Accounting in times of uncertainty: Financial reporting impacts – extreme weather events
Accounting in times of uncertainty: Financial reporting impacts – extreme weather events
Our hearts go out to everyone who has been affected by Cyclone Gabrielle and the recent flooding events in January and February 2023.
As with the recent COVID outbreak, these latest events have occurred in a particularly busy period of financial reporting, with 31 December 2022 annual and 30 June 2023 half-year reporting periods in the process of being finalised, and the 31 March 2023 annual and September 2023 half-year reporting periods very much upon us.
While many entities’ first priorities will be (as they should be) surveying the damage, assisting the need, and attempting to resume and restore some semblance of business-as-usual, these events will create (as they have in the past for COVID, and other natural disaster events such as the Christchurch earthquakes) specific financial reporting considerations that will need to be addressed.
Various areas that entities will need to consider for their current and/or upcoming reporting periods are set out below. We have also created an Extreme Weather Events – Financial Reporting Checklist to assist in highlighting various application areas which may require specific attention.
- Post-reporting date events
- Going concern assumption
- Asset impairment and recognition
- Provisions and liability recognition
- Other areas of impact
If you require specific assistance with navigating these consequential financial reporting areas, BDO’s IFRS Advisory service line is available to assist, including with the analysis and documentation of various application areas for your accounting records.
Post-reporting date events
For most December 2022 year ends, the extreme weather events that occurred in January and February 2023 will have transpired after reporting date, but likely prior to authorisation of the financial statements.
The impacts of the extreme weather events will need to be carefully analysed and consideration given as to whether these will be adjusting- or non-adjusting post reporting date events under NZ IAS 10 Events after the Reporting Period.
For most entities with a 31 December 2022 year end (or prior) the impacts of the extreme weather events are likely to merely result in non-adjusting events, meaning that only disclosures of the impact of these events post reporting date will be required. This is because these extreme weather events do not provide any new information about conditions that existed at reporting date.
However, in severe cases, the impacts of the 2023 extreme weather could raise questions about an entity’s ability to continue as a going concern even though at reporting date the going concern assumption had been met. In these situations, disclosure alone will not suffice, and the entity will need to go back and make recognition and measurement adjustments to its financial statements (refer below).
(For those entities with a 31 January 2023 (or beyond) reporting date the impacts of the severe weather events are not post reporting date, as they have occurred within the entity’s financial reporting period, and any impacts therefrom will directly affect financial reporting.)
Going concern assumption
If, as a result of the severe weather impacts, doubt is raised about an entity’s ability to continue as a going concern it may mean that significant adjustments will be required to be made, as the entity’s financial statements will no longer be prepared on a going concern basis.
The extent to which the extreme weather events will impact an entity’s specific assessment of their own going concern assumption will obviously differ from entity-to-entity.
For example, factors such as the industry it operates in (and how that is impacted), the specific financial health of the entity prior to the extreme events, insurance coverage, and/or how quickly rehabilitation and repair work can occur so that the business can resume operations will all need to be assessed.
This is likely to be an area of significant management judgement, assumption, and estimation.
This assessment must be made on a continuous basis, based on the most recent information available, up until the point at which the financial statements are signed.
Asset impairment and recognition
For entities with a 31 December 2022 reporting date (or prior) that have determined the recoverable amount of non-current assets and/or cash-generating-units (CGUs) by way of discounted cashflow modelling, the temptation may be to update those models to reflect the economic conditions and outlook subsequent to the extreme weather events, including (but not limited to):
- The change in timing and/or amount of cash inflows (i.e.,: revenues) and outflows (i.e.,: expenses and capital expenditure).
- Debt and equity structure.
- The discount rate to be used (i.e.,: weighted average cost of capital).
- The number and nature of different discounted cash flow model scenarios to be probability weighted.
- The probability weightings of multiple discounted cash flows model scenarios.
However, this use of hindsight is expressly prohibited (that is, the assumptions, judgements, and estimates used in an entity’s discounted cashflow model(s) can only be based on facts and information that existed at, and only at, reporting date – ie 31 December 2022 (or prior).
A similar thought process also needs to be followed for impairment testing of financial assets under NZ IFRS 9 Financial Instruments. In expected credit loss (ECL) modelling, only forward-looking economic impacts that would have been known at reporting date - ie 31 December 2022 (or prior) – would be taken into accounts in determining impairment.
Nevertheless, to the extent that the extreme weather events have brought to light that an entity’s discounted cashflow model(s) and or ECL models did not include aspects that it reasonably should have (i.e.,: a multiple scenario approach that considered the likelihood and impact of an extreme weather event) then an entity should go back and ensure that this modelling is as accurate and complete as necessary to comply with NZ IAS 36 Impairment of Assets, and or NZ IFRS 9.
For example, entities operating in parts of the country that have been experiencing an increase in the frequency and ferocity of extreme weather events in recent years, such that they would impact business continuity, should have factored the likelihood of these events occurring into discounted cashflow model(s) and or ECL models.
However, entities will need to be conscious to ensure that hindsight does not creep into any remodelling of their discounted cashflow model(s) or ECL models, such that the resulting (updated) model(s) reflect only those assumptions, judgements, and estimates that could reasonably have been able to be expected to be made based on only the information available to an entity at reporting date – i.e.,: 31 December 2022 (or prior).
For entities with a 31 January 2023 (or later) year end, the severe weather events may have had a direct impact on recoverability of assets. Flood water or land slips could have had a direct impact on the physical state of assets. In addition, the recoverable amounts of assets through use could have been adversely impacted through a number of factors, such as supply chain disruptions, customers being directly impacted, etc.
In these instances, discounted cashflow model(s) and ECL models, will need to be updated to reflect the impacts of the severe weather events on the entity at reporting date, and also up to the date of authorisation of the financial statements, if the updated information provides more information about conditions that existed at the end of the reporting period – i.e.,: 31 January 2023 (or later).
Provisions and liability recognition
The impacts of the extreme weather events may result in certain liability balances needing to be recognised.
For example, certain contracts may become onerous, and liabilities therefore may need to be raised. Financial guarantee contracts written may now be called upon and the measurement of the amounts thereof may be adversely affected.
In addition, items such as restructuring provisions and/ or employee termination liabilities may need to be recognised if certain conditions are met.
Other areas of impact
There are a number of other areas in accounting that may be impacted by the issues that may arise from the severe weather events. For example (not an exhaustive list):
- Variable consideration in revenue contracts with customers under NZ IFRS 15 Revenue from Contracts with Customers may need to be revisited, including refunds, concessions, success-based fees, bonus payments etc. This may introduce additional scenarios into an entity’s expected value measurement determinations, and/or more aggressive negative side weightings. At all times, NZ IFRS 15’s constraint conditions for recognising variable revenue must be adhered to.
- For both lessors and lessees under NZ IFRS 16 Leases, lease modifications and or cancellations may need to be accounted for.
- Vesting conditions under employee share schemes may be adversely impacted. Alternatively, vesting condition requirements may be modified in response to the recent extreme weather events, which will likely have an impact on the accounting required under NZ IFRS 2 Share-based Payments.
- Entities applying hedge accounting under NZ IFRS 9 may find an increase in hedge ineffectiveness occurring.
- Both borrowers and lenders may need to enter into renegotiated terms on borrowings, which will need to be carefully analysed in terms of NZ IFRS 9 requirements as to whether borrowings have been modified or extinguished, and new borrowings issued.
- Government support packages may be received and will need to be accounted for.
- Mergers and acquisitions are likely to eventuate as a result of entities no longer being able to re-establish operations without outside assistance.
- Presentation may be impacted with certain non-current assets or disposal groups being held for sale, or entire operations being disposed of.
- Disclosures of the impacts of the severe weather events may be required, including expanded disclosures around financial risk management, fair values, impairments, going concern and events after the reporting date.
In addition to the above areas that could have been impacted by the severe weather events there are other issues to keep in mind during the current reporting period. As mentioned in our accompanying article What’s hot in 2023 for CFOs and finance teams globally we are in a period of unprecedented uncertainty with rising interest rates, inflation and recession looming on the horizon, all of which may also be having an impact on your entity.
BDO has produced a publication - Accounting in Times of Uncertainty that discusses some of the implications and considerations for entities when preparing financial statements for the year ended 31 December 2022 and beyond. Areas covered by the publication include:
- Going concern
- Judgements, estimates and estimation uncertainties
- Impairment of non-financial assets
- Discount rates
- Events after the reporting period
- Assessment of control, joint control and significant influence
- Effects of inflation
- Financial instruments
Please read our publication for a more in-depth discussion of the above areas.
We understand that dealing with the above may seem overwhelming when trying to fight back to a “business as usual” position. Please contact our IFRS Advisory team who are available to help you in this difficult time.
For more on the above, please contact your local BDO representative.