Question

You are the accountant of a Company whose operations have been largely impacted by COVID-19 and is consequently facing cash flow issues.

(a) The Company will be receiving government subsidy to cover some of its employee costs for the next three months. For tax accounting purposes, how do you think this subsidy should be treated. Provide justifications for your answer.

(b) The Company has a loan of $8 million with an Australian bank. Given its current financial situation, the Company has qualified to defer its monthly loan repayments for the next six months, with its interest capitalised.

The Chief Executive Officer (CEO) of the company advises you that you do not need to include the loan in the general-purpose financial statements ending 30 June 2020, but instead in the financial reports for the year ending 30 June 2021. Do you agree with this advice? Provide justifications for your answer

Answer 1

Please mentioned below the answer

Ans a) To help discharge this duty, the government undertakes promotional activities, provides incentives and grants to businesses. The grants received from the government are in various forms such as subsidy, incentives, duty drawbacks among others.

AS 12 deals with grants given by government but does not covers:

i) The accounting for grants which reflect the effect of price changes
ii) Assistance by the government other than grants like tax exemption, etc
iii) Participation of government in organisation’s ownership

               The assistance was given by the government in cash or kind with certain specific conditions. These do not include such grants from the government which cannot be measured reasonably.Also, the transactions with the government which cannot be separately identified from normal trading of the organization are not considered as a grant.For eg:- Receipt of cash on the sale of packaged drinking water to railways by ‘Bisleri’.

There are two methods outlined by the AS to account for the government grants:

I. Capital approach
II. Income / Revenue approach

The method of accounting for any grant is always based on the nature of grant received. The grants are recognized only where a certainty exists for the fulfilment of conditions and ultimate collection of such grants.

          To state simply, these grants are treated as a part of capital or shareholder’s funds. These are such grants which are given as a proportion of total investment in a business.

Ordinarily, the government does not expect a repayment of such grants. Due to this reason, such grants are credited to the capital or shareholder’s funds.

These grants are divided primarily into three types:

A) Non-monetary grants
B) The proportion of capital in a business
C) For specific fixed assets

The grants are treated as a deferred income in the financial statements. This income is recognized gradually in the profit and loss account over the useful life of an asset or say in the proportion of depreciation on such asset.

A subsidy or government incentive is a form of financial aid or support extended to an economic sector (business, or individual) generally with the aim of promoting economic and social policy. Although commonly extended from government, the term subsidy can relate to any type of support – for example from NGOs or as implicit subsidies. Subsidies come in various forms including: direct (cash grants, interest-free loans) and indirect (tax breaks, insurance, low-interest loans, accelerated depreciation, rent rebates). Furthermore, they can be broad or narrow, legal or illegal, ethical or unethical. The most common forms of subsidies are those to the producer or the consumer. Producer/production subsidies ensure producers are better off by either supplying market price support, direct support, or payments to factors of production. Consumer/consumption subsidies commonly reduce the price of goods and services to the consumer. For example, in the US at one time it was cheaper to buy gasoline than bottled water.

Ans b) The policy rate was cut by 25 basis points twice on March 3 and 19, to 0.25 percent. The Reserve Bank of Australia (RBA) has announced yield targeting on 3-year government bonds at around 0.25 percent through purchases of government bonds in the secondary market. To support liquidity, RBA will conduct one-month and three-month repo operations daily until further notice. Repo operations of longer-term maturities (six months or longer) will be held at least weekly, as long as market conditions warrant. The RBA also stands ready to purchase Australian government bonds in the secondary market to support its smooth functioning. RBA has established a swap line with U.S. Fed for the provision of US dollar liquidity in amounts up to US$60 billion. To allow banks to lend more to SMEs during the period of disruption caused by COVID-19, RBA has established a term funding facility of at least A$90 billion for SMEs lending for access to three-year funding at 25 basis points.

The Australian Prudential Regulation Authority (APRA) has provided temporary relief from its capital requirement, allowing banks to utilize some of their current large buffers to facilitate ongoing lending to the economy as long as minimum capital requirements are met. APRA also announced on March 30 that it is deferring its scheduled implementation of the Basel III reforms in Australia by one year to January 2023. Based on guidance issued on April 7, APRA expects banks and insurers to consider deferring decisions on the level of dividends or approve a dividend at a materially reduced level. APRA is also temporarily suspending the issuing of new licenses for at least six months in response to the economic uncertainty created by COVID-19.

In addition, the Australian Banking Association has announced that Australian banks will defer loan repayments for small businesses affected by COVID-19 for six months. APRA clarified that loans that have been granted repayment deferrals as part of a COVID-19 support package need not be regarded as restructured for borrowers who have been meeting their repayment obligations.

Ans c) Like all other aspects of a company’s operations, financial reporting for the period ended 31 March 2020 will be significantly impacted by the global fallout from the COVID-19 pandemic.

At a fundamental level, for certain companies, the current situation casts significant doubt on their ability to continue as a going concern, particularly if large debt repayments are due within the next 12 months. Management would need to prepare detailed assessments to support the going concern assumption. These assessments may be difficult to make given the high levels of uncertainty. In certain cases, this may require disclosure in the financial statements, and even in the auditor’s report.

Another area involving significant judgment and estimates is the recognition of impairment, which is generally based on forecasted cash flows to be generated from the use of certain asset groups. Companies would need to critically evaluate and revise their previous cash flow estimates to determine any impairment losses to be recorded for plant & machinery, intangibles, strategic investments and goodwill from acquisitions. Similarly, given that realisable value of the company’s inventory may have reduced, there may be a need to write-down inventory.

Issues may also arise in areas relating to revenues. At the basic level, companies would need to determine whether the conditions for revenue recognition have been met for goods that may have been dispatched, but not delivered to the customer. Companies would also need to determine whether they may have breached any obligations to deliver under their contractual arrangements, and whether any provisions need to be established for penalties. Further, companies are now required to record their provision for bad debts based on what is called the Expected Credit Losses (ECL) model. These models have been constructed based on the company’s historical experience, which may not be representative of future expectations of bad debts. In such cases, the ECL model would need to be appropriately updated.

Even as companies deal with the above issues, they need to determine whether their period-end financial reporting processes are geared to operate in the current ‘work from home’ environment. This environment may severely impact the company’s ability to prepare its financial statements and get them audited per original timelines. In several cases, companies may need to defer the dates of their Board meetings to consider the audited financial results. Acknowledging this, the Securities and Exchange Board of India has already deferred the timelines for year-end financial results of listed companies by 45 days to 30 June 2020. Additionally, the work from home environment may impact the efficacy of certain internal controls set up by the company, and thereby expose the company to risks of fraudulent financial reporting.

Given the uncertainties involved, it is important that ‘C’ level executives communicate regularly with all stakeholders, including the Audit Committees and the auditors. Companies should expect a greater level of challenge from these stakeholders. This challenge is essential to ensure that the financial statements accurately capture the impact of various risks and uncertainties involved. In certain cases, auditors may not be able to perform mandated audit procedures such as year-end inventory counts, which may result in qualifications in the auditor’s report.

The impact of COVID-19 reporting is not restricted only to the audited financial statements. While preparing their annual reports and investor presentations, companies would need to ensure that their Management Discussion & Analysis, risk management disclosures and investor decks are also suitably updated.