Fixed assets not in use during the pandemic: What is their impact on the Financial Statements?

The crisis originated by the COVID-19 pandemic has given rise to a series of challenges for all companies, seriously affecting the management of resources, the continuity of their operations, and business transformation.

Some examples of how the pandemic has affected businesses are:

• The offices located in the most important business centers of Lima, as well as most parking spaces, are almost empty due to the increase of remote work, which caused a reduction in office demand.
• The hospitality and restaurant industry was one of the hardest-hit industries given the reduced number of customers due to fear of contagion, temporary closings due to quarantines and, in addition, the fact that not all restaurants were prepared to provide delivery services, which forced many small and medium-sized hotels and restaurants to close down.
• In the case of financial entities, we have seen how digital banking has faced an accelerated growth and, at the same time, most brick-and-mortar offices have been closed.
• Consumer habits have also changed, affecting what companies produce. For example, the purchase of business attire has drastically decreased, and people now prefer sportswear or casual clothing.
• Tour operators in our country have also been severely affected and their recovery is expected to reach pre-pandemic levels in year 2022.

In general, the pandemic has forced many businesses to reinvent themselves as a result of major changes in the behavior of clients and consumers, which has led them to seek technological solutions and new business models, most of them digital. This new scenario requires that companies evaluate how their assets will be used and some of the questions that may arise during such process are the following:

Should assets continue to be depreciated?

If an entity has determined that it has assets which will not be temporarily used, but that their carrying amount is expected to be recovered through use, such entity must take into consideration that, in accordance with IAS 16 “Property, plant and equipment”, said assets will continue to depreciate, even if these are not in use.

Depreciation is only allowed to cease if the assets are classified as held-for-sale in accordance with IFRS 5 or if these are written off.

Another scenario where depreciation ceases is when an entity uses a usage-based depreciation method; e.g., the units-of-production method, which does not generate any depreciation charge if no production activity has taken place.

In the case of entities that use a depreciation method which is not usage-based, it is advisable to assess whether the usage expectations of the assets differ from previous estimates and whether it is necessary to review the residual value and useful life of such assets, which may lead to select another depreciation method that will allow reflecting the pattern of use to be applied to those assets, and which would be accounted for as changes in accounting estimates in accordance with IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”.

What about the assets held for sale?

If an entity has determined that the carrying amount of an asset will be recovered through a sale transaction, said asset will cease to be depreciated and will be classified as an asset held for sale, in accordance with IFRS 5 “Assets held for sale and discontinued operations”.

To make this classification, the asset must be available for immediate sale in its present condition and the appropriate level of management must be committed to a plan to sell that is highly probable, with a program to locate a buyer and complete the plan within one year.

Events or circumstances may extend the period to complete the sale beyond one year. An extension of the period required to complete a sale does not preclude an asset from being classified as held for sale if the delay is caused by events or circumstances beyond the entity’s control and there is sufficient evidence that the entity remains committed to its plan to sell the asset.

The asset classified as held for sale will be measured at the lower of its carrying amount and fair value, less costs to sell.

Must asset impairment be assessed?

The pandemic is changing the behavior patterns of economic agents and, together with the uncertainty and volatility caused by the health crisis and the subsequent economic crisis, is affecting the value of assets and companies in different economic sectors.

In this scenario, companies must assess the impact on the carrying amount of its assets, due to the new indicators of impairment that have arisen, such as:

• Sustained declines in revenues (close-downs, highly-impacted activities).
• Lowered prices causing minimum profit margins or unsustainable losses.
• Increase in purchase prices that will not be recoverable.
• Renegotiation of lease agreements.
• Changes in business models, among others.

To verify the existence of impairment of an asset, IAS 36 “Impairment of Assets” requires the entity to assess, at the end of each reporting period, whether there is any indication of impairment in the carrying amount of its assets. To make this assessment, several financial and business aspects stated in IAS 36 must be taken into consideration.

If it is verified that the carrying amount of an asset is impaired, the next step will be to determine the recoverable amount of the asset and, if such amount is less than the carrying amount, an impairment loss must be recognized in profit or loss, unless the asset is carried at revalued amount in accordance with IAS 16, in which case the impairment loss will be treated as a revaluation decrease.

It is important to point out that the recoverable amount that is determined based on value in use requires making financial calculations (discounted future cash flows), for which it will be necessary to follow the guidelines set out in IAS 36.

Finally, entities will need to make an effort to perform this analysis and maintain the transparency of the financial information, in order to avoid any misstatements. However, in scenarios of great uncertainty, as those caused by the pandemic and the current political instability, making financial projections and an objective evaluation of impairment indicators becomes more complicated.