COVID-19 may result in extra financial statement disclosures
Over the last few months we have highlighted some of the accounting implications that may arise as a result of COVID-19. This month we focus on presentation and disclosures that require particular attention as a result of COVID-19, including:
When preparing financial statements, an entity is required to make an assessment of its ability to continue as a going concern and continue to operate in the future - IAS 1, paragraph 25. It is important to note that:
- In making the going concern assessment, an entity is required to take into account information about the future that is at least, but not limited to, 12 months from the end of the reporting period (IAS 1, paragraph 26).
When there is a subsequent deterioration in operating results and financial position after reporting date, entities may need to reconsider whether the going concern assumption is still appropriate at reporting date. (IAS 10 Events after the Reporting Period, paragraph 15).
Material uncertainties regarding going concern
When an entity is making its assessment and there are material uncertainties that may cast significant doubt upon the entity’s ability to continue as a going concern, disclosure of those uncertainties is required by IAS 1, paragraph25:
…When management is aware, in making its 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, the entity shall disclose those uncertainties….
Extract of IAS 1, paragraph 25
In addition, in July 2010, the IFRS Interpretations Committee noted that for such disclosure to be useful, an entity must identify that the disclosed uncertainties may cast significant doubt upon the entity’s ability to continue as a going concern.
Other than this decision, IAS 1, paragraph 25 is not explicit in what should be disclosed regarding the uncertainties around going concern. However, the New Zealand Accounting Standards Board (NZASB) has recently issued an amendment to FRS-44 Going Concern Disclosures (Amendments to FRS-44) and an equivalent amending standard for Public Benefit Entities - Going Concern Disclosures (Amendments to PBE IPSAS 1) to provide additional guidance to preparers of what disclosures would be considered appropriate if there are uncertainties related to going concern.
The amending standards are effective for annual periods ending on or after 30 September 2020, with early adoption permitted. It is highly recommended that preparers take note of the disclosure requirements contained therein and incorporate these into financial statement disclosures around going concern.
In summary, the amendments require disclosures of the following items, when a material uncertainty around going concern exists:
- that there are one or more material uncertainties related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern;
- information about the principal events or conditions giving rise to those material uncertainties;
- information about management’s plans to mitigate the effect of those events or conditions; and
- that, as a result of those material uncertainties, it may be unable to realise its assets and discharge its liabilities in the normal course of business.
In addition, any significant judgements and assumptions made as part of the assessment of whether the going concern assumption is appropriate or not must be disclosed.
Where an entity has considered events or conditions that may cast significant doubt upon its ability to continue as a going concern, but having considered all relevant information, concluded that there are no material uncertainties that require disclosure, i.e. a ‘close call’, the IFRS Interpretation Committee in July 2014 noted that in reaching the conclusion that there was no material uncertainty involved judgement by the entity, and therefore the disclosures around significant judgments is required under IAS 1, paragraph 122.
No uncertainties – Best practice
Some business may have been positively affected by COVID-19, and there are no indicators that cast doubt on their ability to continue as a going concern. Nevertheless, as best practice, and in order to achieve fair presentation, we consider that entities should provide details of how it has been impacted by COVID-19 (refer IAS 1, paragraph 17(c)).
Classification of assets and liabilities (IAS 1 Presentation of Financial statements)
COVID-19 may result in certain assets no longer being consumed in an entity’s ‘normal operating cycle’. As classification of assets is based on ‘expectation’, these may need to be reclassified as non-current assets.
On the other hand, classification of liabilities depends on rights and not expectation. Liabilities may therefore need to be reclassified as current liabilities if they become due on demand due to breaches of contractual terms and covenants.
|Classification of assets (IAS 1, paragraph 66)
||Classification of liabilities (IAS 1, paragraph 69)
An entity shall classify an asset as current when:
- it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
- it holds the asset primarily for the purpose of trading;
- it expects to realise the asset within twelve months after the reporting period; or
- the asset is cash or a cash equivalent (as defined in IAS 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.
An entity shall classify all other assets as non-current.
An entity shall classify a liability as current when:
- it expects to settle the liability in its normal operating cycle;
- it holds the liability primarily for the purpose of trading;
- the liability is due to be settled within twelve months after the reporting period; or
- it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period (see paragraph 73). Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification.
An entity shall classify all other liabilities as non-current.
Non-current assets held for sale (IFRS 5 Non-current Assets Held for Sale and Discontinued Operations)
During this COVID-19 pandemic period, entities should determine whether certain non-current assets or disposal groups should (should not) be classified as ‘held for sale’ under IFRS 5, and also whether there are any discontinued operations whose results should be disclosed separately.
Things to consider include:
- Non-current assets and disposal groups previously classified as ‘held for sale’ may no longer meet the ‘highly probable’ criteria for a sale because of a disappearance of buyers.
- COVID-19 may result in more non-current assets being classified as ‘held for sale’ under IFRS 5 if the effects require entities to liquidate certain assets.
- Certain business units disposed of may meet the criteria for discontinued operations and require separate disclosure of results and additional disclosures.
- Non-current assets that are to be abandoned (i.e. not sold) cannot be classified as ‘held for sale’ under IFRS 5.
Financial instruments (IFRS 7 Financial Instruments: Disclosures)
COVID-19 impacts may require focussed and expanded disclosures about risks arising from financial instruments under IFRS 7 including:
- Disclosure of credit risk arising from financial assets (e.g. loans receivable, trade receivables, etc.) due to significant judgments and estimates
- Disclosure of liquidity risk, especially in instances where a lack of liquidity may significantly impact an entity’s to continue its operations
- Disclosure of market risks when the entity’s operations are significantly affected by changes in market risks (e.g. currency, interest rate and other price risks), and
- Disclosure of defaults and breaches of loans payable require disclosure surrounding the details of the default.
- (Note, Tier 2 reporting entities have a number of disclosure exemptions available under New Zealand equivalents to International Financial Reporting Standards Reduced Disclosure Regime (NZ IFRS RDR) in this area).
IFRS 7 requires entities to disclose quantitative and qualitative information about the nature and extent of risks arising from financial instruments.
Significant increases in multiple financial risks may exist, some of which may not have been significant in past financial statements. Entities should carefully examine the nature of the risks they are exposed to and ensure their updated disclosures communicate risk exposures and their sensitivities.
Fair value (IFRS 13 Fair Value Measurement)
Reminders when measuring fair value:
- Fair value is an ‘exit price’ in an ‘orderly’ transaction. The effects of the virus may therefore make it challenging to estimate the price that would be obtained due to highly volatile markets and/or a lack of an active market existing. While current market conditions may appear to be a ‘distressed sale’, if such conditions exist broadly in the market, then those factors should be incorporated into a fair value measurement.
- It would generally be inappropriate to adjust a fair value measure for expected ‘rebounds’ in value. For financial instruments with Level 1 prices (quoted on an active market), even if there is a significant decline in activity on that market, this does not mean that the price has become unobservable.
- The level in the fair value hierarchy for inputs into fair value measurements may shift, in particular from level 2 to level 3 with associated enhanced disclosures.
If you require assistance with any COVID-19 disclosure, please contact your local BDO representative.