Question

COVID-19, the global health pandemic has however affected every aspect of our existence today without exception. Accounting and financial reporting and those charged with governance now have to address the mitigation of additional financial risks as they relate to the well-being of their businesses.
Discuss three (3) accounting and financial reporting risks and their implications that have been heightened by the current pandemic situation. At least 2 relevant accounting standards (IASs /IFRSs) must be incorporated in your discussion.   

Answer 1

The COVID-19 pandemic crisis and its economic effects mean that investors and other stakeholders need high-quality financial information more than ever.

To this end, accountancy firms, regulators, IFAC member organizations and others have quickly made available advice and guidance on the accounting and financial reporting requirements that will need to be considered in addressing the financial effects of COVID-19 when preparing financial statements. Many of these resources are conveniently available through IFAC’s COVID-19 resource center.

What are Other Significant Effects on Accounting and Reporting to Evaluate?

Throughout 2020, companies will need to review all areas of the accounts that are subject to judgment and estimation uncertainty. The use of forecast information is pervasive in assessing a range of effects in addition to going concern including the impairment of financial and non‑financial assets, expected credit losses, and the recoverability of deferred tax assets.

Fair value measurements (IFRS 13 Fair Value Measurement - FVM)

A change in the fair value measurement affects the disclosures required by IFRS 13, 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’s used in developing fair value conclusions.

Impairment of non-financial assets subject to the requirements of IAS 36 Impairment of Assets. In addition, other relevant standards to consider for management estimates include IAS 16, Property, Plant and Equipment, IFRS 16 Leases, and IAS 37, Provisions, Contingent Liabilities and Contingent Assets

IAS 36 ensures that a company’s assets are carried at not more than their recoverable amount (the higher of fair value less costs of disposal and value in use) and requires companies to conduct impairment tests when there is an indication of impairment of an asset at the reporting date. Indicators of impairment include significant changes with an adverse effect on the company that have taken place during the reporting period or will take place soon in the market or economic environment in which the company operates.

The scope of assets subject to the requirements in IAS 36 is broad. It includes property, plant and equipment (carried at cost or revalued amount), intangible assets (carried at cost or revalued amount), goodwill, right‑of‑use assets (if carried at cost), investment property (if carried at cost), biological assets (if carried at cost) and investments in associates and joint ventures accounted for using the equity method.

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 and create additional deductibles. 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, and inventories are measured 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.

Measuring expected credit loss assessments (ECLs) under IFRS 9 Financial Instruments

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, 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 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.

Regulators such as The European Securities and Markets Authority (ESMA) are issuing guidance to help ensure companies faithfully represent ECLs and apply IFRS 9 consistently. 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.

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.

Hedge accounting - where a company applies hedge accounting as part of its risk management strategy under IFRS 9 Financial Instruments

COVID-19 may reduce the probability of a hedged forecast transaction occurring or affects its timing. Consequently, the hedge accounting criteria in applicable financial reporting standards may no longer be met, for example if a hedged financial asset becomes credit impaired.

If a hedged forecast transaction is no longer highly probable to occur, hedge accounting is discontinued and the accumulated gains or losses on the hedging instrument need to be reclassified to profit or loss. Hedged items in a cash flow hedge that could be affected due to COVID-19 include: Sale or purchase volumes that fall below the levels originally forecasted; planned debt issuances that are delayed or cancelled such that interest payments fall below levels originally forecasted; business acquisitions or disposals that are delayed or cancelled.

Additional disclosures might also be required. For example, IFRS 7 Financial Instruments: Disclosures requires disclosure of defaults and breaches of loans payable, of gains and losses arising from derecognition or modification, and of any reclassification from the cash flow hedge reserve that results from hedged future cash flows no longer being expected to occur. Disclosures include quantitative data, for example about liquidity risk, and narrative disclosure, for example how risk is being managed.