COVID-19: Top 5 Financial reporting considerations for the Shipping Industry

Both US GAAP and IFRS require management to assess the reporting entity’s ability to continue as a going concern. Management’s assessment should be based on available information and the relevant conditions that are known and reasonably knowable. This means that the assessment should consider the most current information available before the financial statements are issued, requiring companies to consider all relevant subsequent events after the balance sheet date. 

Management should take into consideration existing and anticipated effects of COVID-19 in its assessment and consider performing a sensitivity analysis as part of their going concern assessment.  If the effect of COVID-19 has an extended impact, shipping companies may be unable to recharter their ships at appropriate rates or duration. Potential additional COVID-19 considerations could include: 

• Evaluating charter/freight rate trends from January 1, 2020 through date of issuance of financial statements 

• Evaluating fair value trends of vessels 

• Evaluating fuel price trends

• Evaluating the impact on vessel values over the next 12 months

• Forecasting debt covenant testing for the next 12 months

• Evaluating impact of potential delays at yards for scheduled dd/ss or installation of scrubbers/BWTS

• Evaluating the ability of existing charterers to settle current obligations as well as to utilize the vessels over the remaining charter period

• Evaluating impact to operating costs - such as, crew costs (travel, safety, sanitary etc.), additional provisions, spare parts, minimization of riding teams, inflation etc.  

Management should ensure that it has a strong understanding of its financial covenants, cross default clauses and which financial covenants result in an event of default. Lenders should be kept informed as more information becomes available.  We recommend that management performs a forecast of its debt covenant testing for the next 12 months, with a focus on the following:

• Loan to value covenant – with the volatility in the fair market value of vessels and the potential for COVID-19 to have an adverse impact thereon, this may be the covenant that is most sensitive to the current economic environment.

• EBITDA covenants – a significant decrease in revenue may trigger a breach in financial covenant.

• Vessel lay-up - identify if there is a covenant related to the prohibition of laying up a vessel.

• Material Adverse Clauses –understand the definition of Material Adverse Effect and if the current COVID-19 situation would trigger this definition.

If financial covenants are forecasted to be in violation, management should evaluate its options and consider the following: 

• Start covenant waiver discussions early

• Utilize cure (or grace) periods (if available)

• Consider pledging additional assets (i.e. vessels)

• Consider amending the loan agreement

Events of default, without obtaining a waiver or not curing the covenant violation, will result in current classification of the debt. This current classification may raise substantial doubt about the ability of a company to continue as a going concern. 

COVID-19 may adversely impact a shipping company’s projected cash flows, such as a decrease in future charter rates, increase in off-hire days, increase in fuel prices, increase/decrease in operating expenses, increase in inflation, increase in a company’s discount rate (if applicable), etc. In such situations, a company needs to consider whether the disruption in its business indicates that there is impairment and therefore, a “triggering event” has occurred. If it has, an impairment assessment is warranted, and the assumptions and cash flow forecasts used to test for impairment should be updated to reflect the potential impact of COVID-19. Budgets, forecasts, and other assumptions should reflect the increased risk and uncertainty.

The global financial markets are experiencing unprecedented volatility and the price of oil and other commodities has dropped dramatically.  Couple this with a continued decline in charter rates and vessel values, and a shipping company could determine that indicators of impairment exist and therefore, a triggering event has occurred to perform an interim impairment test.  The determination of a triggering event will vary from company to company based on a variety of factors, facts and circumstances.

Telling the story – As events unfold, disclosures should reflect factors that are specific to each shipping company rather than being boilerplate: 

• The direct effects on results of operations, as well as second order effects (e.g., demand for vessels in affected areas, as well as effects on charterers, service providers, business partners and global economies) 

• Risks and uncertainties about the potential impact of COVID-19 on future periods, considering how recent events may impact current and future judgments and estimates inherent in financial reporting (e.g., debt covenants, impairments, receivables collectability) 

• The current and potential future impact on results of operations, liquidity and capital resources (including consideration of trends and uncertainties)

Subsequent events for the year ended December 31, 2019 – Both US GAAP and IFRS require companies to evaluate if subsequent events are adjusting (recognized) or non-adjusting (unrecognized) events. The impact of COVID-19 has been assessed to be a non-adjusting subsequent event for  financial statements ending as of December 31, 2019. Accordingly, post balance sheet disclosures are expected to include a paragraph about the impact of the COVID-19 outbreak on its operations.  To the extent that COVID-19 results in events and conditions that impact the entity's ability to continue as a going concern, then relevant going concern disclosures should also be provided in the financial statements, with a focus to keep the financial statements from being misleading. To the extent that this impact can be quantified, the disclosures should include this information.  

Looking ahead to periods subsequent to December 31, 2019 year end, the impact of COVID-19 becomes an adjusting event impacting the measurement of  assets, liabilities (financial and non-financial) on the company’s balance sheet and the estimates used to prepare the interim financial statements for the period endedMarch 31, 2020.  If further information provides additional evidence about conditions that existed at the balance sheet date (i.e. Q1 2020 ended March 31, 2020 or subsequent periods), then these conditions are deemed to be an adjusting event. All information that becomes available before the interim financial statements of Q1 2020, or subsequent periods, are issued should be considered in the evaluation of the conditions that existed as of the balance sheet date. 

Interim reporting timeline

Many regulators around the world are revising timelines and requirements for interim reporting. Given the current market conditions and concerns about the growing pandemic, the first quarter is likely to be particularly challenging from an accounting and reporting perspective for many companies. When public shipping companies do issue interim reports, it will be important to keep in mind the overarching requirement to explain events and transactions since the end of the last annual reporting period that are significant to understanding changes in financial position and performance.