From the IFRS Institute – August 28, 2020
As COVID-19 continues to affect financial performance, explaining its effect on the income statement is becoming important for many companies. IFRS Standards allow them to display certain amounts separately on the face of the income statement, but identifying the effect specifically attributable to COVID-19 may be difficult; disclosure in the notes may be a better route. Here we summarize key items companies should consider when determining their approach. We also looked at how US registrants – domestic and foreign private issuers – have chosen to communicate the impacts of COVID-19 to date.
How and where should the income statement impacts of COVID-19 be presented?
Under IAS 11, when items of income or expense are material, a company discloses their nature and amount separately, either on the face of the income statement or in the notes. A company’s approach for COVID-19 will depend on its ability to determine the impacts on a non-arbitrary basis (i.e. quantify them reliably) and on the pervasiveness of those effects to the financial performance of the company.
Quantifying the impacts of COVID-19 on a non-arbitrary basis may require significant judgment – distinguishing between income and expenses that are part of normal operations versus those that specifically relate to COVID-19. As a company adjusts its operations to the new reality, making that cut is becoming more and more challenging. If the impacts cannot be determined on a non-arbitrary basis, we believe the company should not present them on the face of the income statement, but consider disclosure in the notes, providing quantitative (when possible) and qualitative information and stating whether only some, or all, of the effects have been identified.
In some cases, a company may be able to determine the impacts of COVID-19 but find that they are pervasive – e.g. affecting nearly all line items of the income statement. In that case, we believe it may be impracticable or less meaningful to present the impacts on the face of the income statement. Instead, the company should consider disclosing them in the notes.
Ultimately, companies need to ensure that the chosen presentation is not misleading and is relevant to the users’ understanding of financial performance.
COVID-19 related income and expenses must be incremental and directly attributable
When determining the impacts of COVID-19, we believe a company should consider only the income and expenses that are incremental and directly attributable to COVID-19. Income and expenses that would be earned or incurred regardless of COVID-19 (e.g. sunk costs) are not considered incremental and should not be displayed as such on the income statement.
For example, the following expenses are not incremental:
- payroll costs for idle employees during work stoppages;
- depreciation of idle facilities; or
- rent expenses incurred during temporary closures.
Companies may consider disclosure of additional information about such expenses in the notes as long as the information is useful to users’ understanding and, importantly, is not misleading.
Determining the amounts of incremental income and expenses directly attributable to COVID-19 may require significant judgment, depending on the circumstances. For example, certain types of income and expenses may be more readily determinable as relating to COVID-19, such as:
- additional cleaning or testing costs incurred as part of virus prevention;
- incremental hazard pay to employees; and/or
- rent concessions from lessors that occur as a direct consequence of COVID-19.
For other types of income and expenses, it may be more challenging to determine whether, and to what extent, they were driven by COVID-19 or whether they are due to other circumstances such as macro-economic factors – e.g. expected credit losses or impairment losses on nonfinancial assets.
IAS 1 does not prohibit companies from presenting ‘unusual’ or ‘exceptional’ items. However, companies are not allowed to describe such items as ‘extraordinary’.
Labeling income and expenses that relate to COVID-19 as ‘unusual’ or ‘exceptional’ may be acceptable. In that case, we believe the description used by the company should include the nature of the item (e.g. exceptional hazard pay due to COVID-19).
The amount of expenses described as ‘COVID-19 related’ should be classified by function or nature, in the same way as expenses that do not relate to COVID-19. Companies will need to consider the current structure of the income statement, including the classification of expenses by nature or function. Excluding COVID-19 related impacts from an operating profit subtotal, if this subtotal is presented, may not be appropriate if the effects relate to operations (e.g. inventory writedowns).
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.
For more in-depth analysis, read our article, Presentation of COVID-19 impacts in the income statement.
Comparison to US GAAP
US GAAP includes specific guidance around reporting events that are unusual or infrequent.2 That guidance defines 'unusual in nature' as possessing a high degree of abnormality that is clearly unrelated to the ordinary activities of the company. Infrequently occurring items represent events that would not reasonably be expected to recur in the foreseeable future.
If a company determines that a material event is either unusual in nature or occurs infrequently (or both), the company reports the nature and effect of the event as a separate component on the face of the income statement or discloses it in the notes.
Although this determination is company-specific, we believe most companies will consider COVID-19 an unusual event – i.e. it is both unusual in nature and infrequently occurring. However, as the conditions created by COVID-19 persist throughout 2020 and into 2021, companies may need to consider which aspects of COVID-19 are unusual and not expected to recur.
US GAAP is silent on how to determine which income and expenses are attributable to unusual items and judgment is required in this area. Like IFRS Standards, we believe a reasonable approach would be to include direct and incremental income and expenses associated with COVID-19.
What regulators are saying
Companies should also consider relevant regulatory guidance on the presentation and disclosure of COVID-19 impacts. For US registrants – applicable to both domestic and foreign private issuers – the staff of the SEC’s Division of Corporation Finance released CF Disclosure Guidance Topic No. 9A to provide additional guidance and disclosure considerations (read more here). Further, the SEC Chairman and Division of Corporation Finance Director released a joint statement calling for, among other things, high quality and transparent disclosures that enhance valuable communication across the economy.
US domestic registrants reporting under US GAAP that separately present the impact of COVID-19 should carefully consider any subtotals on the face of the income statement (e.g. operating income or gross profit) in light of Regulation S-X Rule 5-03. The regulation allows registrants to present certain material amounts as a separate line(s) item in the income statement subject to clear disclosure of the nature of those costs. However, certain costs are expected to be part of cost of sales or selling, general and administrative (SG&A) expenses, when they relate to activities historically included in those lines. For example, inventory markdowns are expected to be part of cost of sales and be included in gross profit or operating income if those subtotals are presented.
Conversely, foreign private issuers that file financial statements prepared under IFRS Standards comply with the IAS 1 requirements for the form and content of the financial statements rather than with the specific presentation and disclosure provisions of Regulation S-X.
Further, irrespective of GAAP, all US registrants explaining the impact of COVID-19 on their financial information should consider the SEC’s guidance on the presentation of non-GAAP measures (read more here). These registrants may also consider alternatives to non-GAAP measures that include transparent disclosure that simply quantifies the effect of COVID-19 on financial statement line items, but does not adjust GAAP results. Such disclosures are not subject to the SEC’s requirements on non-GAAP measures.
Very few SEC registrants are presenting COVID-19 impacts on the face of the income statement
The half-year reporting season is still underway and has been affected by extended reporting timelines due to COVID-19. However, practice is emerging on how US registrants (both domestic and foreign private issuers) are communicating the impacts of COVID-19. We observed3 that the vast majority of US domestic registrants reporting under US GAAP and foreign private issuers reporting under IFRS Standards are disclosing the impact of COVID-19 in the notes rather than presenting it on the face of the income statement. This comes as little surprise given the discussion above about the potential difficulties of determining the impact of COVID-19 on a non-arbitrary basis, and the pervasiveness of the effects.
Based on our survey, less than 1% of US domestic registrants reporting under US GAAP disclosed COVID-19 impacts on the face of the income statement; 81% disclosed them in the notes to the financial statements; with the rest of the population providing no specific information related to COVID-19, or only including such discussion outside the financial statements (e.g. in Management’s Discussion and Analysis (MD&A)). These trends are consistent with observations for foreign private issuers reporting under IFRS Standards.
As companies continue to assess the impact of COVID-19 on their financial performance, management should carefully consider:
- whether the company can determine the impact of COVID-19 to income and expenses on a non-arbitrary basis;
- how the company’s current income statement structure can accommodate presenting the COVID-19 impacts on the face of the income statement; and
- what additional information (nature and extent) should be provided in and outside the financial statements.
- IAS 1, Presentation of Financial Statements
- ASC 220-20, Income Statement—Reporting Comprehensive Income—Unusual or Infrequently Occurring Items
- KPMG surveyed approximately 2,300 US domestic registrants’ financial statements prepared under US GAAP and filed or furnished between July 1, 2020 and August 7, 2020; and approximately 100 foreign private issuers that furnished financial statements under IFRS Standards related to the six-month period ending June 30, 2020. The financial statements covered a number of industries and various geographies.
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