If you’re a retailer that has suffered through lockdown measures, you’re probably coming to terms with the impact on your financial reports. We’ve highlighted the top four key financial areas of focus for this year end.
As COVID-19 has disrupted the normal trading patterns of most bricks and mortar retailers since the end of March, retailers are now faced with the enormous task of reopening their stores under strict new health guidelines and accounting for the financial impacts of the pandemic.
Whether you are a small, large, listed, non-listed, domestic, or international retailer, these financial reporting implications of COVID-19 will be nothing short of a challenge – with continued uncertainty meaning ‘business as usual’ will not be instantaneous once shop fronts open. On top of this, many retailers are still coming to grips with the implementation of the sweeping changes to two accounting standards.
A look back on the past two seasons
The past two financial reporting seasons were a challenge not only for finance teams, but entire organisations - as retailers overcome operational issues due to AASB 15 and AASB 16. The implementation of the new revenue standard, AASB 15 – Revenue from Contracts with Customers created complexities in the June 2019 reporting period. The new leasing standard, AASB 16 – Leases, was implemented in the December 2019 half-year reporting period for listed entities. For many retailers, this was an incredibly time consuming and challenging task.
After these two standards, listed retailers were looking forward to the June 2020 reporting season. It was supposed to be a normal reporting period. There were no new accounting standards to implement. For non-listed retailers, they are now facing the demands of implementing AASB16 for the first time. AASB16 was supposed to be their main focus this reporting period.
But then the global pandemic of COVID-19 hit - changing everything.
The current pressures for retailers is very real and the impact on financial statements will be seen in numerous ways. As retailers work through this challenging time, many will be asking themselves -what key financial areas should I be focusing on this year-end?
Based on our experience working with retailers, we’ve outlined the top four.
While we understand that financial statements may be impacted in other ways, these four are bound to impact each and every retailer that struggled with the lockdown measures.
1. Expect Inventory Obsolescence to be highly scrutinised
While government restrictions are beginning to lift, the after-effects are likely to be felt for a long time, with a build-up of stock levels and the Australian economy facing a recession predicted to affect discretionary spending.
If you are a traditional bricks and mortar retailer, being closed for almost two months will no doubt have had an impact on your inventory levels.
Questions you will need to consider include:
If you are a fashion retailer, is your trans-seasonal wear from the past two months obsolete? Will social distancing measures be relaxed enough in time to boost sales during End of Financial Year Sales? Are your customers watching their discretionary spending due to uncertain times? Do you sell high-end luxury products and your sales have come to a halt due to decreased spending?
Unfortunately, due to the pandemic, it is likely that for many traditional retail shop fronts, inventory levels will have built up over the lockdown period so long as they didn’t face major disruptions to their supply chain.
The question still remains, will consumer foot traffic and spending pick up to pre-pandemic levels to fight off obsolescence? The answer to that question is a big unknown and likely won’t be known by the time year-end financial reporting comes around. Therefore, estimates and judgements over inventory obsolescence will be highly scrutinised this reporting season.
2. Impairment assumptions must be robust
Due to economic uncertainty, impairment will continue to be a focus area for many retailers. Impairment of intangibles such as goodwill, brand names and trademarks is usually what comes to mind when you think of impairment. However, due to the closure of stores, whether permanent or temporary, and decreased foot traffic, impairment of fixed assets and right of use leased assets will now become a strong focus.
The challenge associated with impairment reviews is that the analysis is based on forward-looking financial information. In these unprecedented times, it may be difficult to accurately estimate future revenues and costs, and therefore the appropriateness of impairment charges. Management must be able to justify and support their assumptions to their board and their auditors. If goodwill is impaired this period and favourable trading results return in the future, the impairment charge cannot be reversed. This is a permanent write down. As social distancing restrictions are lifted, time will tell if results improve. If trading improves significantly in future periods, some impairment charges may be reversed. However, reversals of these impairment charges are likely to be analysed in great detail. One thing that is certain in these uncertain times, is that disclosures around impairment assumptions will need to be robust in financial statements this reporting period. BDO has issued a publication to assist with impairment considerations.
3. Going Concern predictions need to be accurate
Prior to the pandemic, the Australian retail market had already seen numerous retailers go into administration over the last couple of years. The already challenging economic times coupled with the impacts of COVID-19 raises questions about going concern. While many stores are starting to reopen, foot traffic may be slow to return as many consumers continue to work from home. The quick lunch break walk around the city which led to impulse shopping isn’t happening on a large scale at the moment.
Based on phased return to work plans and continued social distancing measures, there is uncertainty around when streets and shopping centres will be filled on a regular basis. Without certainty on when revenue for stores will return to pre-COVID-19 expected levels, will stores be able to cover all of their costs? Will major retailers be in compliance with their debt covenants or will their debt be classified as current, leading to more going concern uncertainty? Going concern will surely be more of a focus than ever before. As with impairment, cash flow forecasting with scenario analysis will be key.
4. Accounting for Rent Concessions can be complex
With many stores closed for almost two months and a drastic decline in foot traffic and revenue, many retailers are seeking rent reductions from their landlords. With lease liabilities now on the balance sheet due to AASB16, the question becomes, how do you account for rent concessions related to COVID-19?
Complications arise as to whether the rent concessions should be considered a lease modification under AASB16. For retailers with a significant number of leases, the task of accounting for each lease as a modification can become complex. In any event, retailers must keep their lease accounting up to date for the constant additions, terminations and modifications to agreements. Due to the complexities arising in this area, BDO has issued a publication on how to account for COVID-19 rent concessions.
COVID-19 has had a major impact on the retail sector and there are significant financial reporting implications. The timeframe for trading recovery is uncertain. While this financial reporting period brings complexity, there is certainty that these four areas will be a strong focus for all retailers. If you’re a retailer requiring assistance with your Financial Reporting obligations, contact your local team today.
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