COVID-19 has brought with it considerable uncertainty for every person and business in Ireland. With the rapid development of the virus in many countries, including Ireland, governments have introduced measures to manage the spread of the virus including requiring entities to limit or suspend business operations. Businesses are dealing with lost revenue and disrupted supply chains and the disruption to global supply chains has already exposed the vulnerabilities of many organisations.
To help you navigate through these unprecedented times, from an accounting perspective, we’ve summarised some of the key impacts for IFRS reporters. This article provides a reminder of some of the existing accounting requirements that should be considered when addressing the financial effects of the COVID-19 outbreak in the preparation of IFRS financial statements for the annual or interim reporting periods ending in 2020.
The issues discussed are by no means exhaustive and their applicability depends on the facts and circumstances of each entity. The financial reporting considerations highlighted in this article are as follows:
- Going concern;
- Impairment assessment;
- Fair value measurement;
- Insurance recoveries;
- Onerous contract provisions;
- Other accounting estimates; and
- Other financial statement disclosure requirements.
More detailed guidance can be found in our publication “Applying IFRS, Accounting considerations of the coronavirus outbreak, Updated March 2020” which provides guidance on a number of additional topics as well as our publication “Applying IFRS, accounting considerations of the coronavirus outbreak, February 2020” which provides guidance primarily for 2019 financial statements.
As the outbreak continues to evolve, it is difficult, at this juncture, to estimate the full extent and duration of the business and economic impact.
Consequently, these circumstances have presented entities with greater challenges when preparing their interim and annual IFRS financial statements.
IAS 1 Presentation of Financial Statements requires management, when preparing financial statements, to make an assessment of an entity’s ability to continue as a going concern, and whether the going concern assumption is appropriate. Furthermore, disclosures are required when the going concern basis is not used or when management is aware, in making their assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern.
When making that going concern assessment, where relevant, management takes into consideration the existing and anticipated effects of the outbreak on the entity’s activities in its assessment of the appropriateness of the use of the going concern basis.
The degree of consideration required, the conclusion reached, and the required level of disclosure will depend on the facts and circumstances in each case, because not all entities will be affected in the same manner and extent. Significant judgement and continual updates to the assessments up to the date of issuance of the financial statements may be required given the evolving nature of the outbreak and the uncertainties involved.
An asset is impaired when an entity is not able to recover its carrying value, either by using it or selling it. An entity estimates the recoverable amount of the asset for impairment testing. Recoverable amount is the higher of the fair value less costs of disposal (FVLCD) and the value in use (VIU). Value in use is defined as the present value of the future cash flows expected to be derived from an asset or cash-generating unit. The calculation of an asset’s value in use incorporates an estimate of expected future cash flows and expectations about possible variations of such cash flows.
FVLCD is the fair value as defined in IFRS 13 and the following section on fair value explains how the impact of the outbreak is considered. The estimation of the VIU involves estimating the future cash inflows and outflows that will be derived from the use of the asset and from its ultimate disposal and discounting the cash flows at an appropriate rate.
In cases where the recoverable amount is estimated based on value in use, the considerations on accounting estimates apply. The forecasted cash flows should reflect management’s best estimate of the economic conditions that will exist over the remaining useful life of the asset. With the current uncertain situation, significant challenges are expected to prepare the forecast of or budgets for future cash flows. In these circumstances, an expected cash-flow approach based on probability-weighted scenarios may be more appropriate to reflect the current uncertainty than a single best estimate when estimating value in use.
Fair value measurement
IFRS 13 Fair Value Measurement specifies that fair value measurement (FVM) is a measurement date specific exit price estimate based on assumptions (including those about risks) that market participants would make under current market conditions.
The objective of FVM is to convey the fair value of the asset or liability that reflects conditions as of the measurement date and not a future date. Although events and/or transactions occurring after the measurement date may provide insight into the assumptions used in estimating fair value as of the measurement date (only those that are unobservable), they are only adjusted for in FVM to the extent they provide additional evidence of conditions that existed at the measurement date and these conditions were known, or knowable, by market participants.
In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement is recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The amount of the provision is not reduced by any expected reimbursement. Instead, the reimbursement is treated as a separate asset and the amount recognised for the reimbursement asset is not permitted to exceed the amount of the provision.
The terms and conditions of an insurance policy are often complex. In the context of a potential insurance recovery, determining that there is a valid insurance policy for the incident and a claim will be settled by the insurer, may require evidence confirming that the insurer will be covering the claim.
Once it is established that it is virtually certain that the entity will be compensated for at least some of the consequences of the COVID-19 outbreak under a valid insurance policy, any uncertainty as to the amount receivable should be reflected in the measurement of the claim.
Onerous contract provisions
An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it. If an entity has a contract that is onerous, IAS 37 requires the entity to recognise and measure the present obligation under the contract as a provision. Before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets dedicated to that contract.
One significant impact of the COVID-19 outbreak is the disruption to the global supply chain. For example, when a manufacturing entity has contracts to sell goods at a fixed price and, because of the shutdown of its manufacturing facilities, as required by the local government, it cannot deliver the goods itself without procuring them from a third party at a significantly higher cost, the provision for the onerous contract will reflect the lower of the penalty for terminating the contract or the present value of the net cost of fulfilling the contract (i.e., the excess of the cost to procure the goods over the consideration to be received). Contracts should be reviewed to determine if there are any special terms that may relieve an entity of its obligations (e.g., force majeure). Contracts that can be cancelled without paying compensation to the other party do not become onerous as there is no obligation.
Other accounting estimates
Apart from the preceding items, the following are some of the other key accounting estimates required to be made by management under IFRS. These estimates generally include management’s assumptions about the future recoverability or settlement of an asset and liability, respectively:
- Variable consideration and related constraints under IFRS 15 Revenue from Contracts with Customers;
- Net realisable value of inventories under IAS 2 Inventories;
- Recoverability of deferred tax assets under IAS 12 Income Taxes; and
- Remaining useful life and residual value of property, plant and equipment, intangible assets and right-of-use assets under IAS 16 Property, Plant and Equipment, and IAS 38 Intangible Assets and IFRS 16 Leases, respectively.
Other financial statement disclosure requirements
In addition to the disclosure requirements for the preceding areas, IAS 1 requires disclosure of information about the assumptions concerning the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities, such as non-current assets subject to impairment, within the next financial year (with the exception of assets and liabilities measured at fair value based on recently observed market prices).
Examples of the types of disclosures that an entity is required to make include:
- The nature of the assumption or other estimation uncertainty;
- The sensitivity of carrying amounts to the methods, assumptions and estimates underlying their calculation, including the reasons for the sensitivity;
- The expected resolution of an uncertainty and the range of reasonably possible outcomes within the next financial year in respect of the carrying amounts of the assets and liabilities affected; and
- An explanation of changes made to past assumptions concerning those assets and liabilities, if the uncertainty remains unresolved.
Disclosure (for year end reporting purposes)
The financial statement disclosure requirements for entities affected by the outbreak will vary depending on the magnitude of the financial impact and the availability of information. Where such a decline in value is determined to be non-adjusting the entity does not adjust the carrying amounts, but instead, discloses such a fact and its financial effect if it can be reasonably estimated.
The outbreak may also result in obligations or uncertainties that an entity may not have previously recognised or disclosed, an entity also needs to consider whether to disclose additional information in the financial statements to explain the impact of the outbreak on areas that might include provisions and contingent assets/liabilities.
In relation to the assumptions and estimation uncertainty associated with the measurement of various assets and liabilities in the financial statements, the occurrence of the outbreak has certainly added additional risks that the carrying amounts of assets and liabilities may require material adjustments within the next financial year. Therefore, entities should carefully consider whether additional disclosures are necessary in order to help users of financial statements understand the judgement applied in the financial statements. Such disclosure may include, for a financial statement item with a carrying amount that is more volatile in response to the outbreak, a sensitivity of carrying amounts to the methods, assumptions and estimates underlying their calculation.
Disclosure (for interim reporting purposes)
In accordance with IAS 34 Interim Financial Reporting, an entity is required to include in its interim financial report an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of the entity since the end of the last annual reporting period. Information disclosed in relation to those events and transactions should also update the relevant information presented in the most recent annual financial report. IAS 34 includes a number of required disclosures as well as a non-exhaustive list of events and transactions for which disclosures would be required if they are significant. For example, where significant, an entity needs to disclose changes in the business or economic circumstances that affect the fair value of the entity’s financial assets and financial liabilities, whether those assets or liabilities are recognised at fair value or amortised cost. In addition, an entity is also required to disclose any loan default or breach of a loan agreement that has not been remedied on or before the end of the reporting period.
The standard presumes a user of an entity’s interim financial report will have access to the most recent annual financial report of that entity. Therefore, it is unnecessary for the notes to an interim financial report to provide relatively insignificant updates to the information that was reported in the notes in the most recent annual financial report. However, as most entities are only recently impacted by the outbreak which is rapidly evolving, they may not have included much relevant information in their last annual financial reports and thus may need to include more comprehensive disclosure on, especially, where relevant, the topics discussed in this publication for interim financial reporting purposes.