost19. In this context, two groups of assets can be distinguished:

• goodwill and the intangible assets with an indefinite useful life, and

• all other assets mentioned before.

For the first-mentioned group of assets the entity has to perform an annual asset impairment test even if there is no indication for an asset impairment20 as no amortisations are recognised on these assets.21 Only under quite particular conditions22 when the recognition of an asset impairment on goodwill seems to be very unlikely the entity is exempted from performing the regular annual asset impairment test. Due to the significant economic effects of the Covid-19 pandemic, the prerequisites for a waiver of the annual asset impairment test of goodwill are fulfilled only in such rare cases in which the last performed asset impairment test shows a significant excess of the recoverable amount of the cash-generating unit including the goodwill over its carrying amount. Therefore, even in the case of a current material decrease of the recoverable amount of the cash-generating unit the recoverable amount is still probably higher than its carrying amount.

For all other assets the entity has to check if there is any indication that the asset may be impaired, as only in the case that at least one asset impairment indicator is existing an asset impairment test has to be performed. IAS 36.12 provides a non-exhaustive list of asset indicators from external and internal information sources. Due to economic effects of the Covid-19 pandemic it may even be possible that several of the listed asset impairment indicators mentioned in IAS 36.12 are satisfied.23 Except for the increase of market interest rates24, all other external impairment indicators (esp. significant changes with an adverse effect on the entity in the market or economic environment, excess of the carrying amount of the net assets over its market capitalisation) may arise as a consequence of the economic effects of the Covid-19 pandemic. Furthermore, internal sources of information, like significant changes in the manner, in which an asset is used or expected to be used, or a deterioration of the expected economic benefits from an asset or a cash-generating unit may also indicate an asset impairment. Nonetheless, it has to be pointed out, that the Covid-19 induced occurrence of one or more asset impairment indicators is highly dependent on the business sectors in which the entity is engaged. Therefore, the existence of asset impairment indicators, which involves some discretion, has to be examined carefully in all potential relevant cases.25

If at least one asset impairment indicator for an asset or a cash-generating unit is existing, in the next step the entity has to determine its recoverable amount.26 Therefore, the two components of the recoverable amount, the fair value less costs of disposal and the value in use, have to be estimated. The fair value less costs of disposal, which is defined as an exit price27, may also be reduced if other market participants are only willing to pay a lower price due to the restricted possibilities of generating cash flows from the use of that asset. Therefrom, the extent to which the single business sectors are affected by the economic effects of the Covid-19 pandemic is most probably also reflected in the fair values of assets typical for these business branches.

For determining the value in use, the expected future cash flows derived from the asset or the cash-generating unit are discounted with an interest rate reflecting the uncertainties of future cash flows from that asset (or cash-generating unit).28 The effects of the Covid-19 pandemic will in many cases affect the estimations of future cash flows and mostly reduce them. Nevertheless, the calculation of the value in use must always reflect the current expectation as of the end of the reporting period. Therefore, despite the uncertainties about the expectations of future cash flows a “freeze” of these estimations at pre-covid-19 period amounts is not appropriate. “A high degree of uncertainties in an entity’s operating environment is likely to result in more frequent changes in management’s expectations about the future.”29 Furthermore, the increased uncertainties induced by the Covid-19 pandemic will probably increase the interest rate used for discounting the future cash flows30 and finally result in a lower value in use. Notwithstanding the above-mentioned analysis, if immediately before the Covid-19 pandemic influenced the future cash flows an (unrecognised) “headroom” existed,31 a reduction of the recoverable amount of the cash-generating unit is allocated to the headroom and has not an immediate effect on the goodwill. Therefore, under this condition an asset impairment loss on acquired goodwill is recognised only when that headroom is reduced to zero.32

If property, plant and equipment and, under rare circumstances, intangible assets33 are measured at revalued amounts an update of the fair value is dependent on the volatility of changes in fair value. In the case of insignificant changes in fair value34 it may be sufficient to determine the fair value for the assets subject to an revaluation only every three or five years.35 Under the present circumstances the conditions for an update of the fair value of the revalued assets only in a few years cycle will probably not be fulfilled. Therefore, even if there is no indication for an asset impairment, the fair value of assets subject to revaluation has to be determined and used for revaluation. Even if such an update of the fair value of the revalued assets does not trigger an asset impairment loss recognised in the statement of profit or loss (p/l-statement), it may be possible that a loss from revaluation is recognised in the other comprehensive income, if there is any credit balance existing in the revaluation surplus in respect to that asset.

4.1.2 Financial assets and hedge accounting

The Covid-19 pandemic may affect the amount of the recognised expected credit losses36 and the fair value of financial assets. Schedule 1 shows the relevant effects for the different kinds of financial assets:

Schedule 1: Types of effects on the comprehensive income for the different kinds of financial assets

The economic effects of the Covid-19 pandemic could also cause an increase of the expected credit losses or the occurrence of impairments for financial assets measured at amortised cost (AC) and financial assets measured at fair value through other comprehensive income (FVtOCI). With regard to the expected credit losses, the entity has at first to assess if the expected credit risk of the single financial assets (measured at AC or FVtOCI) have increased significantly since initial recognition. In this case, the loss allowance for the non-credit-impaired financial assets must be changed from the loss allowance at the amount equal to the 12-month expected credit loss37 to the loss allowance equal to the amount of expected credit losses until the maturity of the financial assets (Lifetime expected credit losses38). Therefore, the loss allowance for expected credit losses is not only affected by the annual update of the credit risk but in addition by a change in the method of calculating the loss allowance for the credit risk.39 For the calculation of the loss, allowance for the financial assets subject to the expected credit loss model an entity shall use all reasonable and supportable information that is available at the end of the reporting period to an entity without undue cost or effort when applying IFRS 9.40 In this context, the ESMA points out that the presumption of IFRS 9. chap. 5.5.11 sent. 2 that a significant increase in credit risk since initial recognition has happened when contractual payments are more than 30 days past due is rebuttable.41 Similarly, the IASB states that it is not sufficient to rely “on some mechanistic criterion (for example, treating payment holidays as automatic evidence of a significant increase in credit risk) to determine”42 a significant increase in the credit risk and in the consequence to change the expected credit loss model for such financial assets. In addition, the effect of most probably implemented public measures on the credit risk has to be considered.43

If a financial asset becomes credit-impaired due to the economic effects of the Covid-19 pandemic the loss allowance on that financial asset has to be calculated at an amount equal to the lifetime expected credit losses. Moreover, the effective interest rate shall be applied to the amortised cost of that financial asset in subsequent reporting periods.44

Besides these above-mentioned effects on the p/l-statement which only arise from financial assets measured at AC or for those measured at FVtOCI, effects on the comprehensive income from the fair value measurement have to be recognised for all financial assets except for financial assets measured at AC. But only in the case of financial assets measured at fair value through profit or loss (FVtPL) the fair value changes have to be recognised immediately in the p/l-statement. The cumulative fair value adjustments of the financial assets measured at FVtOCI recorded in the other comprehensive income during the holding period of these assets have to be reclassified and recognised in the p/l-statement when the financial asset is sold or reclassified45, or otherwise derecognised. In contrast to this, all fair value changes from investments in equity instruments not held for trading purposes are never subsequently transferred to profit or loss. The same also applies for the gain or loss from sale or other derecognition of these equity instruments.46

A Covid-19 pandemic induced reclassification of financial assets from one to another category of financial assets shown under schedule 147 arises only in rare circumstances as at initial recognition the financial assets (of a portfolio) are classified on the basis of the business model under which these financial assets are managed and on the characteristics of their contractual terms.48 According to IFRS 9. App. B. 4.1.3A, even if the entity sells financial assets when there is an increase in the assets’ credit risk the business model for financial assets measured at AC is not breached. This has to be applicable analogous for a higher sales volume of financial assets measured at FVtOCI as the business model for these financial assets allows already under normal circumstances greater frequency and higher sales volumes.49

The Covid-19 pandemic may also affect the hedge accounting. In the case that the hedged item is a forecast transaction at the end of the reporting period the entity has to assess if the transaction is still highly probable.50 A postponement of the forecast transaction by a short period of time might be justifiable and does not induce a discontinuation of the hedge accounting.51 Otherwise it has to be distinguished if the transaction is still expected to occur in the future (but not highly probable) or not. In the first-mentioned case the amount which has already been recognised in the other comprehensive income and accumulated in the cash flow hedge reserve shall be retained in equity, otherwise the amount accumulated in the cash flow reserve shall immediately be reclassified to profit or loss.52 The hedging instrument, which has formed a part of the hedging relationship until the discontinuation of the hedge relationship takes place, is subsequently classified according to the general rules on a stand-alone basis. Normally, the hedging instrument is a financial derivative and therefore classified as a financial asset measured at FVtPL.

4.1.3 Investments in associates and joint ventures

Due to the economic effects of the Covid-19 pandemic it may be possible that an objective evidence of an impairment of the net investment in the associate or joint venture arises.53 Under this condition the entire net investment in the affected associate or joint venture has to be tested for an impairment. The net investment in the associate or joint venture does not only include the carrying amount of the interests in the associate or joint venture determined by using the equity method but also any long-term interests that, in substance, form part of the entity’s net investment in the associate or joint venture. A long-term interest qualifies as part of the net investment in the associate or joint venture if its settlement is neither planned nor likely to occur in the foreseeable future54 (e.g. long-term loans, participating certificates). The asset impairment test according to IAS 36 for investments in associates and joint ventures compares the recoverable amount of the entire net investment in the associate or joint venture as a single asset with its carrying amount.55 Any impairment loss has to be recognised in the profit or loss without any allocation to the assets included in the net investment in the associate or joint venture.56

4.1.4 Inventories and work in progress

The measurement of the inventories for which IAS 2 has to be applied and also the measurement of the work in progress which are in the scope of IFRS 15 (contracts with customers) can also be affected by the Covid-19 pandemic.

For the measurement of the finished and semifinished products belonging to the inventories according to IAS 2 it has to be pointed out that the fixed production overhead costs have to be allocated based on the normal capacity of the production facilities.57 If in the financial year of 2020 due to Covid-19 pandemic induced shutdowns the actual capacity utilization is significant lower than the normal capacity utilization only the fixed overheads are allowed to be included in the costs of conversion which would have be incurred under a normal capacity utilization.58 The fixed overheads which could not be allocated to the products have to be recognised immediately as expenses in profit or loss.

Furthermore, the finished and semifinished products which are in the stock at the end of the financial year 2020 are subject to the asset impairment test for inventories. The net realisable value of these inventories may be decreased due to a Covid-19 pandemic caused lower demand for the sales products of the entity, e.g. from refining industries or from the consumers. If at the end of the reporting period the net realisable value of an item of inventory is lower than its cost this inventory has to be written down and an asset impairment has to be recorded in profit or loss.59 Also, materials and other supplies are subject to an asset impairment if either the net realisable value retrograde derived from the sales price of the finished product for which the materials are consumed or the replacement cost of the materials on the markets on which the entity usually purchases these materials60 is below the cost.

The work in progress in the scope of IFRS 15 could also be affected by the Covid-19 pandemic when after the contract inception significant changes regarding the criteria that are necessary for meeting the requirements of a contract with a customer61 occur.62 For example, this is the case when at a date after contract inception it is probable that the consideration to which the entity is entitled in exchange for goods or services could not be collected from the customer, e.g. due to a significant deterioration of the solvency of the customer.63 When such an event happens, at this point in time the entity has to reassess the sales recognition and eventually to correct the recognised net sales and the corresponding contract assets and contract liabilities (i.e. work in progress already not approved by the customer less any received advance payments).64

4.1.5 Other receivables

If the entity has taken out a business interruption insurance, which covers the lost profits or the incurred expenses during a Covid-19 pandemic induced business interruption (i.e. shutdown) it has to capitalise another receivable for all such insurance claims not paid until the end of the financial year 2020. If due to the conditions of the business interruption insurance it is doubtful that the insurance covers the lost profits or the incurred expenses during a pandemic induced shutdown (e.g. application of a “force majeure” clause) a receivable is only capitalised when it becomes virtually certain that an inflow of economic benefits will arise.65 Otherwise a contingent asset is arising which has only to be reported in the notes when an inflow of economic benefit is probable.66 Furthermore, at the end of the financial year 2020 the entity has also to recognise for any outstanding claim on governmental support payments in the context with the Covid-19 pandemic, e.g. compensation for the losses of a shutdown, receivable if it is virtually certain that this claim will be paid.