THE INTRODUCTION:
The COVID-19 pandemic has caused widespread disruption globally, affecting different sectors. The impact on businesses worldwide has been profound and extensive, leading to substantial unemployment, reduced economic activity, and a decline in foreign investment. Here are some figures that highlight the impact:
According to the International Labour Organization (ILO), the pandemic caused the loss of 255 million full-time jobs worldwide in 2020 [1].
The United Nations Conference on Trade and Development (UNCTAD) estimated that global foreign direct investment (FDI) fell by 42% in 2020 compared to the previous year [2].
Small and medium-sized enterprises (SMEs) were hit particularly hard by the pandemic. A survey by the Organisation for Economic Co-operation and Development (OECD) found that 70% of SMEs reported a reduction in turnover due to the pandemic, and 45% reported a decrease in employment [3].
The pandemic had a significant impact on the travel and tourism industry. The World Travel and Tourism Council (WTTC) estimated that the sector's contribution to global GDP fell by 49.1% in 2020, resulting in the loss of 62 million jobs worldwide [4].
The pandemic also had a significant impact on the automotive industry. According to the International Energy Agency (IEA), global sales of electric cars fell by 15% in 2020, compared to the previous year, due to the pandemic's impact on demand and supply chains [5].
Therefore, it is even more critical for companies to recognise and assess the expenses/costs resulting from this exceptional circumstance.
THE PROBLEM:
Executives worldwide faced the challenge of quantifying and determining the COVID-19 impact on businesses' Profit/Loss (P/L).
THE SOLUTION:
Is COVID-19 an abnormal or a usual event that should be accounted for?
The COVID-19 pandemic has upended how businesses operate worldwide, causing unprecedented disruption and chaos. With the pandemic being an irregular and unexpected occurrence, the resulting impact has been nothing short of abnormal. The concept of Abnormal Cost, well-established through the Cost Accounting Standards [6], perfectly captures the exceptional nature of this situation. Therefore, it is imperative for businesses to recognise that the costs incurred due to the COVID-19 pandemic are not ordinary but rather abnormal costs that require special treatment and attention.
Treatment of various cost elements in light of COVID-19
THE RESULTS:
The FY 2020-21 was widely considered the year impacted by the COVID-19 pandemic due to the abnormalities caused by the global health crisis. However, in FY 2021-22, there were no widespread lockdowns in India, and people started adapting to the new normal, wherein the COVID-19 pandemic continued to persist with varying degrees of impacts across sectors, businesses and households. Given these lasting effects of the pandemic in FY 2021-22 on companies, it is essential to distinguish between abnormal costs incurred during the pandemic and regular operations costs. Therefore, an important lesson learnt is that businesses must carefully review their financial statements and cost accounting practices to ensure accurate reporting of expenses and profits/losses by considering both costs incurred from routine and unprecedented circumstances.
The Cost Accounting Standards consider Abnormal Costs as Non-Cost Items; therefore, they should not be included in Cost Statements [7]. Any expenses related to the COVID-19 pandemic or those incurred during the period of disruption caused by it, which are considered abnormal, should be classified as Non-Cost Items. These expenses must be disclosed in the Reconciliation Statement between Costing & Financial Profit / (Loss).
Quantifying methodology for the abnormal costs of COVID-19 is as follows [7]:
Identify and segregate abnormal costs related to COVID-19 from regular costs.
Document the rationale and basis for determining the abnormal costs.
Quantify the amount of abnormal costs incurred during the period.
Allocate the abnormal costs to the relevant cost centres.
Ensure that abnormal costs are treated as non-cost items and are not included in the cost statements.
Adjusting or reducing the capacity lost due to the COVID-19 situation, including partial or complete shutdown and scaling down of manpower deployment, to calculate the normal capacity.
Prepare a reconciliation statement between the costing and financial profit/loss, including the abnormal costs.
Illustration
Cost Information
Particulars | For the Year | Abnormal (COVID19) | To be Absorbed in Costing |
Variable Cost | 12,00,000 | 1,00,000 | 11,00,000 |
Fixed Cost | 18,00,000 | 1,50,000 | 16,50,000 |
Total Cost | 30,00,000 | 2,50,000 | 27,50,000 |
Capacity Information
Particulars | Numbers |
Normal Days of operation in the Year | 352 |
Standard Production Per Day | 100 |
Normal Capacity (Normal Year) | 35,200 |
Days Lost Due to COVID-19 | 30 |
Loss of Capacity (COVID-19) | 3,000 |
Normal Capacity (for COVID-19 affected Year) | 32,200 |
Actual Capacity | 25,000 |
For Cost Records Compilation
Particulars | Cost Information |
Variable Cost is to be absorbed on Actual Production | 11,00,000 |
Fixed Cost to be absorbed on Standard Production | 12,81,056 |
Un-absorbed Fixed Cost | 3,68,944 |
Presentation in Reconciliation Statement
Particulars | Amount |
Expenses Not Considered in Cost Accounts | |
Un-absorbed Cost (Capacity Under Utilization) | 3,68,944 |
COVID-19: Unabsorbed Abnormal Cost | 2,50,000 |
The Call to Action:
It is recommended that businesses refer to the Board Reporting Framework - A Post COVID-19 Corporate Governance Perspective for guidance on reporting and managing the impacts of the pandemic on their operations. The framework provides a comprehensive approach to addressing businesses’ challenges and ensuring effective corporate governance in the post-COVID era [8].
FOOTNOTES
Abnormal Cost: An unusual or atypical cost whose occurrence is usually irregular and unexpected and/or due to some abnormal situation of the production or operation.
8. ⌃ Conceptual Approach to Board Reporting Framework: A Post-COVID-19 Corporate Governance Perspective 🡕
FREQUENTLY ASKED QUESTIONS:
What are abnormal costs related to COVID-19 in business?
How can abnormal costs be quantified in business due to COVID-19?
What are the examples of abnormal costs in business due to COVID-19?
How can businesses mitigate the impact of abnormal costs due to COVID-19?
Why is it important for businesses to quantify abnormal costs related to COVID-19?
CONTACT US
Reach us if you have any concerns regarding cost management accounting issues in your organization.
SANKALP WADHWA
Partner, Chandra Wadhwa & Co. (Cost Accountants) | B.Com, FCMA, ACA, DISA | Certified SAP-CO Consultant | Executive Program on Management and Finance (IIM, Ahmedabad)
Address: 1305 & 1306, Vijaya Building, 17, Barakhamba Road, New Delhi - 110001, India Mail: sankalp.wadhwa@cwcindia.in
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