*Source SNG Grant Thornton
Please note that every effort has been made to ensure that the advice given in this educational material is correct. Nevertheless, that advice is given purely as guidance readers to assist them with particular problems relating to the subject matter of the educational material, and African Venture Group will have no responsibility to any person for any claim of any nature whatsoever that may arise out of, or relate to, the contents of this educational material.
Assessing the financial impact and required disclosure
Hedge effectiveness assessment is required to be performed at the inception and on an on-going basis at each reporting date or in case of a significant change in circumstances, whichever occurs first. The current volatility in markets may result in an entity requiring to either rebalance the hedge, where applicable, or discontinuing hedge accounting if an economic relationship no longer exists or the relationship is dominated by credit risk. Also, if it is no longer highly probable that a hedged forecast transaction (eg inventory purchases or sales) will occur, hedge accounting will cease prospectively.
Debt repayment and classification
Some financial institutions (and other creditors) are providing debtholders with the option to defer principal payments for a period of time. Management will need to assess whether the change in terms represent a modification or extinguishment of the debt obligation and revisit the portion of the debt that is considered current versus non-current.
As a result of the difficult economic conditions, an entity that is normally able to comply with its debt covenants may find that it is now in violation. In some instances, creditors may not be willing to waive their right to demand repayment. Unless the entity meets certain conditions, it may need to present the entire amount owing as a current liability.
Derecognition of debt or other liabilities
If a creditor forgives an amount owing by an entity, management needs to carefully consider the point in time when the liability is discharged and can be derecognised along with the appropriate accounting treatment
Financial instrument risk disclosures
Due to the rapidly changing economic environment, an entity may find that it is subject to new or increasing risk (eg credit, liquidity, or market risk) or concentrations of risk. In addition, an entity may find that its risks have changed from the prior period. Management should evaluate whether additional risk disclosures are required.
IFRS requires that an entity disclose a sensitivity analysis (including quantitative disclosures) pertaining to changes in the relevant risk variable that are “reasonably possible” at the reporting date. Management may need to perform sensitivity calculations using a larger range for the risk variables or consider a direction of change that reflects expectations resulting from the COVID-19 pandemic.
An entity that has guaranteed an amount owing by another entity/individual should consider how the other entity/individual is impacted by the current global situation. Depending on the circumstances, the entity may need recognise an additional liability related to the guarantee which would be the higher of the ECL and the amount initially recognised less amortisation.
Share-based compensation performance conditions and modifications
If an entity is negatively impacted by COVID-19, the probability that it will meet the performance vesting conditions outlined in its share-based compensation arrangements may change. Furthermore, the entity may choose to modify or cancel its share-based compensation arrangements. Management should consider whether the accounting for such plans needs to be revised based on the guidance in IFRS 2 ‘Share-based payment’.
Foreign currency translation
An entity is required to translate foreign currency transactions into the reporting/functional currency using the spot rate in effect on the date of the transaction. As a practical expedient, an entity may translate revenue earned and expenses incurred in a foreign currency using an average rate (eg a monthly or annual average). In years when exchange rates remain fairly stable, the difference between using the spot rate vs the average rate will be insignificant. However, some exchange rates are fluctuating significantly during this period of economic uncertainty. As a result, an entity may need to revisit the way it translates foreign currency transactions in its income statement and assess whether its current accounting is appropriate.
An entity that has historically not been eligible for government assistance may be entitled to receive government assistance as a result of the COVID-19 pandemic. Management may need to establish an accounting policy regarding government assistance which needs to be appropriate and in line with the requirements in IAS 20 ‘Accounting for Government Grants and Disclosure of Government Assistance’. It is essential to distinguish between government assistance and government grants and ensure that grants are recognised only when the recognition criteria in IAS 20 is met. Some of the government assistance may involve deferral of tax payments or other tax allowances. The accounting treatment of tax allowances may need to be accounted for under IAS 12 ‘Income Taxes’ rather than IAS 20.
Insurance claims for business interruption
An entity may have an insurance policy that covers losses from business interruption. If the entity is forced to temporarily cease operations as a result of COVID-19 it may be entitled to recover some or all of its losses from its insurance provider. Such claims would be contingent assets in the financial statements if the entity has a clear right to reimbursement. While contingent gains/assets are not recognised in an entity’s financial statements unless they are virtually certain, (in accordance with IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’), they would be disclosed in the notes to the financial statements when their existence is likely. They can be recognised as income in the financial statements only when virtually certain, for example on acceptance of the claim by the insurer. When considering insurance claims, the insurers ability to settle the claim on a timely basis should be assessed.
As a result of the difficult economic environment, an entity may be considering or implementing restructuring plans such as the sale or closure of part of its business or the downsizing of operations (either temporary or permanent). Management should consider whether any long-lived assets need to be classified as held for sale or if any portion of its business qualifies for presentation as a discontinued operation. Preparers of financial statements need to be mindful that IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’ has specific conditions to be held for sale.
Fair value measurement
The fair value of an item (such as certain financial instruments, investment properties, and items of property, plant and equipment) must reflect market participant views and market data at the measurement date under current market conditions. There may be an increase in the amount of subjectivity involved in fair value measurements, especially those based on unobservable inputs. In some cases greater use of unobservable inputs will be required because relevant observable inputs are no longer available.
• Determining the incremental borrowing rate (IBR) – it is often necessary for a lessee to calculate an IBR in order to account for most leases under IFRS. Due to the impact of the COVID-19 pandemic, including changes to interest rates and to the entity’s own credit risk, this rate may need to be reconsidered.
• Lease modifications – In response to operational disruptions associated with COVID-19 (such as office closures) lessors and lessees might agree to modify their lease arrangements. Both lessors and lessees must consider how to account for such modifications, including determining whether the changes result in a new lease or a modified lease. Lessees may also need to determine a new incremental borrowing rate.
Accounting for income taxes
• Deferred Tax Asset (DTA)– An entity that has historically recognised a deferred tax asset on its statement of financial position may need to revisit its assumptions about the likelihood that it will be realised in the future. Management may determine that it is no longer appropriate under IAS 12 ‘Income taxes’ for the entity to recognise the deferred on the entity’s balance sheet because it is no longer recoverable in the future.
• Deferred Tax Liability on outside basis differences (DTL) – An entity may assert that earnings in foreign jurisdictions are indefinitely reinvested and, thus, does not recognise a deferred tax liability for these accumulated earnings and other taxable outside-basis differences. Such assertions may need to be revisited to determine if they remain appropriate given the entity’s current cash flow projections.
• In some jurisdictions, companies may also be granted tax waivers or deferrals, which need careful assessment of eligibility and the consequential impact on tax provisioning.
• Any income tax reliefs provided by governments have to be assessed in light of not only IAS 12, but also IAS 20.
Entities may anticipate losses on account of reduction in demand, supply chain disruptions or losses due to an overall decline in economic output. However, future operating losses on existing contracts do not meet the definition of a liability unless they fall in the category of onerous contracts, and hence, should not be provided for in accordance with IAS 37.
An entity that is otherwise not economically dependent on another entity or individual may find that circumstances change during this period of crisis. Management should consider whether disclosure regarding economic dependence should be added to the financial statements.