Going concern and pandemics

Going concern and pandemics

IAS 1 Presentation of Financial Statements requires management, when preparing financial statements, to make an assessment of an entity’s ability to continue as a going concern, and whether the going concern assumption is appropriate.

Furthermore, disclosures are required when the going concern basis is not used or when management is aware, in making their assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern.

Disclosure of significant judgement is also required where the assessment of the existence of a material uncertainty is a significant judgement.

In assessing whether the going concern assumption is appropriate, the standard requires that all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period, should be taken into account.

This assessment needs to be performed up to the date on which the financial statements are issued.

Refer to ‘Current vulnerability due to concentration and liquidity risks‘ below for further discussion on the current vulnerability entities are facing due to concentration and liquidity risks.


Management is required to assess the entity’s ability to continue as a going concern. When making that assessment, where relevant, management takes into consideration the existing and anticipated effects of the pandemic on the entity’s activities in its assessment of the appropriateness of the use of the going concern basis.

For example, when an entity has a history of profitable operations and relies on external financing resources, but because of the pandemic, its operations have been suspended before or after the reporting date, management would need to consider a wide range of factors relating to the current adverse situation including, expected impact on liquidity and profitability before it can satisfy itself that the going concern basis is appropriate.

Management should consider all available information about the future which was obtained after the reporting date including measures taken by governments and banks to provide relief to affected entities in their assessment of going concern.


Given the unpredictability of the potential impact of the pandemic, there may be material uncertainties that cast significant doubt on the entity’s ability to operate under the going-concern basis.

When the entity prepares the financial statements, it is required to disclose these material uncertainties in the financial statements in order to make clear to readers that the going-concern assumption used by management is subject to such material uncertainties.

Food for thought – Significant judgement required

The degree of consideration required, the conclusion reached, and the required level of disclosure will depend on the facts and circumstances in each case, because not all entities will be affected in the same manner and to the same extent.

Significant judgement may be required given the nature of the pandemic and the uncertainties involved. Continual updates to the assessments up to the date of issuance of the financial statements are required.

Current vulnerability due to concentration and liquidity risks

Entities with concentrations of risk may face greater risk of loss than other entities. IFRS 7.34(c) requires that concentration of risk should be disclosed if not otherwise apparent from other risk disclosures provided. Therefore, entities should consider including the following information:

  • A description of how management determines concentrations of risk
  • A description of the shared characteristic that identifies each concentration. For instance, the shared characteristic may refer to geographical distribution of counterparties by groups of countries, individual countries or regions within countries and/or by industry
  • The amount of the risk exposure associated with all financial instruments sharing that characteristic

Entities that have identified concentrations of activities in areas or industries affected by the pandemic (e.g., the airline, hospitality and tourism industries) and have not previously disclosed the concentration because they did not believe that the entity was vulnerable to the risk of a near-term severe impact, should now reconsider making such a disclosure.

Similarly, liquidity risk in the current economic environment is increased. Therefore, it is expected that the disclosures required under IFRS 7 in this area will reflect any significant changes in the liquidity position as a result of the coronavirus pandemic. Entities should be mindful that this disclosure is consistent with their assessment of the going concern assumption.

For entities that will prepare interim financial statements under IAS 34 Interim Financial Reporting, if concentration and liquidity risks have significantly changed compared to their most recent annual financial report, they should disclose the above information in their interim financial statements.

COVID-19: Issues for Shipping Entities

Management should consider the potential implications of COVID-19 and the measures taken to mitigate such risks when assessing the entity’s ability to continue as a going concern. If the effect of COVID-19 is ongoing, shipping entities might be unable to re-charter their ships at reasonable rates or for a reasonable duration. Additional considerations might include:

  • the ability of existing charterers to settle current obligations or to utilise the vessels over the remaining charter Going concern and pandemicsperiod;
  • fair value of the vessels;
  • fuel price trends;
  • the impact of lower Heavy Fuel Oil (“HFO”) and Low Sulphur Fuel Oil (“LSFO”) margin on projected inflows for scrubber-fitted vessels;
  • debt covenants (as discussed below);
  • potential delays for scheduled dry docking and special surveys, or for the installation of scrubbers and/or ballast water treatment systems and/or availability of personnel for repairs;
  • potential delays in delivery of vessels under construction; and
  • the impact to operating costs, such as crew costs and spare parts.

Borrowings and covenants

A global downturn in the shipping industry might impact financial covenants, and the classification of loans and other financing liabilities between non-current and current. Management should review financial covenants and ‘cross default clauses’, such as:

  • loan to value or net worth – due to the volatility in the fair value of vessels and the potential for COVID-19 to have a negative impact, this type of covenant might be significantly impacted;
  • EBITDA – due to a possible significant decrease in revenues; and
  • vessel lay-up clauses – management should consider if there is a covenant related to the prohibition on laying up a vessel.

Management should also seek to understand any material adverse change clauses and whether the current COVID-19 events could trigger such clauses.

Entities should seek waivers for covenant violations before the end of the reporting period, because waivers obtained after the reporting date are treated as non-adjusting events. Management should also consider potential challenges in obtaining valuations for vessels to support the ‘loan to value’ or ‘loan to net worth’ ratios.

Where the contractual terms of the borrowings are amended, management should determine whether this change results in derecognition or modification of the loan.

Vessels, goodwill and other intangibles

– Impairment considerations

IAS 36 requires goodwill and indefinite-lived intangible assets to be tested for impairment at a minimum every year, and other non-financial assets whenever there is an indicator that those assets might be impaired.

Shipping entities should determine whether impairment indicators exist for vessels, goodwill and other non-financial assets. Management should consider whether the general economic downturn, a decline in certain charter rates and vessel market values, and the volatility in oil and other commodities prices trigger the need to perform an impairment review.

When measuring value in use, management should update cash flow projections in accordance with the most recent budgets that reflect the conditions that existed at the balance sheet date. Revised assumptions should be consistent with market evidence in relation to future charter rates and fuel prices (including changes in charter rate premiums for scrubber-fitted vessels), the possible increase in off-hire days and any impact in other operating expenses.

There are a number of considerations for assessing impairment in the current environment. In particular, an expected cash flow approach (multiple probability-weighted scenarios) might be a better way to capture the increased risk and uncertainty when estimating a recoverable amount, as opposed to a single predicted outcome. It is expected that, depending on the circumstances, either the cash flows or the discount rate should reflect the increased risk caused by the COVID-19 uncertainty.

Vessel lay-up and suspension of vessel construction

With governments and ports imposing various travel restrictions, and due to falling demand, owners might be required (or decide) to lay up vessels. IAS 16, ‘Property, plant and equipment’, requires depreciation to continue to be charged in the income statement while an asset is temporarily idle if the entity uses a straight-line depreciation method.

In addition, the current situation might result in the construction of vessels being suspended. If vessels are under construction, IAS 23.20 of IAS 23 ‘Borrowing costs’, requires the capitalisation of interest to be suspended during extended periods when active development is suspended.

Directly attributable costs incurred cannot be capitalised while the vessel is standing idle (for example, a vessel that can operate but is not brought into use immediately). IAS 16 only permits directly attributable costs to be capitalised until the point at which the asset is ‘capable of operating in the manner intended by management’.

Expected credit losses

Expected credit losses (ECL) are likely to be higher in the current environment. Shipping entities should consider theGoing concern and pandemics impact on all of their financial assets subject to the IFRS 9 impairment requirements.

Many shipping entities use the simplified model for trade receivables (including receivables from lessees) and they measure ECL for lifetime expected losses. Macroeconomic factors could impact the measurement and result in higher ECL due to the credit deterioration of charterers.

For financial assets not subject to the simplified model (such as intercompany loans), shipping entities should again consider macroeconomic factors in assessing increases in credit risk and the estimate of ECL by adjusting probability of default, exposure at default and the losses given default (since the values of vessels given as collateral might have fallen or might take longer to realise).

Modification of contracts accounted for as leases

Due to current market conditions, charterers might seek to renegotiate their time charter and bareboat agreements that are typically within the scope of IFRS 16. Such renegotiations might result in one or a combination of the following: reduction in charter rate; change in lease term; and/or deferral of payments. The accounting treatment of any changes in rates or the possible deferral of payments could be complex and requires judgement.

Shipping entities should determine the accounting treatment of any such changes in the contracts, as either a modification, or negative variable lease payments, or a combination of the two.

For example, changes in payments required under the contract’s initial terms (or required by laws or regulation) might result in negative variable lease payment treatment. In making this assessment, careful evaluation of the terms of the relevant agreements and of the applicable laws is required. Adequate disclosure of any significant judgements should be made.

Lease amendments might impact lease income recognition for concessions granted to customers. However, shipping entities might also enter into ‘charter-in, charter-out’ agreements, and so they might also be impacted as lessees.

On 24 April 2020, the IASB issued proposed amendments to IFRS 16 that would provide lessees (but not lessors) with a practical expedient to elect not to treat certain rent concessions that are a direct consequence of the COVID-19 pandemic as a lease modification. Entities should monitor progress on this project, which is expected to be completed in the near term.

Demurrage revenue

Recognition of revenue in relation to demurrage is an area that usually involves significant estimates. IFRS 15 requires variable consideration to be included in the transaction price only when it is highly probable that it will be due and that it will not subsequently result in a significant reversal.

Many countries have imposed lockdown and restriction of movement, causing disruption in the supply chain. Even where ports remain open, they usually operate with reduced workforce.

The situation creates significant delays and congestion of cargo, and shipping entities will likely be required to use estimates to a greater extent in order to determine demurrage revenue. In making these estimates, management should consider all facts and circumstances and carefully evaluate the relevant terms in the agreements, including force majeure clauses.

Shipping entities are expected to provide adequate disclosures in their financial statements in relation to such significant estimates.

Force majeure clauses

Entities in the shipping industry often have contracts which contain force majeure clauses, which can relieve parties of all or certain obligations in a contract in the case of serious unforeseen circumstances beyond the control of the parties to the contract.

Entities should seek to understand the scope of such clauses in their contracts, and how these might apply in the relevant legal jurisdiction. Such clauses could, for example, impact charter hire agreements or agreements for the construction of vessels.

In some cases, significant judgement and legal advice might be required to interpret such clauses. Where such clauses are triggered, the impact on revenue/lease income recognition, expenses and provisions due to possible legal disputes with charterers, yards or ports will need to be considered. Entities will need to carefully consider what disclosures about estimates and judgements are required in such circumstances.

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