COVID-19: Accounting for its Cost

I am sure that we all remember a time when social distancing, face masks and staying at home (perhaps being unable to trade or work), were the stuff of waking up in a sweat in the middle of a nightmare. Sadly, that nightmare became a reality for way longer than we would care to admit, and the pandemic’s impact on our lives and livelihoods requires no further introduction.

COVID-19 impacted us all, with the hospitality sector arguably being impacted more than any other. One aspect of the pandemic which did not make the headlines is the accounting implications for entities that are required to prepare statutory financial statements. Those implications are many, and we will focus on two of them in this article.

Perhaps the most critical impact is the assessment of whether an entity is a going concern. Both accounting frameworks available in Malta (IFRS and GAPSME) are based on a fundamental presumption that an entity is a going concern, i.e. the entity is expected to continue to operate for at least twelve months from the financial year end. Why is this important? Financial statements’ purpose is to enable stakeholders (‘users’) to make decisions, whether those decisions are investment decisions (buy, hold or sell), lending decisions (such as whether to lend money to an entity, or to grant it credit), or other decisions. In order to make those decisions, users need to know whether an entity is expected to still be in business within twelve months from the financial year end.

Amongst others, the closures and disruptions to entities operating within the hospitality sector, together with low occupancy rates or patronage, and difficulties meeting loan repayments and complying with debt covenants, have combined in a way that continuing to operate for a period of twelve months is not necessarily a certainty. Preparers of financial statements are therefore obliged to make a formal, realistic and unbiased assessment of whether the entity is a going concern, and the financial statements should only describe the entity as a going concern if it is so. Material uncertainties about this judgement must be disclosed so that users of the financial statements can make informed decisions.

On the other hand, if it is determined that an entity is not a going concern, the financial statements should disclose this fact, together with the basis on which they have been prepared. For instance, if as a result of not being a going concern it is anticipated that the company’s assets will be sold off, then one would expect those assets to be measured within those financial statements at the net proceeds expected from a sale, and information on this measurement basis will need to be provided to users of the financial statements through appropriate disclosures.

All is however not necessarily well even if it is determined that a company is a going concern. This is because preparers of financial statements must also be aware that they will likely need to test their assets for impairment. In simplistic terms, ‘assets’ are resources that are controlled by an entity, and from which the entity will obtain benefits either from selling the assets, or from using them in the process of generating returns. ‘Assets’ need not necessarily be owned, as they could, amongst others, be leased (in which case the ‘asset’ is a contractual right to use someone else’s resource). Food items are assets, as they will be sold to earn a return; a hotel is likewise an asset, as it will typically be operated to earn a return.

The concept of impairment is perhaps best understood by making reference to a couple of plain English words (‘existence’ and ‘valuation’) and using an analogy. If an entity owns a machine which was purchased recently for €25,000 and which has, unfortunately, suffered significant damage, then saying that the company has a machine (i.e. ‘existence’) is factually correct and is not in itself an issue. However, users have a right to assume that, in its current state, the machine can earn a return – either through sale or through use – of at least the amount at which it is presented in the financial statements. Showing the significantly damaged machine at a value of €25,000 is, at best misleading, and at worst fraudulent, if in its current state it cannot earn that amount through sale, and neither through use.

Indeed, an asset is impaired if the amount at which it is measured is more than can be earned from selling or operating it. Preparers of financial statements are required to test some assets for possible impairment on an annual basis; most other non-current assets must be tested whenever there is anything to indicate that the asset may be impaired. Indicators that an asset may be impaired could be internal, such as damage to the asset, or a decision to retire it from use, and they could also be external, such as factors impacting the wider economy or the specific sector. There is no doubting that within the hospitality sector, COVID-19’s impacts are generally an external indicator that assets may be impaired.

If it is determined that an asset is impaired, then its value within the financial statements (i.e. its ‘measurement’) must be reduced to the amount which can be earned through sale or use, whichever is higher. The reduction in value is generally recognised in the income statement. Following an impairment, users will correctly be able to assume that the assets can at least earn the amount at which they are measured.

In the case of a hypothetical sale, one should however consider net proceeds (after deducting any selling costs such as duty or brokerage). Meanwhile, in the case of using the asset, one needs to:

• consider the net cash flows that can be earned from using the asset (for instance, when testing a hotel, one must look not only at future operating revenues, but also at future operating costs);


• test the asset in its current state (uncommitted upgrades or refurbishments cannot be reflected); and


• cash flows will need to be discounted to present value (this is a concept that cash flows earned in the future are worth less today, given that earning cash flows today would allow the recipient to invest them and earn a return).

It is also important to note that because some assets do not earn separately identifiable cash flows – for instance, the oven in a restaurant – they need to be grouped up with other assets which, together, have separately identifiable cash flows. Thus, it may very well be determined that a restaurant needs to be tested for impairment as a whole.

If an asset was previously impaired, then one should be on the lookout for indicators that the matter which originally gave rise to the impairment may no longer exist. For most assets, a reversal of previous impairment charges is possible.

COVID-19’s accounting implications are far reaching, and this article is intended to give an overview of two of them. As the saying goes, however, the devil is in the detail, and even within the two areas of this article’s focus, the accounting requirements can get very complex. As needed, readers are encouraged to seek an accounting expert’s guidance.