What impact will Covid-19 have on disclosure considerations under FRS 105?
Coronavirus has created a high level of uncertainty, not only in daily life but also in the financial position of businesses. During these difficult times, accountants have a dual responsibility of not only compiling the historical data for compliance purposes but also to remind directors of their responsibilities for the key assumptions they make for the preparation of their financial statements.
FRS 105 is applicable to the preparation of the financial statements of a micro-entity which are presumed in law to give a true and fair view in accordance with the micro-entity’s regime. The micro-entity’s regime specifies certain minimum presentation and disclosure requirements. Financial statements that include the prescribed minimum accounting items are presumed in law to give a true and fair view and no further disclosures need to be made.
FRS 105 reflects the legal minimum presentation and disclosure requirements. Section 6 of the standard sets out the mandatory disclosure requirements as below:
6.2 The notes to the financial statements of a micro-entity in the UK shall be presented at the foot of the statement of financial position and shall include information about:
off-balance sheet arrangements as required by section 410A of the Act (see paragraph 6A.1 of Appendix A to this section);
employee numbers as required by section 411 of the Act (see paragraph 6A.2 of Appendix A to this section);
advances, credit and guarantees granted to directors as required by section 413 of the Act (see paragraph 6A.3 of Appendix A to this section); and
financial commitments, guarantees and contingencies required by regulation 5A of, and paragraph 57 of Part 3 of Schedule 1 to, the Small Companies Regulations (see paragraphs 6A.4 and 6A.5 of Appendix A to this section).
An indication of the nature and form of any valuable security given by the micro-entity in respect of commitments, guarantees and contingencies within paragraph 6A.2 must be given (paragraph 57(2) of Schedule 1 to the Small Companies Regulations or paragraph 55(2) of Schedule 1 to the Small LLP Regulations).
The directors need to make a careful assessment of these mandatory disclosure notes before they give their approval for financial statements to be issued. Covid-19 impact may have triggered one or the other disclosure to be included which may otherwise not be required in normal circumstances.
Key issues to watch out for when making assumptions
A micro-entity shall not prepare its financial statements on a going concern basis if management determines after the end of the reporting period that it either intends to liquidate the micro-entity or to cease trading, or that it has no realistic alternative but to do so.
The management of a micro-entity shall make an assessment of whether the going concern basis of accounting is appropriate, for which management takes into account all available information about the future, which is at least, but is not limited to, 12 months from the date when the financial statements are authorised for issue.
When assessing the appropriateness of the use of the going concern assumption, entities are required to consider events both before and after, irrespective of whether those events are adjusting or non-adjusting events. In their assessment, management will need to consider actual and projected foreseeable impact from various factors, such as the following:
Potential liquidity and working capital shortfalls
Significant decline in demand for products or services
Significant erosion of profits
Travel bans and restrictions
Financial health of suppliers and customers
Breach of debt covenants
If the micro-entity’s accounts have not been prepared on a going concern basis, there is no specific requirement to disclose, whereas if the directors wish to include this in the notes then they should follow paragraph 1AC.10 of FRS 102 as below:
‘If it appears to the small entity that there are special reasons for departing from any of the principles set out in company law in preparing the small entity’s financial statements in respect of any reporting period, it may do so, in which case particulars of the departure, the reasons for it, and its effects must be given in the notes to the financial statements (Schedule 1, paragraph 10(2))’.
Reporting accountants may also wish to consider the FRC guidance: aimed at auditors it provides useful insight for all.
Post balance sheet events
A fundamental principle in the preparation of accounts is that they should reflect the conditions that existed at the balance sheet date (FRS 105.4.1).
Section 26 clarifies the accounting and disclosures of any events which happen post balance sheet reporting date but prior to them being authorised for issue. These can be:
adjusting events: those that provide evidence of conditions that existed at the end of the reporting period
non-adjusting events: those that are indicative of conditions that arose after the end of the reporting period.
Covid-19 impact for the above events
Reporting periods ending on or before 31 December 2019 There is general consensus that the effects of the Covid-19 outbreak are the result of events that arose after the reporting date ie 31 December 2019. FRC has stated that Covid-19 in 2020 was a non-adjusting event for the vast majority of UK companies preparing financial statements for periods ended 31 December 2019.
FRS 105 does not mandate any disclosures for non-adjusting events (unlike FRS 102). However, there is no prohibition for doing so, if the directors intend to include them in the accounting notes, provided they follow relevant requirements of section 1A of FRS 102 for such disclosures to be sufficient.
Reporting for periods ending in 2020
For later reporting dates (eg February or March 2020 year ends), it is likely to be a current-period event which will require ongoing evaluation to determine the extent to which developments after the reporting date should be recognised in the reporting period.