Global, national, and local responses to the COVID-19 outbreak are continuing to evolve and change. The implications of this virus are far reaching. It is impacting operations in nearly every sector and has led to widespread economic uncertainty and volatility in financial markets. Some of the ways in which the pandemic is affecting entities include:
- 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.
- Disruption of global supply chains due to restrictions placed on the movement of people and goods.
- Difficulties in collecting from customers, taxpayers and other counterparties facing financial difficulties.
- 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.
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 December 31, 2020 and March 31, 2021 year ends, while some issues will have more of an impact on subsequent year ends.
Issues impacting December 31, 2020 and March 31, 2021 year ends
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
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.
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.
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.
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.
Due to the effects of COVID-19, public sector entities may see impairment of non-financial assets over the next few years.
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 COVID-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. Refer to our IFRS in Practice 2020-2021 – IAS 36 Impairment of Assets publication, which includes additional guidance on dealing with impairment related to COVID-19.
Government transfers and transfers through the tax system
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.
Tax revenue is ultimately an estimate. The initial measurement of tax revenue involves management’s best estimate of the realizable amount of the revenue as a result of the original taxable event in accordance with the tax legislation. At the point of initial measurement, tax revenue is not known with certainty even though it may be based on actual tax assessments. This is because better information is obtained by management over time as a result of events such as audits, appeals and court decisions. When this information becomes available tax revenue adjustments are required and are treated as a change in estimate in accordance with Section PS 2120, Accounting Changes.
Subsequent measurement involves a regular assessment of how much of the tax receivable is ultimately collectible. Due to an increase in financial difficulty of taxpayers as a result of the impact of COVID-19, governments may experience difficulties in the collection of taxes receivable (e.g. income taxes, property taxes). As a result, the related valuation allowance would need to be evaluated and adjusted as necessary. Additionally, at each financial statement date, the government must evaluate the likelihood of having to repay taxes previously collected (e.g. as a result of a successful tax appeal) and whether a liability would need to be recognized.
Refer to our PSAB at a Glance: Section PS 3510 – Tax Revenue publication for more information on accounting for tax revenue.
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.
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.
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 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.
Additionally, public sector entities may react to the COVID-19 crisis in a number of ways over the next couple years, which could impact the obligation for defined benefit plans (e.g., temporary
deviations, plan curtailments). In such cases, an entity will also 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.
As public sector entities deal with the fallout of the COVID-19 pandemic and look for ways to save funds or make their operations more efficient, some entities may consider entering into restructuring transactions. For example, two smaller municipalities may decide to amalgamate, or one government not-for-profit organization may transfer its operations/programs to another government not-for-profit organization. There may be an increase in restructuring transactions over the next few years. Refer to our PSAB at a Glance: Section PS 3430 - Restructuring Transactions publication for additional information on accounting for such transactions and reach out to your BDO advisor if you are considering undertaking such a transaction.
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.
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:
Sayja Barton, CPA, CA, MAcc
National Accounting Standards Director
The information in this publication is current as of September 30, 2020.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.