COVID-19: Financial Reporting Implications for the Public Sector

June 17, 2020

Global reactions and responses to the COVID-19 outbreak are continuing to evolve and change. The implications of this virus are far reaching. It is impacting daily operations in nearly every sector and has led to widespread economic uncertainty and volatility in financial markets. The COVID-19 outbreak is affecting entities in the following ways:

  • Reduced consumer demand for goods and services due to lost income and restrictions on consumers’ ability to move freely.
  • Reduced ability to provide goods and services due to government-imposed shutdowns – and resulting lost revenues.
  • Difficulties in collecting from customers, taxpayers and other counterparties facing financial difficulties.
  • Reduction in market prices for commodities and financial assets, including equity and debt instruments.
  • Increase in governments providing grants, discounted loans and tax deferrals for economic stimulus and stabilization.
  • Uncertainties over future receipt of government and other types of funding for some public sector entities as cost-cutting measures are undertaken.
  • Reduction in donations received by not-for-profit organizations as individuals and businesses face financial difficulties.
  • Disruption of global supply chains due to restrictions placed on the movement of people and goods.

The financial reporting implications for public sector entities and the precise effects will depend on the circumstances of each entity. This publication outlines accounting and financial reporting considerations related to the COVID-19 pandemic for entities following Public Sector Accounting Standards (PSAS). Many of the issues discussed in this publication impact March 31, 2020 year ends, while some issues will have more of an impact on subsequent year ends.

Issues impacting March 31, 2020 year ends

Subsequent events

The World Health Organization declared the COVID-19 outbreak a global pandemic on March 13, 2020. As a result, the business and economic impacts of the COVID-19 outbreak are in existence for March 31, 2020 and subsequent year ends, so it’s no longer just a subsequent event. Instead, there will most likely be recognition and measurement adjustments needed to various items in the financial statements.

However, some of the actions introduced to slow the spread of the virus may have been implemented subsequent to year end. The effectiveness of these actions may also become known in the subsequent event period. These actions may be introduced in reaction to conditions that existed at year end, so professional judgement will need to be exercised on whether these are adjusting or non-adjusting subsequent events. If information becomes known that confirms assumptions built into estimates, whether these are adjusting or non-adjusting subsequent events will depend on the nature of the estimate. In general, hindsight should not be reflected in estimates, as a result judgment will need to be applied.

In situations where it is determined that a subsequent event is non-adjusting, disclosure may still be required. Under PSAS, disclosure must be made of events that occur subsequent to year end that:

  • cause significant changes to assets or liabilities in the subsequent period; or
  • will, or may, have a significant effect on the future operations of the public sector entity.

Subsequent events must be considered up to the date of completion. The longer the subsequent event period, the more specific the subsequent event disclosures should be about the impact on the public sector entity, as more information will be known.

Going concern

It is management’s responsibility to make an assessment of a public sector entity’s ability to continue as a going concern. Under PSAS, financial statements are prepared on the assumption that a public sector entity is a going concern, meaning it will continue in operation, and will be able to realize assets and discharge liabilities and meet its statutory obligations in the normal course of operations for the foreseeable future. When assessing going concern for a public sector entity, the facts and circumstances of each situation must be considered.

Governments are long-term institutions that under normal circumstances are expected to operate in perpetuity. As a result, in the past the determination of whether the going concern assumption is appropriate was primarily relevant for individual government organizations.

However, the COVID-19 outbreak is an unprecedented situation. Due to the rapidly changing economic conditions, a more robust assessment of going concern may need to be performed for all public sector entities than may have been done in the past. This does not mean that all or many public sector entities will automatically have a going concern issue requiring going concern disclosure in their financial statements, but that a more robust assessment should be performed.

Impairment – financial assets

Investments

Public sector entities hold many types of investments. Due to the impact of COVID-19, these investments may incur a loss in value. Under PSAS, the timing of when that loss in value is recognized depends on the type of investment and which handbook section it is recognized under. Consider the following investments:

  • Investments measured at fair value

    For investments measured at fair value (e.g., investments in equity instruments quoted in an active market) under Section PS 3450, Financial Instruments, a loss in value is recognized immediately.

  • Temporary investments

    Temporary investments are short-term investments made to obtain a return on a temporary basis (e.g., investments in treasury bills or investment certificates) and are generally capable of reasonably prompt liquidation. Such investments are measured under Section PS 3030, Temporary Investments, when an entity has not yet adopted the Section PS 3450 suite of standards. When the market value of temporary investments has declined below their carrying value, they are written down to market value.

  • Portfolio investments

    Portfolio investments are long-term investments in organizations that do not form part of the public sector reporting entity. Such investments are accounted for in accordance with the requirements of Section PS 3040/PS 3041, Portfolio Investments. When a loss in value of a portfolio investment is considered to be other than temporary, the investment is written down to recognize the loss. A loss in value is considered to be other than temporary when the actual value of the portfolio investment becomes lower than the amount it is recorded at on the entity’s books and the impairment is expected to remain for a prolonged period. However, a decline in the value of a portfolio investment with a fixed maturity amount would not be considered temporary if it is anticipated that the investment will be disposed of before it matures or that the carrying value may not be realizable.

Receivables

Public sector entities have various types of accounts receivables and lease receivables. Due to an increase in the financial difficulty of the payor or lessee, an increase in the valuation allowance provision may be required at year end.

Many public sector entities have issued loans receivable. Many borrowers are facing financial difficulty due to the effects of COVID-19. As a result, public sector entities will need to reassess the collectability of loans receivable. This may lead to an increase in the valuation allowance provision or an increase in write-offs. When the collectability of the principal or interest of a loan receivable is no longer reasonably assured, a public sector entity would also stop accruing interest revenue.

Governments may experience difficulties in the collection of taxes receivable (e.g., income taxes, property taxes) due to an increase in the financial difficulty of taxpayers as a result of the impact of COVID-19. The related valuation allowance would need to be evaluated and adjusted as necessary.

Debt issued by a public sector entity on behalf of a government business enterprise is recognized net of the related receivable from the government business enterprise when certain conditions are met. Due to the impact of COVID-19, a public sector entity would need to consider whether the receivable from the government business enterprise may be impaired and whether the conditions for net presentation are still met.

Obligations & Loan Guarantees

A public sector entity may incur a liability as a result of an agreement, its own legislation (for governments), another government’s legislation, a constructive obligation, or an equitable obligation. As part of the response to the COVID-19 crisis, governments may introduce legislation that results in obligations for itself or other public sector organizations.

Additionally, a public sector entity may incur constructive or equitable obligations when it has created a valid expectation among others and has no realistic alternative but to settle this obligation (e.g., through making announcements that individuals or organizations have then acted upon). Professional judgment will be needed in determining whether constructive or equitable obligations exist and need to be reflected in the financial statements at year end.

Due to financial difficulties caused by the impact of the COVID-19 outbreak, a public sector entity may also need to increase its provision for loan guarantees it has provided. Loan guarantees are accounted for as contingent liabilities and a provision for losses is recorded when it is determined that a loss is likely.

Employee Benefits

Decreases in the fair value of plan assets as a result of COVID-19, coupled with changes in discount rates, could result in an increased retirement benefit liability on the financial statements of many public sector entities with defined benefit plans in the current and future years. Public sector entities would need to consider whether a change in the discount rate used (i.e., changes to a public sector entity’s cost of borrowing or changes to plan asset earnings) in measuring the accrued benefit obligation for a defined benefit plan indicates a need for a new actuarial valuation to be completed.

Disclosures

In addition to the recognition and measurement considerations discussed previously, public sector entities must also consider the transparency of the financial statement disclosures overall. Entities should exercise professional judgment to provide sufficient information about the extent and nature of the impact of COVID-19 on their financial position, results of operations, remeasurement gains and losses, changes in net debt, and cash flows.

Additionally, where measurement uncertainty exists around amounts recognized or disclosed in the financial statements, appropriate disclosure of this uncertainty should be included in the financial statements as required by Section PS 2130, Measurement Uncertainty.

Disclosures about the effects of the COVID-19 outbreak are also likely to appear in the narrative sections of the annual report, for entities that produce annual reports. Public sector entities need to ensure that such disclosures are consistent with those made in the financial statements and with wider current and forecasted economic and other conditions.

Issues impacting year ends subsequent to March 31, 2020

The issues previously discussed will also need to be assessed for year ends subsequent to March 31, 2020. However, there are other issues that, while they may affect March 31, 2020 year ends and so will need to be assessed, are likely to have a greater impact on subsequent year ends.

Impairment – non-financial assets

Under Section PS 3150, Tangible Capital Assets, the cost of a tangible capital asset is written down to reflect a decline in the asset's value when conditions indicate that either:

  • the tangible capital asset no longer contributes to a public sector entity’s ability to provide goods and services; or
  • the value of future economic benefits associated with the tangible capital asset is less than its net book value.

A tangible capital asset is considered to no longer contribute to a public sector entity’s ability to provide goods and services when the public sector entity has no intention of continuing to use the asset in its current capacity and there is no alternative use for the asset. Conditions that would indicate that the future economic benefits associated with a tangible capital asset have been reduced and a write-down may be appropriate include:

  • a change in the extent and/or manner in which the asset is used;
  • removal of the asset from service; and
  • a decline or cessation of the need for the services provided by the asset.

The persistence of such conditions over several successive years would increase the probability that a write-down is required.

For government not-for-profit organizations following the PS 4200 series of standards, there is no concept of partial write-downs in Section PS 4230, Capital Assets Held by Not-for-Profit Organizations. As a result, when a capital asset (tangible or intangible) no longer contributes to the organization's ability to provide services, its carrying amount would be written down to its residual value, if any. In such a situation, a corresponding amount of any unamortized deferred contributions related to that capital asset would need to be recognized as revenue, provided the entity has complied with all restrictions.

Government business enterprises and business partnerships

When a public sector entity has an investment in a government business enterprise (GBE) or a business partnership (BP), it records its share of income or losses using the modified equity method under PSAS. Due to the effects of CCOVID-19, a GBE or BP may incur losses, which could result in a decrease in the carrying value of the public sector entity’s investment.

A public sector entity may also need to assess whether the carrying value of its investment in the GBE or BP is impaired. In such a situation, an assessment would also need to be made as to whether the GBE or BP still meets the criteria to be classified as such under PSAS or if a change in classification of the entity is needed. Due to the effects of COVID-19 on the economy, we will likely see an increase in GBEs and BPs over the next couple of years that no longer meet the criteria to be classified as such. This issue may be especially prevalent for GBEs and BPs that had already been struggling financially.

GBEs and BPs are required to follow International Financial Reporting Standards (IFRS). Refer to our International Financial Reporting Bulletin 2020/03 – Potential Effects of the Coronavirus Outbreak on 2020 Reporting Periods and Onward for guidance on the potential impacts COVID-19 could have on these entities. One issue to keep in mind is that under IFRS, an entity is likely to need to record impairment much sooner than would be required under PSAS.

Government transfers and tax revenue

As part of the response to the COVID-19 crisis, governments are looking to provide relief in a variety of ways, such as via grants, stimulus packages, and tax deferrals. For entities that are providing the relief (transferor), an assessment will need to be made as to whether the entity is providing a government transfer that would be accounted for in accordance with Section PS 3410, Government Transfers, or a transfer through the tax system that would be accounted for under Section PS 3510, Tax Revenue. The criteria of the applicable section would need to be analyzed to determine the timing of the recognition of the transfer.

For entities that are the recipient of a government transfer, an assessment will need to be made as to whether any eligibility criteria and/or stipulations are met in order to determine whether a government transfer can be recognized at year end.

Refer to our PSAB at a Glance: Section PS 3410 - Government Transfers publication for more information on when a transferor or a recipient recognizes a transfer. Refer to our PSAB at a Glance: Section PS 3510 – Tax Revenue publication for more information on accounting for transfers made through a tax system.

A government not-for-profit organization following the PS 4200 series of standards that is the recipient of such government funding, will need to assess the type of contribution and whether the recognition criteria are met in determining the timing and method of recognition under Section PS 4210, Contributions – Revenue Recognition. Refer to our PSAB at a Glance: Contributions publication for more information.

Loan and lease modifications

As a result of the impact of COVID-19, lenders and borrowers may enter into an agreement to modify the terms of financial instruments such as loans. These modifications may take the form of reduced interest rates, modification to payment terms and ‘grace periods’ for covenant violations.

From the borrower’s perspective, when the terms of an existing financial liability are substantially modified, the original financial liability is extinguished and a new financial liability is recognized. From the lender’s perspective, the restructuring of the terms of a loan receivable would be accounted for in accordance with Section PS 3050, Loans Receivable.

Additionally, some lenders may issue loans with significant concessionary terms. An assessment will need to be made of such loans to determine if they are more in the nature of a grant and should be expensed at the time the loan is made.

Public sector landlords may also offer concessions to lease tenants (e.g., rent-free periods, deferral of payment, cash payments from lessors to lessees) to compensate them for disruptions to operations due to COVID-19. PSAS does not provide specific guidance on accounting for lease modifications. As a result, professional judgment will need to be used.

Employee benefits

Over the next couple of years, public sector entities may react to the COVID-19 crisis in a number of ways, which could impact the obligation for defined benefit plans (e.g., temporary deviations, plan curtailments). In such cases, an entity will need to determine whether an updated actuarial valuation is required.

Some public sector entities may downsize their workforce in the future in an effort to cut costs. A public sector entity recognizes termination benefits when it is demonstrably committed to either:

  • terminate the employment of an employee or group of employees; or
  • provide termination benefits as result of an offer made to encourage voluntary termination.

Refer to paragraphs .29-.31 of Section PS 3255, Post-employment Benefits, Compensated Absences and Termination Benefits, for guidance on when a public sector entity is demonstrably committed.

Other BDO resources available

This publication highlighted some of the main areas where public sector entities may be affected as a result of the impact of COVID-19; however, it is not a complete list. As a result, it is important to consider a public sector entity’s specific facts and circumstances related to COVID-19 when the financial statements are being prepared, to determine the appropriate financial reporting implications. For further information to assist you in responding to the impacts of COVID-19 on your entity, refer to our BDO COVID-19 Hub and our PSAS Knowledge Centre, and reach out to your BDO advisor.

To learn more, contact your local BDO partner or:

Armand Capisciolto, FCPA, FCA, National Accounting Standards Partner

Sayja Barton, CPA, CA, MAcc, National Accounting Standards Director

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