COVID-19 the most debated topic of 2019 has created threats not only to human lives but also to business. It seems that we were able to survive through the tough pandemic time and now it is time to save our businesses and economy in the road to recovery. Australian business owners should bear in mind specific issues that may affect the businesses due to the uncertainty arising on the extent and the duration of COVID-19. This article elaborates key accounting and tax implication changes that business needs to consider on their road to recovery from the COVID-19 pandemic.
Presentation of Financial Statements
According to ‘AASB 101 – Presentation of Financial Statements’, businesses need to assess their going concern when preparing financial statements and as per ‘ASA 570 -Going Concern’ auditors are required to audit this information and form an opinion. Due to the pandemic, management is required to assess the suitability of preparing the financial statements according to Going Concern basis. If the managers are aware of a material effect that affects the going concern that needs to be disclosed in the financial statements. If there are persistent facts that threaten the going concern, then financial statements should not be reported based on ongoing concern and the alternative methods of preparation needs to be explained on the financial statements. Also, as per current market changes, there can be changes to the current and non-current classification of debt and there may be a greater level of uncertainty when doing judgments and estimations. AASB 101 requires all these changes to be correctly presented with proper references.
Many businesses in the retail, FMCG sectors in Australia deals with perishable inventory which may have destroyed due to supply chain disruptions. There can be excess inventory due to less demand and disruptions to manufacturing. According to ‘AASB 102-Inventories’, such entities need to consider the impact on the Net Realisable Value. If there are significant inventory write-downs those needs to be disclosed and if there are significant costs entities should consider the chances in capitalizing those costs.
Impairment of Assets
There are significant changes in Impairment of Assets. ‘AASB 136- Impairment’ requires businesses to assess the impairment of assets with the current market conditions. If an entity’s market capitalization falls below the net assets carrying amount then the entity has to impair the assets. Goodwill and other intangible assets are required to be impaired at least every year. Because of the interruptions to the operations and going concern uncertainties, there is a reduction in demand and profitability.
Also, the capital market has become highly volatile. All these factors affect the Beta and cost of equity which results in an increase of the weighted average cost of capital as well as the decrease in NPV of future cashflow. According to ‘Fair Value less Costs of Disposal’ method entities may face difficulties in measuring fair value in the absence of arm’s length transactions of willing parties. ‘Single Predicted Outcome approach’ also need to be adjusted based on the incorporated risk arising due to COVID. Discounted Cashflow model has to consider the assumptions such as inflation, product prices considering the effects of Covid-19.
The discounted rate would be higher than the past rates to reflect the higher risk. When considering Property Plant & Equipment the other major change is for the depreciation. If there are changes to the market conditions that affect the asset which leads to a change in residual value or useful value then there is a requirement to change the depreciation rates as per ‘AASB 116- Property Plant & Equipment’. Also, as per the ‘AASB-13 Fair Value Measurement’, there can be changes to the fair value of assets and liabilities. Market model may change due to market condition changes and Income model may change due to the uncertainty of future cashflows.
Past assumptions might no longer be valid in the current economic conditions when it comes to financial instruments which makes the calculations more complex than usual. For example, the risk of default might have changed in loans. Businesses need to assess what is the probability the loan will get defaulted and what would be the defaulted loss. All the assumptions, the baseline of inputs needs to properly disclosed as per ‘AASB 7- Financial Instrument Disclosures’. For the entities who are involved with hedge accounting, in the event of discontinued hedges; the cash flow hedge reserve and the fair value identified in the income statement needs to be revised. Similarly, if the hedge is reduced or deferred still there needs to be a change in fair value and the cash flow hedge reserve. There can be situations where businesses try to renegotiate the terms of existing debts. If there are substantial modifications to the terms of an existing debts ‘AASB 9- Financial Instruments’ requires all the previously identified debt value and capitalized costs relating to the previous debt to be disregarded. Instead, the new debt needs to be identified at a fair value. Almost all the entities hold cash in a financial institution. Usually for Cash at the bank face value is equal to the reported value. But the conditions have changed due to COVID-19 especially with the small financial institutions, foreign jurisdictions where there are no insurance or ADI deposits. There can be changes to derivatives too. Derivative includes a promise to perform by both the parties involved. Entities may have assumed the other party will perform as per the contract. But with current circumstances, there are slumps in the creditworthiness of many counterparties. In such cases, the fair value of derivatives will get impacted.
Provisions, Contingent Liabilities, and Contingent Assets
There may be instances where the cumulative cost of satisfying a contract may have increased its economic benefit because of penalties, delays, disruptions to inputs, etc. In such instances, those contracts need to be acknowledged as Onerous contracts and appropriate provisions to be made as per ‘AASB 137- Provisions, Contingent Liabilities, and Contingent Assets’. Also due to the pandemic businesses might be facing different litigations, claims, employment contract issues, redundancy issues. For those instances, necessary provisions or contingent liabilities have to be made. Some fortunate entities may have obtained Business Continuity Insurance where there can be possibilities in recovering costs of closing down due to COVID-19. In such cases, entities have to identify contingent assets or insurance recovery receivable in the financial statements.
In Australia, there are many companies with foreign operations. Due to COVID-19, it was noted that numerous companies have liquidated their foreign operations. Those businesses have to calculate the impact on foreign currency translation reserve. If the entities have disposed of the foreign operation then a profit or a loss needs to be identified as per ‘AASB 121-The Effects of Changes in Foreign exchange Rates’.
Leases are another major area in accounting that has been affected due to COVID-19. There can be business decisions that have been taken which makes the termination of the lease agreement. Businesses have to consider all the termination penalties and the calculations have to happen based on the revised discount rates. Similarly, reducing a lease asset or decrease in lease terms would result in a profit or a loss that needs to be accounted for.
If in any case, the lessor modifies the lease contracts, the implications will be different. In an instance where the lessor modifies an operating lease, from that date, it will be considered as a new lease after adjusting for all the accrued or prepaid lease costs of the original lease agreement. In a situation where a lessor adjusts a finance lease and it’s still a finance lease even after the modification, then as per ‘AASB 9 financial instruments’ lease receivables need to be identified.
Revenue from Customer Contracts
Contracts with customers include different variable considerations incorporated to measure the performance and declines. With the current situation, these conditions might need to be reassessed and previously recognized revenue might no longer be revenue with the reassessments. Credit risk has risen and due to that contracts may no longer be enforceable. In such cases as per AASB 15 revenue needs to be recognized as deferred. At the same time if the entity is not going to have future contracts with the customer there needs to have changes to the amortization period of the capitalized costs relevant to that contract.
Apart from the above major accounting implications, there are several tax changes also which affects the businesses in Australia.
The recoverability of deferred tax assets arising due to tax losses needs to be re-assessed due to changes in the economic conditions. For companies that receive income tax incentives by the government due to COVID-19 should adjust their current and deferred tax provisions.
Job Keeper Wage Subsidy
For Australian businesses who have faced a material decline in turnover, the government initially has introduced a Job keeper stimulus package from March to September 2020 and now it will continue till March 2021. There are certain guidelines for a business to be able to qualify for this scheme. The program allows a pre-tax payment of AUD$1,500 for a fortnight for qualified businesses. These businesses then need to make a minimum of AUD$1,500 for their employees per fortnight before tax.
Fringe Benefit Tax
Employers may have incurred additional expenses in relation to its employees in terms of accommodation, first aid, transport, emergency healthcare, etc. These may be liable to Fringe benefits tax. However, if the expenses can be categorized as ‘emergency assistance’ there can be tax relief. If an organization has provided equipment, devices for the employees to work from home, those expenses are exempted from the Fringe Benefits Tax.
Accelerated Depreciation on New Assets
Businesses can become eligible to deduct the cost of the new depreciated assets at an ‘accelerated depreciation rate’ if there is an aggregated turnover of less than AUD$500 million in the year of the deduction. This deduction is claimable when submitting the tax return for the period. For each brand-new asset, the business holds accelerated depreciation is applicable if the asset is ready for use for taxable purposes from 12 March 2020 to 30 June 2021. However, for subsequent years normal rates have to be used.
Instant Asset write-off
Under the Instant Asset Write off scheme Australian business can claim a deduction for the business portion of the cost of a particular asset which or first used or ready to use. From 12 March 2020 to 31 December 2020 this write-off will be applicable. However, the threshold amount for each asset needs to be AUD$150,000. The business turnover also needs to be less than AUD$500 million. This can be used for multiple assets within the threshold and also for both new and second-hand assets which use the simplified depreciation rules.
There are many changes to the accounting and tax system along with so many other changes to the businesses. For a business to go pass this rough ‘Road to Recovery’ there are few gears to be accelerated on.
1.Keeping up to date financials
2. Regular finance health checks on the business
3. Improve the cashflow
4. Developing a contingency plan
5. Regular contacts with the employees
6. Regular contacts with key customers, improve online sales.
7. Regular contacts with key suppliers
Adhering to these facts will be the definite ‘Road to Recovery’.