Covid-19 pandemic has terribly affected life around the world, but business goes on in the midst of many disruptive trends. This includes, but is not limited to, financial market volatility, erosion of values, deteriorating credit, liquidity crunches, reduced production levels due to decreased demand, layoffs and furloughs.
In this scenario, companies will have to report on their operations, financial condition, and cashflows; and those reports will have to be audited.
This has exerted enormous pressure on the business world and forced a host of challenges to financial reporting.
Some significant challenges are discussed here.
Impairments and Sensitivity
A global economic downturn for many industries is a triggering event which requires impairment testing for almost all assets. One of the biggest challenges in this regard is the high level of uncertainties and the impact of the determination of the value-in-use. Particularly, projecting future cash flows is a huge challenge in times of increasing uncertainty.
Based on the significant amount of judgement required in conducting an impairment test with a high degree of uncertainty, it is imperative to go beyond the required disclosures to give financial statements users more insights and enable them to make their own assessments about future projections.
In this regard, Sensitivity Information is very useful. IFRS (International Financial Reporting Standards) only requires to disclose Sensitivity Information when reasonable possible changes in input parameters would lead to an impairment. But in times of high degree of uncertainties, disclosing “break even” can be very useful in assessing future projections.
Material judgments and Estimates
Accounting estimates rely on an entity’s judgmental assumptions, which must be based on a reasonable interpretation of conditions or events that are either known or knowable as of the measurement date. In other words, the assumptions used by an entity in its estimates must be both reasonable and supportable.
Determining what constitutes a reasonable and supportable assumption during times of economic uncertainty requires an entity to exercise professional judgment grounded in a well-controlled and supported estimation process.
A number of assumptions or estimates may be required for more than one purpose, like forecasting revenues may be relevant to impairment testing and fair value measurement.
Consistent assumptions should be used for all relevant assessments. When reporting in uncertain times, it is particularly important to provide users of financial statements with appropriate insight into the entity’s resilience.
Changes in economic activity caused by the pandemic will cause many entities to renegotiate the terms of existing contracts and arrangements.
Examples include contracts with customers, compensation arrangements with employees, lease agreements, bank facilities and the terms of many financial assets and liabilities.
Entities shall need to ensure that the relevant requirements of IFRS are complied with and duly applied.
As a result of Covid-19 and its associated effects, entities need to consider whether, in their specific circumstances, they have the ability to continue as a going concern for at least, but not limited to, 12 months from the reporting date. Management’s assessment of the entity’s ability to continue as a going concern involves making a judgment, at the year end, about inherently uncertain future outcomes, events or conditions.
This will require consideration of the extent of operational disruption; potential diminished demand for products and services; contractual obligations due or anticipated within one year; potential working capital shortfalls; and access to existing sources of capital, etc.
Entities must carefully consider their unique circumstances and risk exposure when analysing how recent events may affect their financial statements, specifically disclosures that need to convey material effects of the pandemic.
The unprecedented nature of the events during the past two years with unpredictable developments results in significant uncertainties which provides a substantial challenge to financial reporting. In addition to the impact on the past results, it might even lead to reconsideration of the strategic position of many businesses and their business models, resulting in increased requirements for portfolio adjustments.
Securing access to sufficient capital, equity and debt, is crucial to maintain and strengthen the market position in this environment. Against this background, it is in the interest of business entities to provide sufficient and relevant information to their shareholders and other users of financial information.
Clear and transparent information on the pervasive effects, how management is responding to this major challenge and its consideration and assumptions regarding the uncertainties will enhance the confidence of the investors, lenders and other stakeholders.