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It is no doubt that many if not all the Governments and citizens worldwide are facing dramatic times due to the outbreak of the Covid-19 global pandemic. Everyone’s current focus is on ensuring that doctors and nurses can treat affected patients alongside with safeguarding public health through restrictive measures on people’s mobility, and the adoption of precautionary behaviours to minimise spreading of the virus.
At the same time, there are visible signs that Governments are working to devise relief mechanisms to support all parties affected by the crisis, both companies and workers. This will become even more evident once the flattening of the ‘contagion curve’ will become more convincing. There are no doubts that in the aftermath of the health emergency, many companies and organisations will be the ‘patients’ to be treated. Prolonged halts to their production facilities are severely threatening their ability to survive. Yet we do not know what treatment should be and its duration.
The current debate revolves around (1) the nature of the intervention to support companies and workers; (2) the amount of resources required to replenish the economy, and (3) how the interventions should be funded, be them a EU-wide issuance of bonds, or rather a State-based intervention with the backing of the European Central Bank (or other institutions) as a last-resort guarantor.
We firmly believe that a key objective should be ensuring that any intervention (on the short term) should not trade off with the long-term survival of companies. Here accounting and accountants can offer a significant contribution and suggest actions, instruments and processes to be implemented in order to minimize the economic fallout of many companies in Europe. This can be achieved by the European Accounting Research community in multiple ways:
1. Analyse, Diagnose and Quantify Losses.
At present, we are not fully able to ascertain the amount of losses companies are facing due to the halt to their activities. Undoubtedly, this varies across industries and countries. In the same way, we cannot quantify the number of companies facing insolvency and bankruptcy risk due to such an exogenous event. Yet some key principles may help as an organising framework: first and foremost, we should ensure companies will continue to be going concern rather a gone concern.
In these days, companies are primarily experiencing losses in revenues, alongside with drops in cash. Yet some of the (fixed) costs are non-deferrable (e.g. salaries, service expenses, rentals); this will inevitably call firms to face cash disbursements on the short term – thus putting them under higher financial pressure. Income statements will also be severely hit, and more for companies with high (financial) fixed costs, bearing with a direct negative impact on equity. The damaging consequences on employees, work relations and other stakeholders will emerge rapidly. Depending on the country-specific regulation and business law, equity depletion may trigger default and/or worsen leverage ratios of survived companies.
The accounting group at the University of Padua has recommended one potential way to shield income statements and equity from the severe losses due to drop in revenues. In brief, we suggest capitalising undeferrable and extraordinary costs suffered during the halt periods and amortise them over a 5-years period. These costs – presumably stemming from past investments - do not match any present revenues, thus substantiating our approach. This approach is not intended to be simply an accounting gimmick but it carries two clear advantages for the policy makers: (i) it allows an estimation of the incurred losses due to the crisis, and (ii) it spreads its negative effects over time.
2. Design of Actions and Relief Measures.
The ongoing debate is - rightly so - on ensuring liquidity injections to firms to safeguard employees’ salaries, ensuring payments to suppliers and face any outstanding obligations. Most importantly this should prevent them from stopping their production. European countries are likely to follow different approaches in terms of relief mechanisms (www.voxeu.org): some envisage a direct support through unemployment insurances (e.g. reducing costs in the income statement) or equity injections; whereas others are pursuing a more indirect support through extremely low-interest rates and unusually long-term loans backed by government guarantees with the help of financial institutions and other public / private agencies.
This may not suffice, and accounting here can be helpful: the relief mechanisms should not only replace cash (generated by revenues) with cash stemming from debt. The crisis is hitting the underbelly of all companies, their strategies, plans and financing options, at least in the short run. Additional debt may help companies overcome the current downturn, but it has long-lasting detrimental effects on companies especially if it does not allow an inevitable re-shape of the organization and production facilities. In fact, it would generate a downgrading of companies’ ratings, with a domino effect on banks’ financial statements of banks whose risk weighted assets would deteriorate significantly.
Any intervention should take into account both the financial and income-related, effects of this crisis and the unavoidable replenishing of equity capital. Here we envisage a broad array of possible interventions:
– tax incentives for private liquidity injection to back up equity;
– temporary and reversible State-liquidity injection to reinforce equity;
– direct, one-off contribution in the form of ‘special item’ to partially offset lost revenues (e.g. in line with the current proposal within the Emergency Measurement Agreement in the UK for railway companies);
– offering unlimited support to raising debt.
While all these are plausible actions, accountants could help in clarifying the implications of each, and suggesting criteria and standards which can safeguard the going concern option for the affected companies. Notwithstanding the opportunity to design a mix of relief mechanisms (i.e. public and private roles) to minimize moral hazard and risk transferring toward the weakest stakeholders.
3. Recasting the Role of Accounting Principles and Standard Setting
There is a substantive evidence that large systemic crisis (e.g. the 2008 GFC) trigger revisions or suspensions of accounting standards. Recently, the European Securities and Market Authority (ESMA) issued a statement on the accounting implications of the Covid-19. The IFRS 9 will be under the spotlight especially in relation to the estimation of non-performing loans and expected losses (for banks). It is likely that similar actions will be taken in relation to the valuation of financial instruments - especially those held at fair value.
Even more problematic is the application of impairment test according to IAS 36, particularly for firms whose fiscal year end is June 30th. The comparison between recoverable amount through use or the exit value through disposal are likely to trigger an impairment with direct effects on income and equity. The halt to the production facility reduces the cash generating ability through sales (value in use) whereas the illiquid markets would underestimate exit values.
At a more general level, accountants play a key role in explaining why a temporary deviation from some of the key accounting standards (e.g. IAS 36 and IFRS 9) is desirable in this period. We suggest avoiding rigor mortis: strictly adhering some accounting principles may actually trigger earnings management – or losses – thus going counter to their principles: ensuring high quality financial statements. On the other hand, we should avoid an all too easy approach of discarding standards at all times, because these are inadequate: current deviations should not necessarily speak to their general suitability during ‘non-crisis’ periods.
Relatedly, if relief measurement programme does contain government grant for companies, it will matter how companies will account for those. If there is “reasonable assurance” that the grant will be received (IAS 20) accounting principles should clarify the preferred accounting treatment (e.g. one-off item, part of the other comprehensive income, an equity ‘provision’).
Last but not least, time is ripe for a call to action for the accounting research community in Europe. Governments, Central Banks, Business Communities will face key decisions in the next few weeks and months. Given the extraordinary and interconnected nature of the crisis and the types of relief mechanisms we can foresee, providing well-thought suggestions, with supported evidence is part of what we call ‘Third Mission’ of Researchers and Universities. For the time being this rather seems to be the first and most urgent.
Giacomo Boesso, Fabrizio Cerbioni, Francesco Favotto, Michele Fabrizi, Andrea Menini, Emilio Passetti, Silvia Pilonato, Antonio Parbonetti, Amedeo Pugliese (University of Padua)