Business is passing through an unprecedented time and incurring huge direct and indirect costs due to Covid 19 pandemic. Lockdown protocols have led to severe supply chain disruptions and labour shortages, hurting both the top and the bottom lines of almost all companies. Writing offs inventory with low shelf life or high storage costs or inadequate demand is a common news. Payments from customers are delayed, adding the burden of interest and increasing the chances of bad debts or loan defaults.
Should the losses arising out of Covid 19 lockdown be categorized as ordinary or should it be treated as extraordinary or exceptional losses is the question which will not only determine the comparability of internal (with previous periods) and external (with industry peers) financial statements but also impact the interest of investors, due diligence and banker’s credit limits. The article aims at bringing clarity on reporting these losses as per accounting standards for the presentation of financial statements while highlighting the difference between extraordinary and exceptional items in the light of present scenario. The disclaimer is this article does not provide any insight into the direct or indirect tax implications of disclosure under exceptional items for which appropriate adjustments will have to be made on a case to case basis.
ICAI’s Advisories and Guidance Notes for Auditors on Covid 19 Reporting: As a matter of practice whenever, there is any confusion in reporting of transactions, we refer to the Accounting Standards issued by Institute of Chartered Accountants of India (ICAI) as these standards deal comprehensively with recognition, measurement, presentation and disclosure requirements of almost all events and transactions in business. In the present Covid 19 situation, to guide the preparers and auditors of accounts, the Accounting Standards Board & Auditing and Assurance Standards Board of ICAI has issued “Accounting & Auditing Advisory- Impact of Coronavirus on Financial Reporting and the Auditors”. The Auditing and Assurance Standards Board (AASB) has also issued a guidance note on “GOING CONCERN Key Considerations for Auditors amid COVID-19” and a guidance note on Physical Inventory Veriﬁcation Key Audit Considerations amid COVID-19. These advisory and guidance notes highlight impact of Coronavirus on Financial Reporting under Ind AS 2 on Inventories, and AS 2 on Valuation of Inventories, Impairment of Non-Financial Assets (Ind AS 36 and AS 28), Financial Instruments (Ind AS 109 and AS 113), Leases (Ind AS 116 and AS 19 and AS 29), Revenue Recognition (Ind AS 115 and AS 9) and many other aspects.
The Advisory contemplates that in order to ensure that the potential impact of COVID-19 is suitably considered in preparing and reporting their financial statements for the year ended March 31, 2020, the situation may demand writing down inventories to net realisable value, impairment testing of assets and measurement of expected credit losses (ECL) on financial instruments. While assessing the significance of any write-downs of Inventory or reviewing the residual life of fixed assets, the advisory suggests disclosure in accordance with AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. The scope of the said Accounting Standard AS-5 reveals that it should be applied by an enterprise in presenting profit or loss from ordinary activities, extraordinary items and prior period items in the statement of the profit and loss, in accounting for changes in accounting estimates, and in disclosure of changes in accounting policies.
Going in-depth, AS 5 Standard defines, Ordinary activities and ‘extraordinary items’ in para 4 as:
4.1 Ordinary activities are any activities which are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance of, incidental to, or arising from these activities.
4.2 Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.
So, AS-5 while defining the ordinary and extra ordinary activities makes it clear that if an event or transaction is clearly “rare” and not expected recur frequently, and then it had to be separated from the transactions from ordinary operations. However, before going into the details of whether, losses arising out of Coronavirus are ordinary or extraordinary, it would be important to have a look at “exceptional items”, though not defined categorically in AS 5, but having a sufficient reference therein.
Exceptional Items: Circumstances which may give rise to the separate disclosure, commonly referred as “Exceptional Items” are dealt with in Para 12-14 (and also para 97-98 of Ind AS 1). As the Advisory suggest disclosure in accordance with AS 5, the relevant paras (para 12 to 14) of AS 5 are being reproduced hereunder:
12. When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.
13. Although the items of income and expense described in paragraph 12 are not extraordinary items, the nature and amount of such items may be relevant to users of financial statements in understanding the financial position and performance of an enterprise and in making projections about financial position and performance. Disclosure of such information is sometimes made.
14. Circumstances which may give rise to the separate disclosure of items of income and expense in accordance with paragraph 12 include:
a) the write-down of inventories to net realisable value as well as the reversal of such write-downs;
b) a restructuring of the activities of an enterprise and the reversal of any provisions for the costs of restructuring;
c) disposals of items of fixed assets;
d) disposals of long-term investments;
e) legislative changes having retrospective application;
f) litigation settlements; and
g) other reversals of provisions.
It is to be noted para 98 of Ind AS 1 also deal with exceptional items on similar lines as under:
98. Circumstances that would give rise to the separate disclosure of items of income and expense include:
a) write-downs of inventories to net realisable value or of property, plant and equipment to recoverable amount, as well as reversals of such write-downs;
b) restructurings of the activities of an entity and reversals of any provisions for the costs of restructuring;
c) disposals of items of property, plant and equipment;
d) disposals of investments;
e) discontinued operations;
f) litigation settlements; and
g) other reversals of provisions.
The above paras from AS-5 and Ind AS-1 show that though the term exceptional item has not been specifically defined but both the Accounting Standards (AS-5 and Ind AS-5) give reference and examples of situations which should be disclosed separately in exceptional situations.
Extraordinary Items deleted from IFRS, US GAAP and Ind AS 1: It is worthwhile to highlight here that the International Accounting Standards Board, (IASB), erased the concept of extraordinary items under International Financial Reporting Standards (IFRS) in 2002. Similarly, Financial Accounting Standards Board (FASB) on January 9, 2015, via Accounting Standards Update (ASU) No. 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items removed with the concept of extraordinary items from US GAAP. When FASB was discussing about eliminating extraordinary items, it found that it was extremely rare for companies to report extraordinary items, but auditors and regulators had to spend a lot of time in deciding if an event required a special reporting. Moreover, it noted that in the past, events such as terrorist attacks of September 11, 2001, and the Japanese tsunami in 2011 had also not been considered by FASB as extraordinary items.
On being questioned as to why 9/11 should not be considered as extraordinary event, Timothy Lucas, then chairman of the Emerging Issues Task Force (EITF) for FASB said “The extraordinary item treatment could never hope to capture the full event,” “The airlines lost three days of revenue, but lost revenue is not a cost that can be included in an extraordinary item, so the airlines would have had to break that out. We were not going to accomplish anything useful by having extraordinary item treatment of this event.”
As per a statement issued by FASB “Any approach to extraordinary item accounting would include only a part, perhaps a relatively small part, of the real effect”. The EITF concluded that showing part of the effect as an ‘extraordinary item’ would hinder, rather than help, effective communication.
The removal of extraordinary event concept from IFRS and US-GAAP was followed in India through Para 87 of Ind AS 1 which was drafted to direct that “An entity shall not present any items of income or expense as extraordinary items, in the statement of profit and loss or in the notes”.
Now the situation is that even though AS 5 requires the classification and disclosure of extraordinary items, such a disclosure has been eliminated long ago from US GAAP, IFRS and Ind AS 1.
Schedule III of Companies Act,2013: Another difference which is often discussed between extraordinary items and exceptional items is the disclosure requirements specified in Schedule III to the Companies Act,1956. The Schedule at S.No VI and VIII requires disclosure of exceptional and extraordinary items respectively. An extract of the Part B of the schedule is placed at the Annexure 1.
While the above para discusses on elimination of extraordinary items, exceptional items included in all accounting standards as can be understood as ordinary items which are infrequent but not unusual. A thin difference between extraordinary and exceptional is the “unusualness “or “rareness” or “a clear distinction from the ordinary activities”. Considering the Covid 19 scenario, the losses cannot be qualified as extraordinary items, but yet they are definitely exceptional. They are ordinary and infrequent. This categorization of losses as ordinary but exceptional can also aid significantly in tax assessments for direct and indirect taxes.
Can Covid 19 losses be considered as exceptional items: As per educational material on IND AS 1, IND AS (IFRS) Implementation Committee, exceptional items have not been defined in IND AS1. However para 97 as discussed above requires a company to disclose separately the nature and amount of items of income and expense that are material. Exactly on lines of para 97, UK companies following FRS 3 “Reporting Financial Performance” prior to moving to IFRS recognized exceptional items, and defined it as material items which derive from events and transactions that fall within the ordinary activities of a company and which individually, of, if of a similar type, in aggregate need to be disclosed by virtue of their size and incidence if the financial statements are to give a true and fair view.
Covid 19 losses are significant even though they fall within the ordinary activities of business, but considering their size, they undoubtedly need to be disclosed separately to give a true and fair view to the financial statements. These losses are advised to be positioned as “exceptional items” in the income statement at S.No. VI of Schedule III of the Companies Act, 2013.
On a comprehensive review of AS-5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, and Ind AS -1 Presentation of Financial Statements along with the requirements of Schedule III of the Companies Act, 2013, it can be suggested that necessary amendments are required to be brought in AS 5 and Schedule III to eliminate “extraordinary items” to bring it in alignment with Ind AS 1 and US-GAAP. It is pertinent to mention that a separate disclosure of actual and potential losses arising due to Covid 19 lockdown is definitely required considering the size of losses, the same may be termed as “exceptional” and not “extraordinary”. Both AS-5 and Schedule III still deal with “extraordinary items”, though the concept has become redundant as it has been removed from US GAAP and Para 87 of Ind AS 1 clearly provides that no entity shall present any items of income or expense as extraordinary items, in the statement of profit and loss or in the notes. Based on above, it would not be advisable to report such losses as extraordinary items. Covid 19 losses and expenses are exceptional and should be disclosed as exceptional items in line with para 14 of AS-5 and para 98 of Ind AS 1.
PART II – STATEMENT OF PROFIT AND LOSS
Name of the Company…………………….
Profit and loss statement for the year ended ………………………
|Particulars||Note No.||Figures as at the end of current reporting period||Figures as at the end of the previous reporting period|
|I||Revenue from operations||xxx||xxx|
|III||Total Revenue (I+ II)||xxx||xxx|
Cost of materials consumed
Purchases of Stock-in-Trade
Changes in inventories of finished goods work-in-progress and Stock in-Trade
Employee benefits expense Finance costs
Depreciation and amortization expense
|V||Profit before exceptional and extraordinary items and tax (III – IV)||xxx||xxx|
|VII||Profit before extraordinary items and tax (V – VI)||xxx||xxx|
|IX||Profit before tax (VII- VIII)||xxx||xxx|
(1) Current tax
(2) Deferred tax
|XI||Profit (Loss) for the period from continuing operations (VII-VIII)||xxx||xxx|
|XII||Profit/(loss) from discontinuing operations||xxx||xxx|
|XIII||Tax expense of discontinuing operations||xxx||xxx|
|XIV||Profit/(loss) from Discontinuing operations (after tax) (XII-XIII)||xxx||xxx|
|XV||Profit (Loss) for the period (XI + XIV)||xxx||xxx|
|XVI||Earnings per equity share:
1. ICAI Accounting & Auditing Advisory: Impact of Coronavirus on Financial Reporting and the Auditors Consideration, Joint Initiative of Accounting Standards Board & Auditing and Assurance Standards Board, The Institute of Chartered Accountants of India, March 2020
2. Indian Accounting Standard (Ind AS) 1: Presentation of Financial Statements March 2020 accessible at http://www.mca.gov.in/Ministry/pdf/IndAS1_2019.pdf
3. Accounting Standard (AS) 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies accessible at https://www.mca.gov.in/Ministry/notification/pdf/AS_5.pdf
4. Coca-Cola to write off unsold Indian stock accessible at https://economictimes.indiatimes.com/industry/cons-products/food/coca-cola-to-write-off-unsold-indian stock/articleshow/75281478.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
5. FASB Rules on attacks accessible at https://money.cnn.com/2001/10/01/news/fasb/