COVID-19: Guidance for public sector entities in Canada
Welch LLP had originally issued this guidance on March 26th, 2020. This was the first publication in Canada to provide financial statement impact and fiscal analysis to address the budget pressures the public sector would face.
Eight months later, this guidance remains relevant. For accounting purposes, many public sector entities still have their year-ends coming. Most of these issues will persist for the next fiscal year as well. Challenges remain in trying to determine impairment to public sector revenues from taxation and user fees, which will ultimately determine the extent of funding needed to move forward.
Financial statement analysis and insights:
ASSETS and REVENUES
|Financial Statement Item||Year-end consideration||Fiscal 2020 Budget impact||Analysis|
|Tax Revenue and accounts receivable||Impairment. Many receivables will not be collected and will require an adjustment to the allowance for doubtful accounts.||Future revenues and receivables will be deferred or may not be collected. This may require adjustment to the allowance for doubtful accounts.||Don’t use past data to determine the extent of the adjustment. This was a mistake made in the 2008-2009 crisis – past data will not account for the unemployment shock we are experiencing. Looking at segments of revenue in isolation along with sensitivity analysis is the key. Revisions to revenue estimates must comply with the Accounting Changes section of the handbook PS 2120.|
|Loans Receivable||Potential write-offs of existing loans receivable.||Potential assets may need to be treated as expenses for budget purposes.||Existing loans may need to be revalued. New loans made in this environment are critical but also very risky. An appropriate risk-based analysis may reveal these loans are not recoverable and may, in substance, be a government transfer expense. Credit risk is pervasive at the moment.|
|Restricted assets /revenues||Minimal impact on past accounts.||Analysis should be performed to asses if any funds may be repurposed to address more immediate needs.||Be strategic. Can designated assets be repurposed to meet short-term cash flow needs? Can you initiate discussions that may lead to changing or modifying external restrictions?|
|Government Transfers received||For some entities there may be deferred revenues if this is received by year end.||This will help balance in public sector budgets, but at this point there is no insight into what assistance will be available.||This is one of the reasons why performing this analysis is so critical. Senior levels of government need quality information to make decision on government transfers.|
|Inventories||Write-down to recoverable values.||Write-down to realizable values for budgeting too.||Realizable values are the most useful values during this time.|
|Financial Instruments and Portfolio Investments||Financial instruments have specific guidance, most of which will require a write-down to market values.
Current market values of financial instruments are most relevant to the 2020-2021 budget.
|For public sector entities that have yet to adopt PS 3450 suite of standards, financial instruments would be held at cost unless there is evidence of a permanent decline in value.
For entities that have adopted the PS 3450 suite of standards, listed equities and derivatives would be recorded at their fair value at the year-end date. Impairment tests must still be applied.
Market values are the most relevant information for decision-makers, especially if other sources of cash are not available.
|Investments in GBEs||Investment in GBEs are recorded at cost unless there is a permanent impairment in value. This analysis may be required at year-end.||GBEs require case-by-case evaluation to determine if 2020-21 cash flows reflect potential impact of Covid-19.||A cash flow analysis on each GBE is vital. Some will remain operational (eg. Electric utilities) while others will not (eg. casinos). GBEs may be a source of additional capital for some governments.|
LIABILITIES and EXPENSES
|Financial Statement Item||Year-end consideration||Fiscal 2020 Budget impact||Analysis|
|Post-employment benefits||If terminations, compensated absences or other event-driven benefits occur, would be accrued as a liability for year-end.||If terminations, compensated absences or other tactical decisions are made given closure of certain public services, there is a need to plan for the accrual and payment of these liabilities.||Reducing services may not always result in savings. Need to assess what portion of labour wages, benefits and post-employment benefits are variable first.|
|Retirement benefits||For defined benefit plans: market values of financial assets and lower market interest rates both move to increase an entity’s pension liability at year end. Potential for material impact.||Funding requirements are different from accounting requirements. Further analysis is required based on the specific entity, plan and jurisdiction.||In the financial crisis of 2008-09 regulators relaxed funding requirements. We may see similar measures this year.
Public sector accounting permits smoothing of certain market adjustments to mitigate the impact on the balance sheet and the annual surplus and deficit.
For decision-makers, it is important to understand of the underlying causes for the increase in the liability and the impact to the cash flows of the pension fund liability.
|Government Transfers paid||May require accrual in 2019-20.||Will likely impact cash flow for fiscal 2020-21?||Signs point to this crisis lingering for months. Various levels of government may need to roll out a targeted stimulus plan. Decisions on transfer payment programs may require large one-time accruals close to the year-end date.|
|Tax Concessions||May require accrual in 2019-20||Will impact cash flows when projecting revenues for fiscal 2020-21||Tax concessions like refundable tax credits, deductions, exemptions are treated and presented as expenses in the period.|
|Loan Guarantees||Note disclosure or an accrual for expense if losses are likely||Will not impact cash flow for fiscal 2020-2021, unless a loss event occurs||Loan guarantees may be a way for governments to avoid direct transfer payments and bridge the funding gap for many of their organizations. This tool can be powerful in this setting, but has limits and consequences.|
|Leased Tangible Capital Assets||Likely minimal impact for current reporting year||Needs to be actively managed to minimize cash outflow||Tax payments and mortgage payments are being deferred. Public sector entities need to negotiate revisions or deferrals to their lease agreements to ease the cash flow burden for fiscal 2020. The window for this is now.|
|Contingent Liabilities, contractual obligations and contractual rights||Likely minimal impact for current reporting year||Budget for legal counsel||There are unanswered questions regarding the impact of Covid-19 interruption and how it will be interpreted in tort law. Consider if legal counsel could assist in mitigating risk, re-negotiating contracts, settling disputes, and recovering amounts through insurance.|
|Control of other organizations||Being responsible for an outside entity’s risk of loss is a primary indicator of control. May result in unanticipated consolidation at year end.||Budget for liabilities that may result from organizations you fund but do not currently consolidate.||Speak to the CFOs of related organizations to understand their immediate financial situation and needs. It will impact you and you need to understand how.|
I’ve done the analysis – what’s next?
Depending on the nature of the public sector organization you are with, your funding options will differ.
- Many government organizations are separate legal entities and may borrow on their own. For these entities, having a properly valued balance sheet will be the key piece of information for banks to understand the risk they are taking on. The above analysis will get you there.
- Local governments and indigenous governments can borrow, subject to restrictions. For example, Ontario municipalities have Annual Repayment Limits which restrict the amount and structure of borrowings. This limit is based on revenues, which are impaired right now. Further analysis is required to determine if this is a tool available to a particular local government.
- Many public sector entities have their own sources of revenues. The key question is, can they continue to collect these revenues? Colleges and universities have different sources of financing available to them (tuition paid in advance, reserves, endowments and foundations). Continuity of their operations is critical and additional funds will be needed to finish the school year and start the next one.
- Museums have their own source revenues but those revenues have vanished. Transit authorities will feel the same absence of revenues, despite still technically being open. They will require government assistance. The question they need to answer – how much can they reduce their fixed and variable costs to survive in the next year.
- Other entities like school boards, hospitals, and special crown agencies have always been dependent on government funding to operate. Hospitals will need to extend their normal level of service, which means a near term expansion plan needs to be budgeted for and tracked. Other organizations like school boards will need to plan for a shutdown of schools and minimize costs until it is safe to re-open. Costs related to virtual classrooms may need to be incurred. Again, these revised plans and budgets need to be prepared and costs need to be tracked.
Welch LLP Public Sector Team
This document provides a high-level framework for our clients to use during these turbulent times. Welch has an experienced public sector team with experts in accounting and financial management policy, valuation and analysis.
|Welch LLP Partner, Umar Saeed, is widely recognized as an expert in public-sector accounting standards (PSAS) as well as International Public Sector Accounting Standards (IPSAS).|