The effects on the balance sheet and P&L as well as ...
The question that generally arises is whether or not the effects of the coronavirus crisis have to be reported in the annual or consolidated financial statements that have to be prepared, in accordance with German commercial law, for the financial year ending 31.12.2019. This will depend on whether the causes of the spread of the virus existed already prior to the reporting date or only after that date. If the cause was present prior to the reporting date then, in the sense of an adjusting event, all the financial consequences would have to be taken into consideration in the balance sheet as at 31.12.2019. If the cause was present in 2020 then this would constitute anon-adjusting event, as it did not occur until 2020, and no consequences whatsoever would have to be acted on in the 2019 balance sheet.
Shortly before the turn of the year, China informed the WHO about the first cases of coronavirus infections. At this point in time however, in Europe, it was not assumed that this constituted the start of a pandemic of the magnitude that we can see today. It was only the spread of the virus in 2020 that resulted in the current economic effects. Therefore, as the outbreak of the coronavirus crisis did not occur until 2020 it should be regarded as a non-adjusting event (also the view of the IDW [Institute of Public Auditors in Germany] in its Technical Guidance on the effects of the spread of the coronavirus on accounting, Part 1 from 4.3.2020). Due to the purely reporting date-based approach in the balance sheet, any effects that arise for the balance sheet (e.g. valuation adjustments for equity interests or receivables) will only have to be reported in financial statements with reporting dates after 31.12.2019.
... on the notes to the financial statements
The notes form part of the annual financial statements and fulfil a variety of functions. These include streamlining, interpreting, supplementing and adjusting the balance sheet and P&L. The adjustment function, in accordance with Section 285 no. 33 of the German Commercial Code (Handelsgesetzbuch, HGB), is performed through so-called supplementary reporting of: “events of particular significance that occurred after the end of the financial year and that have not been taken into account either in the profit and loss statement or the balance sheet, indicating their nature and financial effects.”
Within the scope of supplementary reporting, the nature and financial effects of an event should generally be explained. In doing so, the coronavirus crisis and its significance for the business should be described. If it is not yet possible to quantify the financial effects then it would be sufficient to provide a qualitative description and to note that an assessment of the financial effects is not yet possible.
Cross-referencing notes/management report
In principle, in view of the similar nature of the report content, it is possible that a reporting requirement will arise for both the notes and the management report. To avoid duplication and to increase the transparency of forward-looking information it is possible to present the effects in a prominent place. The IDW, in its Technical Guidance (Part 3 from 8.4.2020) clarified that in the supplementary report it would be permissible to refer to the descriptions in the management report. This would be on condition that identical information would otherwise have had to be included in both reports and that in the supplementary report there is a clear reference to the management report.
The explanations in the supplementary and/or management reports have to adequately present the impacts on business. The time period for which the effects have to be presented should extend to the date on which the annual financial statements were drawn up; in the case of companies that are subject to mandatory audits this is normally the date of the auditor’s report.
Specific effects on the management report
In the case of medium-sized companies and large companies, the management report complements the backward-looking information in the annual financial statements. According to Section 289(1) clause 4 HGB “the management report has to provide an evaluation and explanation of the developments that are expected as well as their main opportunities and risks”. A distinction has to be made here between the reporting requirements in the risk report, on the one hand, and the report on expected developments, on the other hand.
In the risk report, the following risk categories, in particular, are reportable:
- risks to the company as a going-concern, such as e.g., imminent illiquidity or impending over-indebtedness as well as
- risks that could materially affect the financial position, cash flows and results of operations of the business.
In the course of the coronavirus crisis, the liquidity risk or rather the risk of illiquidity, in particular, have to be documented. This can be done, e.g., in liquidity and financial plans extending at least to the end of the new financial year. The tax measures to bolster liquidity and the potential loans from the KfW (a German government-owned development bank) should be included in these plans.
Report on expected developments
In the report on expected developments, the management has to make statements about the anticipated (i.e. the planned) development of revenues and earnings for at least the first year after the balance sheet date. During the coronavirus crisis, the forecasting ability of those businesses affected will be adversely impacted to a great extent. Against this background, it would be sufficient to provide qualified comparative forecasts, such as e.g., “ ... for the financial year 2020, in view of the coronavirus crisis, we expect significantly lower revenues … strongly negative EBIT…“.
Conclusion: There is neither a requirement nor a possibility to take into account the coronavirus crisis in the balance sheet and P&L as at 31.12.2019. Nevertheless, you will have to give an account of the effects of the coronavirus crisis in the notes to the financial statements, in the so-called supplementary report as well as in the management report. The greater challenge is likely to be the preparation of the risk report where statements will have to be made as to whether or not, if all the risks are aggregated, the risk-bearing capacity can be ensured and the extent to which there are developments that could jeopardize the company as a going-concern. This could require, e.g., the presentation of annual liquidity and financial plans.