We recently looked at the issue of earnings measures adjusted for the impact of covid-19…
…which don’t actually appear to be that common at present. As I noted, many regulators and similar bodies preemptively spoke up against the practice, with the UK’s Financial Reporting Council for instance saying: “(Adjusted Performance Measures) which attempt to provide a measure of ‘normalized’ or ‘pro-forma’ results, excluding the estimated effect of the covid-19 crisis, are likely to be highly subjective and, therefore, potentially unreliable.” My closing overall comment was: “Perhaps there are some companies out there for whom the pandemic’s impact is entirely short-lived, incremental and measurable, and who can meaningfully present an adjusted earnings number treating it as such. But plainly such companies will be an extreme exception, and for most others covid-19 will evade certainty in accounting just as it does in most other areas of life. Fortunately, it looks like they aren’t currently trying to persuade us otherwise.”
Now I’ve come across an interesting KPMG publication which considers another aspect of the issue – presentation within the income statement. The publication makes the same basic point as above: “Determining the impacts of covid-19 on a non-arbitrary basis may be challenging because distinguishing between income and expenses that are part of normal operations and those that relate to the pandemic may involve significant subjectivity. Companies need to assess carefully whether they are able to determine covid-19 impacts on a non-arbitrary basis, in order to provide relevant and reliable information to users of their financial statements.” Where that’s not possible, and the impacts of covid-19 on a company are pervasive, KPMG believes it would be inappropriate to present them within its income statement, but that the company “should consider disclosing them in the notes, providing quantitative (when possible) and qualitative information and stating whether it has identified only some or all of the impacts.” The presentation should not be misleading: “For example, it would be inappropriate to present or disclose only the expenses relating to covid-19 – and omit the related income – if both income and expenses are affected.” In practice this sounds like something that many companies may see as the territory of MD&A rather than the financial statements (the publication only addresses management commentary in passing though).
The publication provides the following examples of expenses which may be considered covid-19-related in that they’re incremental and directly related:
- additional cleaning and sanitation costs incurred as part of infection control or prevention;
- temporary hazard pay to employees;
- penalties for delays or non-performance of contracts due to closure of production facilities; and
- rent concessions from lessors that occur as a direct consequence of covid-19.
This is in contrast to items such as “expected credit losses, impairment loss on non-financial assets and fair value loss on equity investments” where it may be more challenging to determine the impact. It’s easy to think how even the kinds of items covered by their bullet points may be problematic – for example, regarding rent concessions or penalties, the adverse effect of covid-19 may be the tipping point for preexisting economic difficulties, rather than the only cause of difficulty or default. Maybe some kinds of expenses will initially arise as a response to covid-19 but, once established, will then never be rolled back, at least not in the foreseeable future. But if we go with the premise, we come to the most interesting part of the publication, on how such costs might actually be presented on the face of the income statement. For an entity classifying its expenses by nature, it provides the following examples, one using parenthesis, the other using subtotals:
At least for me, the parenthesis approach is rather more easy on the eye, but of course the substance is the same in both cases. Still, as I said, given the extreme prominence that such presentation gives to the numbers, it will be crucial that they’re only applied when it can be demonstrated why, in effect, a reader should feel justified in placing lower ongoing significance on the numbers identified as covid-19-related.
A couple of other points from the KPMG publication:
- companies should not present covid-19-related income and expenses outside operating results solely because they may be non-recurring or unusual. Instead, companies should apply the definition of ‘operating’ consistently to income and expenses regardless of whether they relate to covid-19. For example, cleaning costs are generally part of operating activities and are therefore presented within operating results. As such, incremental cleaning costs incurred to prevent the spread of covid-19 are also presented within operating results.
- hypothetical, ‘as if’ measures or notional numbers – e.g. those that reflect originally budgeted or normalized amounts – do not represent historical financial information and are generally not included in the financial statements. Therefore, it is inappropriate to present these items (e.g. ‘expected revenue had the covid-19 outbreak not happened’) in the income statement. Similarly, presentation of ‘lost revenues’ is also inappropriate.
I certainly wouldn’t disagree with that, even though in some cases the company may be as sure in asserting that certain lost revenues would have been received if not for covid-19 (relating for instance to canceled contracts which would almost certainly have been executed otherwise) as in pointing to certain costs that it would otherwise have avoided. Well, as we know, the virus isn’t marked by the even-handedness of its impacts…
The opinions expressed are solely those of the author