Financial Reporting Pdf Notes

[Maren Ruminski]

Themagnitude of disruption from the Covid-19 pandemic has significantly impacted organizations of all sizes, across all industry sectors. Management and those charged with governance (TCWG) are having to make difficult decisions daily about operational, financial, and strategic matters.

The consequences on financial statement reporting and audit engagements are complex. There is an unprecedented level of uncertainty about the economy, future earnings and many other inputs that represent fundamental elements of financial reporting. There will be multiple financial reporting implications to be considered by preparers of financial statements for the purposes of reporting in the short and potentially medium term.

The responsibility for preparing and overseeing financial reporting is with management, with oversight from TCWG. They will have to exercise significant judgment in the current business environment. Of particular importance is:

Professional accountants must remain focused on their ethical responsibilities and on the public interest. It is important for them to exercise heightened diligence and professional judgment to combat higher risks of financial misrepresentation and fraud, and to ensure government and other assistance is used appropriately. The application of the IESBA International Code of Ethics for Professional Accountants (including International Independence Standards), including compliance with the fundamental principles (integrity, objectivity, professional competence and due care, confidentiality and professional behavior) is key to preservation and expansion of public trust in all professional accountants .

Professional accountants will be asked to produce, analyze, and deliver the information upon which critical decisions will be made. The Code requires that in preparing or presenting information, professional accountants do so in a manner that is intended neither to mislead nor to influence contractual or regulatory outcomes inappropriately. The Code also requires professional accountants to exercise professional judgment to represent the facts accurately and completely in all material respects; describe clearly the true nature of business transactions or activities; and classify and record information in a timely and proper manner.

Given the significant uncertainty, disclosure should include those significant assumptions and judgments applied in making going concern assessments. Assessments will likely need to include different scenarios with varying assumptions, including different timelines for lifting restrictions, which can be updated to take into account the evolving nature of uncertainties. Frequent stress testing of projections and identifying factors that would make a business model unworkable are considered good practices.

IAS 10 Events After the Reporting Period contains requirements for when adjusting events (those that provide evidence of conditions that existed at the end of the reporting period) and non-adjusting events (those that are indicative of conditions that arose after the reporting period) need to be reflected in the financial statements. Amounts recognized in the financial statements are adjusted to reflect adjusting events, but only disclosures are required for material non-adjusting events.

With respect to reporting periods ending on or before 31 December 2019, there is a general consensus that the effects of the COVID-19 outbreak are the result of events that arose after the reporting date (e.g., in the UK, the Financial Reporting Council has stated that COVID-19 in 2020 was a non-adjusting event for the vast majority of UK companies preparing financial statements for periods ended 31 December 2019). For later reporting dates (e.g. February or March 2020 year ends), it is likely to be a current-period event which will require ongoing evaluation to determine the extent to which developments after the reporting date should be recognized in the reporting period.

If management concludes the impact of non-adjusting events are material, the company is required to disclose the nature of the event and an estimate of its financial effect. If it cannot be reliably quantitively estimated, there still needs to be a qualitative disclosure, including a statement that it is not possible to estimate the effect. Management should also consider whether it is able to properly assess going concern, in the event that it can not reliably quantify the affect of non-adjusting events.

Examples of non-adjusting events that would generally be disclosed in the financial statements include breaches of loan covenants, management plans to discontinue an operation or implement a major restructuring, significant declines in the fair value of investments held and abnormally large changes in asset prices, after the reporting period.

A change in the fair value measurement affects the disclosures required by IFRS 13, Fair Value Measurement, which requires companies to disclose the valuation techniques and the inputs used in the FVM as well as the sensitivity of the valuation to changes in assumptions. Disclosures are needed to enable users to understand whether Covid-19 has been considered for the purpose of FVM. A key question is what conditions and the corresponding assumptions were known or knowable to market participants at the reporting date.

For 2020, fair value measurements, particularly of financial instruments and investment property, will need to be reviewed to ensure the values reflect the conditions at the balance sheet date. This will involve measurement based on unobservable inputs that reflect how market participants would consider the effect of Covid-19 in their expectations of future cash flows related to the asset or liability at the reporting date.

During the current environment, the volatility of prices on various markets has also increased. This affects the FVM either directly - if fair value is determined based on market prices (for example, in case of shares or debt securities traded on an active market), or indirectly - for example, if a valuation technique is based on inputs that are derived from volatile markets. Consequently, special attention will be needed on the commodity price forecasting that is used in developing fair value conclusions.

Companies will need to assess whether the impact of Covid-19 has potentially led to an asset impairment. For most companies, the economic effects are likely to trigger an impairment test for long-lived assets and other asset groups. Estimates of future cash flows and earnings are likely to be significantly affected by direct or indirect impacts. Asset impairment may also reduce the amount of deferred tax liabilities. Management may need to make estimates about expected timing of reversal of the deductible and taxable temporary differences when considering whether a deferred tax asset can be recognized. Ongoing identification and evaluation and re-evaluation are essential to understand the extent of the need for recognition and for what periods.

Valuation of inventories is subject to IAS 2 Inventories - requiring measurement at the lower of their cost and net realizable value (NRV). In the current environment, the NRV calculation will likely require more detailed methods or assumptions (e.g. companies may need to write-down stock due to less sales). Interim inventory impairment losses should be reflected in the interim period in which they occur, with subsequent recoveries recognized as gains in future periods.

There is a need for clear and transparent disclosures by companies on how fair value measurement and value in use have been determined, including key inputs and assumptions as well as disclosures of significant non-adjusting post balance sheet events.

The Covid-19 impact on credit risk will be more severe and immediate in various sectors. The IASB has published a document responding to questions regarding the application of IFRS 9, Financial Instruments which requires companies to incorporate reasonable and supportable information about past events, current conditions and the forecast of future economic conditions into the assessment of Expected Credit Losses (ECLs) for financial assets not measured at fair value through profit or loss. Such an assessment should be based on information at the reporting date. Events after the reporting date should be considered for whether they provide additional evidence on the information already existent as at the reporting date.

The increased credit risk faced by banks and lenders is related to exposures to borrowers in highly affected sectors. Provisions need to be estimated based on the ECL for the entire remaining life of a financial instrument, such as loans to borrowers whose credit risk has increased significantly since origination.

The European Central Bank (ECB), European Banking Authority (EBA), European Securities and Markets Authority (ESMA), and Prudential Regulation Authority (PRA) at the Bank of England have issued public statements with reminders about IFRS 9 and its application in the current environment. The U.S. government has also offered voluntary relief for banks on the application of the new U.S. GAAP CECL model through the CARES Act.

ECL is a probability weighted amount that is determined by evaluating a range of possible outcomes. Qualitative and quantitative disclosure enables users of financial statements to understand the effect of credit risk on the amount, timing, and uncertainty of future cash flows. This includes the basis of inputs and use of assumptions and estimation techniques. The measurement of ECL applies to companies across industries other than financial services, but specific considerations and ECL guidance for lenders and banks is available.

The objective of IFRS 16, Leases is to report information that faithfully represents lease transactions and provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.

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