How to best account for COVID-19 under IAS 10

How to best account for COVID-19 under IAS 10 Events after the reporting period? The question is whether the COVID-19 crises is an adjusting event of a non-adjusting event for the Financial Statements for the period ended 31 December 2019 that have not been authorised for final distribution to stakeholders or for filing at a chamber of commerce or similar institute.

If it is a non-adjusting event what disclosures does it still require in the financial statements or management report accompanying these financial statements?

In terms of accounting implications, the current consensus is that an entity shall not adjust the amounts recognized in its financial statements (IAS 10 10 Non-adjusting events) as at 31 December 2019 to reflect events caused by the COVID-19 outbreak that occur after the reporting period. How to best account for COVID-19 under IAS 10

That is unless such events seriously call into question the validity of the ‘going concern’ assumption (IAS 10 14-16). Consequently, the COVID-19 outbreak impact on end of 2019 financial statements is viewed as a non-adjusting event and limited to disclosures only. How to best account for COVID-19 under IAS 10

1 Credit losses, cash flow forecasts and fair value

At a more granular level, however, corporates may seek clarification relating to issues such as credit losses, cash flow forecasts and fair value. How to best account for COVID-19 under IAS 10

In terms of the impact on the provision of expected credit losses, the erosion in the credit quality of customers due to the COVID-19 outbreak is caused by events that occurred in 2020. As a consequence, the impairment of trade receivables at 31 December 2019 shall not include the effects of the outbreak. However, it seems logical to disclose that the effect of the outbreak is not taken into account.

Cash flow forecasts should also not consider the effects of the outbreak, insofar as business plans are based on the existing situation as at 31 December 2019 when there were no observable indications that asset values had declined due to COVID-19-related events.

Similarly, the fair value (level 3) of unlisted securities shall not be reassessed as any erosion of customer credit quality due to COVID-19-related events occurred in 2020. How to best account for COVID-19 under IAS 10

However, things could change if and when common opinion in the medical industry becomes that the  COVID-19-related events have their origin in 2019! So when at such a moment the Financial statements for 2019 are not final or interim financial statements are prepared update all estimates relating to credit losses, cash flow forecasts and fair values.

2 Going concern assumption

Notwithstanding these issues, it is essential that corporates can assess whether the going concern assumption is still appropriate. Factors to consider include all the existing and anticipated impacts of the outbreak on the economic conditions of the entity. How to best account for COVID-19 under IAS 10

These factors include any significant decline in revenue; significant erosion of profits due to higher costs or occurrence of unforeseen expenses; breach of debt covenants; cash flow issues; and expected impacts of announcements of government support to the economy. How to best account for COVID-19 under IAS 10

In addition, corporates should consider events both before and after the reporting date, up to the date of authorization for the issue of the financial statements. They should not consider the accounting qualification of events, i.e. irrespective of whether those events are adjusting or non-adjusting. How to best account for COVID-19 under IAS 10

So what are the accounting implications if such assessments conclude that the validity of the going concern assumption is seriously undermined? Going concern assumption

Under International Financial Reporting Standards (IFRS), an entity shall not prepare its financial statements on a going concern basis if management determines after the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so. In such a case, the financial statements at 31 December 2019 shall, therefore, be prepared from a business termination perspective based on net asset values. How to best account for COVID-19 under IAS 10

In terms of disclosures in the notes of financial statements, corporates must approach this with the key principle in mind; to ensure the adequacy and the relevance of the information disclosed in order to assess significant sources of estimation uncertainty at the end of the reporting period.

3 Focus disclosure areas

To achieve the objective of measuring the risk of material adjustment to the carrying amounts of assets and liabilities within the next financial year, items to consider include information about non-adjusting events after the reporting period (IAS 10 21) . Such items would include the nature of the event and an estimation of its financial effect or a statement that such an estimation cannot be made. How to best account for COVID-19 under IAS 10

Other important considerations in terms of disclosures would be information about the assumptions made for the future, and other major sources of uncertainty at the end of the reporting period (starting with IAS 1 125), as well as information regarding why financial statements are not prepared on a going concern basis (IAS 10 16) . Also, any material uncertainties that may cast significant doubt upon the entity’s ability to continue as a going concern, albeit without questioning the relevance of the going concern assumption.

It’s worth pointing out that European Securities and Markets Authority (ESMA) expects issuers to provide both qualitative and quantitative information on the actual and potential impacts of the outbreak. How to best account for COVID-19 under IAS 10

Finally, as the pandemic persists and the world heads into a period of economic uncertainty in 2020, and beyond, it is imperative that entities in their financial reporting need to be mindful that regulatory bodies are continually assessing the impact of COVID-19. Discussions on how to account for such events continue, and corporates need to be alert to further changes and interpretations in the coming months. How to best account for COVID-19 under IAS 10

4 Banking industry

As the industry continues to feel the effects of the global pandemic, the banking sector, like many other sectors, now faces unprecedented uncertainty. While banks are generally going into this pandemic in a stronger position than the global financial crisis of 2008, the current environment presents challenges for standard accounting procedures and processes that could impact a bank’s risk profile. How to best account for COVID-19 under IAS 10

Several risk factors need continuous and careful assessment. How to best account for COVID-19 under IAS 10 Banking industry

4.1 Credit risk reporting

Current models may be less relevant than in the past, but in practice it is impossible to update them in such a short period. Therefore, banks need to reflect this change in the economic environment by updating both the significant increase of the credit risk (SICR) and the expected credit losses (ECL) parameters. How to best account for COVID-19 under IAS 10

Those that are likely to be impacted by COVID-19 include the probability of default (PD), loss given default (LGD), staging and bucketing parameters, forbearance, non-performing loans (NPLs), as well as forward-looking information and weightings allocated to multiple scenarios approaches. ECL calculation will be a pivotal area of estimation, even more so than usual. How to best account for COVID-19 under IAS 10

The particular case of suspended payments (debt moratorium measures) is a further credit risk. It would be inappropriate to consider that the suspension of contractual payments as part of moratorium measures automatically results in all the loans concerned being in default. Equally, it would be just as inappropriate to consider that none of the companies benefiting from the moratorium measures will default in the coming months. How to best account for COVID-19 under IAS 10

Analysis, therefore, should be conducted on a case-by-case basis, taking into account several factors. These factors include the bank’s policy for granting moratorium-related measures, modalities of the moratorium implemented (e.g. does interest continue to accrue?), as well as the risk profile of the counterparty which benefits from the moratorium (e.g. pre-crisis rating, sector of activity). Such analysis may have to be performed at a portfolio level before being able to collect individual information. But it also depends on governments/central banks/supervisory bodies actions (guarantees, replace financing contracts for certain industries etcetera) and guidelines. How to best account for COVID-19 under IAS 10

4.2 Operational and liquidity risks

The operational risk should be monitored since, unlike in 2008, finance teams may be reduced in number. Besides, information systems and home office procedures may weaken the process of closing accounts and internal control environments. Careful attention to cyber risk is also advised. How to best account for COVID-19 under IAS 10

As for liquidity risk, even though the situation is different from the one the banks were facing in 2008, liquidity is once more a key element of business continuity and a capacity concern of credit institutions during this period of crisis. How to best account for COVID-19 under IAS 10

There are, of course, several other potential impacts banks need to bear in mind. These include assessment of valuation and fair value; levels in the IFRS 13 fair value hierarchy; as well as goodwill impairment tests for cash-generating units (CGUs) that were already close to reaching impairment thresholds. Also to be aware of the impacts on demand deposit withdrawal and loan early prepayment assumptions.

While it is still early days in terms of the full impact of COVID-19 on accounting procedures for banks, the continual assessment of potential risks is a top priority.

How to best account for COVID-19 under IAS 10

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