3.Effects of the Coronavirus Pandemic on Financial Reporting
Business performance in the first half of 2020 was heavily influenced by the coronavirus pandemic. During this period, Covestro saw substantial sales losses, primarily due to a decline in volumes sold. Whereas the APAC region's sales had dropped considerably as early as the first quarter of 2020, sales in the EMLA and NAFTA regions did not begin their steep decline until the second quarter of 2020. In contrast, the slowdown in sales in the APAC region, particularly China, was much less severe than in the other regions in the second quarter of 2020.
Sales in all segments fell significantly in the first half of 2020. This was mainly due to a decline in volumes sold and a lower level of selling prices. The change in volumes resulted from weaker demand in all main customer industries. Only in the Polycarbonates segment did volume growth in the construction sector offset the downturns in the other main customer industries.
Additional disclosures on the effects of the coronavirus pandemic and the countermeasures taken by Covestro are presented in the interim group management report.
In view of the aforementioned changes in the business environment, preparation of the consolidated interim financial statements required Covestro to make assumptions and estimates to a certain extent that affected the measurement of reported assets and liabilities, as well as income and expenses, and that could deviate from the actual results in individual cases. Such estimates, assumptions and the exercise of discretion related primarily to the following areas:
- impairment testing of non-financial assets, particularly goodwill;
- assessment of the probability that deferred tax assets can be utilized in the future;
- calculation of impairment losses on trade accounts receivable;
- calculation of provisions relating to contractually agreed minimum purchase volumes (“take-or-pay” clauses) in supply contracts.
As a consequence of the significant decline in Covestro’s market capitalization, the carrying amounts of all cash-generating units were subjected to impairment testing as of June 30, 2020. For this purpose, the most recent Covestro corporate planning approved by the Supervisory Board was used under consideration of currently available planning data.
As of June 30, 2020, there was no need to recognize an impairment loss for any of the cash-generating units.
As part of an extended sensitivity analysis, a 10% reduction in the future free operating cash flow, a 10% increase in the WACC, or a one-percentage-point reduction in the long-term growth rate were assumed. On this basis, there would be no need to recognize an impairment loss for any of the cash-generating units. The same applies at the measurement date of June 30, 2020, to other deviations from the assumptions used in the impairment testing that were deemed possible.
The probability that deferred tax assets resulting from temporary differences, tax credits or loss carryforwards can be utilized in the future is the subject of forecasts by the individual companies regarding the future earnings situation in the respective Covestro companies and other parameters. These forecasts have been updated to reflect the effects of the coronavirus pandemic and did not result in any impairment losses on deferred tax assets in the current financial statements.
The level of default risk associated with the Covestro Group's trade accounts receivable depends mainly on the creditworthiness of our customers. The coronavirus pandemic has heightened industry risk (equivalent to the default risk relating to the companies in a particular industry), because demand, and subsequently sales revenues, in certain industries have declined sharply. This can directly affect the creditworthiness of customers in these industries. In order to appropriately reflect the increased default risk when measuring trade accounts receivable, industry risk was additionally considered when assessing the creditworthiness of customers. The expected losses in trade accounts receivable therefore increased by €3 million (additional information on the calculation of default risk for trade accounts receivable can be found in note 24.2 “Financial Risk Management and Information on Derivatives” in the Consolidated Financial Statements in the 2019 Annual Report).
Due to weaker demand, the agreed minimum purchase amounts in some supply contracts (“take-or-pay” clauses) cannot be met for 2020. Provisions were recognized for the expected payments resulting from the failure to purchase the agreed volumes.
In addition, attention is drawn to the following accounting issues associated with the coronavirus pandemic:
In March 2020, the “Coronavirus Aid, Relief and Economic Security (CARES) Act” was passed in the United States. This economic relief package gives U.S. companies various options including carrying back losses at the federal tax level, incurred after December 31, 2017, and prior to January 1, 2021, to prior years and offsetting them against taxable income. Tax income of €4 million was realized by Covestro LLC, Pittsburgh (USA), in this context in the first half of 2020.
Covestro received public subsidies abroad in accordance with IAS 20 for managing sales losses resulting from the coronavirus pandemic. These subsidies related mainly to a reduction in personnel costs and amounted to €5 million in the first six months of 2020.