FRC tells companies to divulge coronavirus risks
The UK accounting regulator is urging firms to disclose how the coronavirus is impacting operations, as disruption from the global epidemic wreaks havoc on supply chains at some of the world's largest businesses.
Such is the speed and ferocity of which the disease has continued to spread rapidly around the globe, major companies such as Apple, Puma and Adidas have reported a significant decline in business activity due to closed stores.
In response, the Financial Reporting Council (FRC) has issued guidance to companies and auditors advising full disclosure of the risks and the degree to which coronavirus might crystallise in year-end accounts.
"The thinking is to prevent situations where a company goes bust and the auditors haven't thought about the risks,” said Julia Penny, founder of JS Penny Consulting and former SWAT technical director.
Business feeling the heat
"Viability and risk reporting should take in wider risks to the business, so it makes sense to consider the impacts of something like the coronavirus,” said Penny. “It’s not just the people getting ill, which is bad enough, but movement restrictions will cause significant economic impacts – as we have already heard with Apple's trading announcement about limited iPhone supplies.”
Apple said this week it won't meet its first quarter revenue guidance because the virus outbreak has harmed both production and sales in China more than previously expected. The decision roiled stock markets and sent shares down, as other companies and entire sectors such as hospitality and leisure began to issue warnings of how the virus was damaging trade.
Consumer brands Under Armour and Canada Goose have published statements advising that the outbreak will hurt their bottom line, with food and beverage giants McDonalds and Starbucks also preparing to issue warnings having closed stores to prevent spread of the disease.
According to the World Health Organization, as of Wednesday, coronavirus has infected more than 75,000 people, killing more than 2,000, since December 31, and has been confirmed or suspected in 29 countries and territories.
Consequential risks and mitigation
The FRC update is aimed particularly at companies either operating in, dependent on supply chains in, or having close trading associations with China. However, other companies can be impacted, it said, due to the extent the virus has spread outside of the world’s second largest economy.
“This could have a knock-on effect on companies that buy goods directly from China because they may suffer delays in getting goods for onward sale to their customers,” said Steve Collings, partner at Leavitt Walmsley Associates Limited.
“We encourage companies to consider carefully what disclosures they might need to include in their year-end accounts relating to these events,” the FRC said. Consequential staff shortages and production delays are two immediate and noteworthy risks to business, the FRC said.
“Where mitigating actions can be taken, these should also be reported alongside the description of the risk itself,” the FRC said. “As well as possible inclusion within a company’s disclosures of principal risks and uncertainties, the carrying value of assets and liabilities might also be affected with a need to perform additional impairment tests and to assess whether leases have become onerous.”
For December year-end reports, the events would be likely to represent non-adjusting post balance sheet events as at December 31, 2019, the FRC said, as at that date few cases had been confirmed and the virus only just identified. However, for companies with later reporting dates, year-end balances might be affected, the regulator said.
“Given the potential for rapid spreading of the virus, required disclosures will likely change over time as more information about the epidemic emerges,” the FRC said. “As a result, companies will need to monitor developments and ensure that they are providing up-to-date and meaningful disclosure when preparing their year-end reports.”
Novel, but logical statement
Accounting experts said the unusual move by the regulator is consistent with its approach to push firms for greater transparency in reporting.
“The FRC advice is a novel departure, but is a logical step on from its work around viability reporting and its desire to see better disclosures on risks,” said Penny. “The council has been unhappy with how auditors and companies are dealing with going concern and made it clear that it extends further than fulfilling the technical requirements of ISAs.”
In encouraging firms to consider whether the outbreak of a disease poses a principal risk or uncertainty and if the company can mitigate the threat of the virus, they are advising that the planned mitigation be reported alongside the threat.
“It’s all about trying to be transparent where this virus is concerned and how such a threat is being managed,” said Collings. “The FRC also recognise that amounts reported in the financial statements for assets and liabilities may also be affected.”
This may include impaired assets that will need to be written down to recoverable amounts, Collings said, and additional liabilities may need to be recognised in respect of lease contracts that have become onerous. For example, lease payments still have to be made even though the entity may not derive any benefit from the payment, said Collings.
“They’re trying to encourage companies to think about how this virus can affect the day-to-day operations of the entity and then to consider whether amounts reported in the financial statements (assets and liabilities) have to be adjusted at some stage to reflect the associated threat,” he said.