As the impact of a novel strain of coronavirus (COVID-19) continues to unfold around the world, those individuals responsible for preparing financial statements and approving them for issue need to be cognisant of not only what has happened and is happening at the reporting date and the time the financial statements are approved, but also what is likely to happen next.
IFRS requires that all the material effects of COVID-19 are appropriately recognised, measured and disclosed at the entity’s reporting date; be it interim or at year-end.
10 key questions for CFOs
COVID-19 – the big picture: what should be included in financial statements that have not yet been authorised and approved for issue?
An entity’s stakeholders will use financial statements to evaluate the magnitude of potential disruptions to their businesses and if any estimates are included, they will want insight into how these were determined. The stakeholders will want to understand the impact COVID-19 is having on their business. In many instances, extensive observations will have already been included in the management commentary.
Will the outbreak of COVID-19 result in more disclosures?
The answer to this question is almost certainly yes. In many situations, the outbreak will result in revised obligations or uncertainties that an entity may not have previously recognised or disclosed in its financial statements. The additional disclosures will not only relate to the revenues, expenses, assets and liabilities they have already recognised, but also what might end up recognised in subsequent reporting periods.
There has recently been a significant drop in the value of equities so if you have a 31 December 2019 reporting date, should your financial statements be adjusted for this?
The answer is no. Fair value in accordance with IFRS 13 ‘Fair Value Measurement’ is based on the price to sell an asset at the measurement date. Also, in accordance with IAS 10 ‘Events after the Reporting Date’ a fall in fair value after the reporting date does not provide new evidence about the fair value at the reporting date. However, IAS 10 requires disclosures about ‘non-adjusting’ events after the reporting date, including abnormally large changes in assets prices (including an estimate of the financial effect unless it cannot be reasonably estimated). NB. This assessment assumes the entity is a going concern.
If there is estimation uncertainty, what should be reported in the financial statements?
In 31 March 2020 financial statements, for example, businesses will need to pinpoint where accounting estimates have been made and what assumptions were used to determine the amounts that are reflected in the financial statements. For example, an organisation may have perishable goods that due to market circumstances brought about by COVID-19, will have to be sold for less than it cost to produce them. Having never faced this situation, a range of selling prices exists which means the loss arising from having to write down the value of its inventory will also change. In many instances there will be a range of possible outcomes. IAS 1 ‘Presentation of Financial Statements’ requires disclosure about the assumptions made and the nature and carrying amounts of the assets and liabilities affected. It does not prescribe the exact information you should disclose about these assumptions but gives examples of the types of information:
- The nature of the assumptions
- Sensitivity of carrying amounts
- Expected resolution/range of reasonably possible outcomes
- Changes made to past assumptions
How does information about COVID-19 that becomes available after the reporting date affect the financial statements?
In our view it depends. Entities are required to determine amounts based on their facts and circumstances at the reporting date, not after it. This is particularly important when considering whether assets are impaired or not. When information becomes available after the reporting date, its impact on the financial statements depends on whether it provides additional evidence of conditions that existed at the reporting date. So, the determination of the recoverable amounts of an asset can only consider the information obtained after the reporting date if such conditions existed as at the reporting period end.
Is it reasonable to take the view “the more uncertain the environment, then more detailed disclosures of the assumptions and assessments used to prepare the financial statements should be made”?
In our view, yes, it is reasonable. Those preparing financial statements should always be mindful of who will be reading them and how they might be used. The financial statements need to provide enough transparency to enable users to understand the key assumptions that have been adopted so that they can make their own assessment of their reasonableness.
When assessing expected credit losses (ECL), what should be taken into consideration?
Set out in IFRS 9 ‘Financial Instruments’ is that past events, current conditions and the forecast of future economic conditions for any financial asset that is not measured at fair value is fairly presented in the financial statements in accordance with the requirements of IFRS 7 ‘Financial Instruments: Disclosures’. ECL is a probability weighted amount that should be determined by evaluating a range of possible outcomes and the time value of money. This is often overlooked. To make this assessment often takes a considerable amount of time and professional judgment. In responding to the likely deterioration of credit, consideration must also be given to the support packages that are being given by governments and central banks around the world. If there is uncertainty about the extent and applicability of support available to the reporting entity, then our view is that this should be disclosed.
What should be taken into consideration when determining fair values at a reporting date?
The relevant accounting standard is IFRS 13 ‘Fair Value Measurement’ and it states the fair value of an asset or a liability at a measurement date is a specific exit price estimate that is based on assumptions (including those about risks) that market participants would make under current market conditions. Put another way: at the reporting date, what assumptions would market participants have made using all available information, including information that may be obtained through due diligence efforts that are usual and customary?
In some cases, greater use of unobservable inputs will be required because some markets have become less active such that relevant observable inputs are not available. However, if a quoted price in an active market (a so-called level 1 price) is available then that price must be used, even if the market has become less active and/or prices more volatile. The key point to recognise is that the fair value measurement objective remains the same, i.e. an exit price at the measurement date from the perspective of a market participant.
How much attention needs to be given to going concern for COVID-19?
A considerable amount. In assessing whether the going concern assumption is appropriate, an entity is required to consider all available information about the future, which is at least, but not limited to, twelve months from the reporting date of financial statements for issue. IAS 1 requires that this assessment considers events after the reporting date. One downside is that the longer it takes an entity to complete their financial statements after its reporting date, the more information they need to take into consideration. So, if the business is being audited, it should work very closely with its auditor to agree the level of analysis and evidence that is appropriate to support whatever going concern assumption is made.
A key component of assessing going concern is to report all the material uncertainties that exist at the date of approval of the financial statements concisely. In some instances, there may only be one factor, in other situations there could be several. Preparers of financial statements need to be mindful that under ISA 570 ‘Going Concern’, the auditor is required to refer to the specific note that appears in the financial statements in their audit report. So this will require the auditor to secure sufficient appropriate audit evidence to confirm all assumptions made in relation to going concern.
Ultimately, what impacts of COVID 19 will the users of the financial statements be most interested in?
For many entities, it will be how they have coped with the outbreak so far. Their focus should be on disclosing in their financial statements what steps have been taken to contain and minimise the impact of this global event on their operations. Almost every entity with a 31 December 2019 reporting date is likely to conclude that this outbreak is a non-adjusting event – but that does not absolve it from fully disclosing the post-reporting date consequences on the organisation and its future operations and activities. However, if your entity has a later reporting date, say 31 March 2020, then adjustments to the carrying amounts included in your financial statements will almost certainly be required if the entity is able to quantify then. If not, then this should be disclosed as well because the objective of preparing any set of financial statements should be to provide readers with insight not only on the entity’s past activity, but also its current operating situation and its future viability.