Financial Reporting 2020 – An ‘Exceptional’ Year
Financial Reporting Brief: November 2020
A challenge unprecedented in modern times!
With the second wave of the pandemic upon us and the Global and Irish economies firmly in recession, we are in a time of great uncertainty as to scale and duration. The challenges are added to by Brexit and the uncertainties that will potentially bring.
The recent Budget 2021 is the largest in the history of the State, reflecting the funding, protection and investment priorities required for the year ahead. It reflects the overarching priority to protect lives and livelihoods. Since then, Ireland has moved to Level 5 with even more public funding required to support our economy.
The financial reporting community – preparers, those in charge of governance, auditors, regulators - has a major role to play in the coming months. Ensuring that information presented to investors and other stakeholders is reliable, robust, meaningful and transparent takes on even greater importance in times of difficulty. Consistent application of the accounting standards and overall frameworks is critical to the proper functioning of capital markets – investment decisions on allocation of resources - and of importance also to relationships with financiers, suppliers, customers, employees and possibly others.
Meaningful reporting and robust governance mechanisms are key tenets of public interest and drive trust. Further Deloitte insight is here.
In these challenging times, companies should feel particularly encouraged to go beyond the constraints of the specific requirements of Financial Reporting Standards and to be guided by whether additional disclosure would assist the user of the financial statements to understand the impact of COVID-19 on performance and financial position and how it may affect future prospects.
There is a substantial wealth of guidance and useful insights available on various websites to assist in the process of maximising efforts to produce high quality annual reports. To draw attention to just a few, a good starting point would be the reports from the European Securities and Markets Authority (ESMA) and the supervisory authorities in both Ireland and the UK:
The FRC has also produced a number of other publications since the pandemic began in March offering substantial guidance, recommendations and ‘best practice’ examples. These include:
- March 2020 (updated in May): Guidance for Companies on Corporate Governance and Reporting
- June 2020: Investors Expect Timely and Clear Disclosures
- July 2020: Covid 19 – Thematic Review
- October 2020: Reporting in Times of Uncertainty – A Look Forward
Coping with uncertainty
Management and those charged with governance of entities have, in most cases, never had to approach year end reporting with so much uncertainty. The recent move to Level 5 has heightened the awareness of the difficulties being faced and the absence of any assurance in relation to scale and duration. Certain industries unfortunately suffer more than others, and some entities face enormous stress with liquidity and related issues, reliance on government and other supports, ability to negotiate arrangements with financiers, other lenders and suppliers.
Ultimately, many will be faced with the question of – can we make it through to the other side and how do we evaluate the extent to which going concern may be an issue. Considerations in that evaluation are likely to include - (1) the extent of operational disruption; (2) potential diminished demand for products or services; (3) contractual obligations due or anticipated within one year; (4) potential liquidity and working capital shortfalls; and (5) access to existing sources of capital (e.g. available lines of credit, government aid).
Entities will have to give intense consideration to how to tell their story to investors and other stakeholders. Huge importance attaches to key disclosures in the financial statements being robust and transparent, and at the ‘front end’ the description of principal risks and uncertainties and the manner in which entities are responding being equally so.
Skills, experience and controls over the financial reporting and underlying information processes take on substantially heightened importance at times of great uncertainty. Not alone must the impact on the results and financial performance for 2020 be considered, but accompanying that must be the ability to look forward and forecast future prospects. Experience of the conditions we are in, or anything similar, is scarce and there will be great pressure on the ability to exercise a balanced view in forming critical judgements and reliable estimates.
The publications referred to above provide substantial insight into key areas, including asset impairment, contract modifications, financial arrangements including covenants, going concern, and many others.
Forecasting the future
Investors expect companies to be able to articulate their expectations of the continuing and possible future impacts on their specific business in different scenarios. This makes the need for full disclosure of judgements, assumptions and estimates, including their sensitivities to different scenarios, significantly more important than in otherwise normal circumstances.
The use of forecast information is pervasive to many areas of financial reporting. There are unique complexities associated with preparing forward‑looking information as a result of the pandemic and economic downturn. There is a wide range of possible outcomes, resulting in a particularly high degree of uncertainty about the ultimate trajectory of the pandemic and the path and time needed for a return to a “steady state”. The possibility, which is becoming more likely, that we shall be in and out of Level 5 until an effective vaccine is available renders it nigh impossible to forecast the future over any extended period.
Nevertheless, entities will need to do their best to make reasonable estimates, prepare comprehensive documentation supporting the basis for such estimates and provide robust disclosure of the significant judgements exercised, the key assumptions made and their sensitivity to change.
Relevant judgements and assumptions might include those in relation to:
- the availability and extent of support through government support measures that have been announced;
- the availability, extent and timing of sources of cash, including compliance with banking covenants; and
- the duration of social distancing and other restrictive measures and their potential impacts.
Fundamental to the information provided by entities in their corporate reports is that they must be transparent as to how results are affected by ‘exceptional’ or other unusual items arising from COVID-19 and whether they should be separately identified and disclosed in accordance with the entity’s existing accounting policies.
Where material, items such as restructuring costs, impairment charges, incremental health and safety costs, and the costs of onerous contracts will need to be considered by each entity. One way of achieving ‘best practice’ is to include in a single note all ‘exceptional’ or unusual items, cross-referenced to other financial statements items as appropriate, and accompanied by explanatory narrative.
- be even-handed in identifying any gains as well as losses;
- not describe amounts as ‘non-recurring’ or ‘one-off’ if they are also expected to arise in future periods;
- provide comprehensive explanation of any costs or revenues split on an arbitrary basis;
- not disclose costs (sometimes described as ‘stranded’, ‘sunk’ or ‘excess’) as ‘exceptional’ solely because of a reduction in, or elimination of, the related revenue streams due to the Covid-19 crisis; and
- not identify incremental costs as ‘exceptional’ if they result in incremental revenue that is not also described as ‘exceptional’; for example, additional staff costs related to managing unusually high levels of sales of in-demand items.
Entities often use Alternative Performance Measures (APMs) in their Reports to supplement information provided under IFRS or FRS. These frequently include measures such as profit adjusted for exceptional or similar items. Entities are expected to provide APM disclosures that:
- have an explanation of their relevance and use;
- are reconciled to the closest IFRS measure; and
- are not given more prominence than the equivalent IFRS measures.
APMs should be presented consistently year-on-year. However, there may be circumstances where the Covid-19 crisis has, for example, resulted in an entity making changes to its operations or business model. These may result in changes to the APMs used to highlight these changed circumstances. Readers should be informed of any such changes and provided with an explanation of why they provide an enhanced level of reliable and relevant information.
Looking back to our two most recent articles, on Climate Risk and ESG Risk, entities must bear in mind that investors have a strong expectation that corporate reports will be greatly improved in these areas in the next round of reporting. The IFRS Foundation has shown intent with their recently published Consultation Paper on Sustainability Reporting with the ultimate goal of developing a comprehensive reporting structure, to include both financial and non-financial reporting.
The gauntlet has been thrown down for the financial reporting community to deliver. Investors’ patience will be severely tested if improvements to corporate reports with regard to Climate Risk and other ESG Risks are put on the long finger.
The peak of the financial reporting season is nigh. Entities that have laid their plans and considered their approach to recognition, measurement and disclosure in relation to the challenges presented by COVID-19, be they new or made more extreme than other years, should be well placed when the time comes to ‘put ink to paper’. Let us not lose sight of the other challenges such as – Brexit, climate risk and other ESG risks.
For any entities that have not yet caught up, immediate action is needed to avoid the oft-quoted maxim of ‘fail to prepare, prepare to fail’.
The market has justifiable expectations that reliable and robust corporate reports will be available.
Monthly Reporting Pack - October 2020
Irish/UK GAAP and related developments
- FRC publishes findings on the quality of corporate reporting in 2019/2020
- FRC amends FRS 100, FRS 101, FRS 102, FRS 104 and FRS 105
- FRC guidance on reporting in times of uncertainty
- FRC Lab publishes a set of tips to help companies make S172 statements more useful
- FRC Lab publishes a report on video in corporate reporting
- FRC publishes discussion paper on the future of corporate reporting
- FRC publishes review of early reporting against the new UK Stewardship Code
- Financial Reporting Lab newsletter: October 2020
- ICAEW publishes going concern considerations guide for FRS 105 reporters
IFRS and related developments
- ESMA Common Enforcement Priorities
- IFRS Foundation consults on establishing a sustainability standards board
- Short video on the Trustee's sustainability reporting consultation
- IOSCO stands ready to support global sustainability reporting standards
- IFRS Foundation publishes third compilation of IFRS Interpretations Committee agenda decisions
- Recent sustainability reporting developments
- Survey of accounting for intangibles by SMEs
- EFRAG early-stage analysis of rate regulation proposals
- EFRAG publishes September 2020 issue of 'EFRAG Update'
- New TCFD status report, additional guidance, public consultation
Legal and regulatory developments
- IESBA - Using Specialists in the COVID-19 Environment
- FRC publishes a review into AGMs held during the first half of 2020
- FRC publishes 'Key Facts and Trends in the Accountancy Profession'
- IFRS model financial statements 2020
- Need to know — accounting considerations related to the coronavirus 2019 disease for FRS 102 reporters
- IFRS in Focus — Ground-breaking proposal from IFRS Foundation points to global standards for sustainability reporting
- IFRS on Point
- IBOR reform - A new era of benchmark rates
- OneView - Operational Resilience
- Corporate Reporting and Audit—a Collective Responsibility