Financial Reporting Brief
Our featured article for August is 'Uncertainty – The Accounting and Reporting Challenge' with Brendan Sheridan commenting on the challenges of clear, entity-specific reporting during periods of uncertainty, with Brexit presenting such challenges.
Uncertainty – The Accounting and Reporting Challenge
Financial statements provide investors and analysts with information about a company’s ability to manage its financial transactions and build value in the organisation. The information gathered to prepare financial statements includes estimates which require the entity to determine what financial value to record when the actual amount is unknown.
Accounting estimates take on additional complexity where there is significant uncertainty. The challenge is to recognise uncertainty and apply appropriate methods to measurement and recording of uncertain amounts in the financial statements.
An entity shall disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period. Determining the carrying amounts of some assets and liabilities requires estimation of the effects of uncertain future events on those assets and liabilities at the end of the reporting period. The greater the scale of variables and assumptions, the greater the scale of uncertainty and consequently the potential for consequential material adjustments to be made in future periods.
In the following paragraphs we comment on how Brexit is giving rise to such uncertainty with it only being in the early stages of evolution as to its potential impact on the profitability, financial condition and prospects of a wide range of entities.
Not since the peak of the economic recession in the late noughties have there been circumstances that have sent shockwaves through the business community and the economy in general more than Brexit.
The challenges to the UK will include the lack of clarity over the UK’s future trading relationships in goods and services (including financial services) with Europe and the rest of the world, and the changes that may be required to UK legislation where it has followed EU laws.
Over the next couple of years how the UK deals with these challenges is likely to have a substantial impact in Ireland with room for both positives and negatives.
Stakeholders need to know the overall environment of the company with which they are engaged, either by investment or otherwise. The financial reports should provide a general understanding of a company’s business model, including a description of the main markets in which a company operates and its value chain.
Not all businesses will be affected to the same extent. Boards must determine what disclosures, if any, are required to ensure their financial statements and narrative reporting meet the needs of investors and other stakeholders.
Entities in the UK will be aware that there are many financial and regulatory reporting considerations, which may even at a secondary level have a major impact on Irish entities, with some of the main areas being:
- Risk factors – Brexit may be expected to have an affect on an entity’s risk factors, including new risks or changes to existing risks that may need to be disclosed,
- Accounting policies – in a volatile environment, disclosure of accounting policies and the methods of applying those policies may be particularly critical to an investor’s understanding of the entity’s financial statements. Disclosure requirements should be carefully considered,
- Impact of market volatility on assumptions and forecasts – entities should identify which judgements and disclosures could be affected by volatility, with a good starting point being an evaluation of the assumptions underlying the critical accounting policies,
- Impairment reviews – market reaction may have triggered a reaction to consider whether financial or non-financial assets, including goodwill and other intangible assets, are impaired,
- Financial instrument considerations – which may include such matters as hedge accounting and fair value considerations, and
- Going concern – movements in anticipated short-term cash flows in regions affected by Brexit may lead entities to consider whether they should continue to prepare their financial statements on a going concern basis.
The areas above are fundamental, they should not be considered to be exhaustive and the relative significance of the matters may vary between entities.
The most immediate challenge for listed companies, many of which have half-years ending on 30 June, will be the interim reporting to be carried out by the end of September. Some may already have filed. These interim reports will have to give due consideration and appropriate disclosure to:
- Important events during the first six months and their impact on the interim financial statements. For many, the Brexit impact will be potentially significant on their business model and disclosure should consider detail of the main markets in which the company operates.
- Risks and uncertainties for the remaining six months – which for many may have changed from those disclosed in their most recent annual reports. Currency risk and volatility in the market place, for both customers and suppliers, will most likely be matters of concern.
Disclosures should be entity specific and ‘boilerplate’ disclosures should be avoided. It is important that the information conveyed provides a clear picture of the entity’s circumstances and how they are changing.
The longer term political and economic effects of Brexit are likely to remain unclear for some time, but it has triggered a significant amount of turbulence in the marketplace in terms of declining equity values and falling currency rates. The impact of these challenges will be significant for all entities.
Clear and concise reporting attaches great importance to disclosure of risks and uncertainties, enabling the user of the information to understand how those risks and uncertainties are relevant. Explanations should be reviewed by the company directors of any steps being taken to manage or mitigate the risks.
In these changing times those entities that make the effort to keep stakeholders informed of developments and their impact have greatly improved the prospects of earning the benefits of continuing investor and stakeholder loyalty.
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Financial Reporting Brief
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- June 2016: The Challenges of a New Leasing Standard
- May 2016: Revenue Standard - Moving Towards Implementation
- April 2016: A Focus on Non-Financial Reporting
- Quarterly Financial Reporting Brief: April 2016
- March 2016: Integrated Reporting – A Way Forward for Corporate Reporting?
- February 2016: Lease Accounting: The New Standard
- January 2016: Transparency of Reporting: Importance to Financial System
- Quarterly Financial Reporting Brief: January 2016
- December 2015: Supervisors Help Response to Reporting Challenge
- November 2015: CORE & MORE
- October 2015: Corporate Reporting – Future Expectations
- Quarterly Financial Reporting Brief: October 2015
- September 2015: Conceptual Framework – A New Foundation
- August 2015: IFRS 9 - Moving forward
- Quarterly Financial Reporting Brief: July 2015
- July 2015: Quality of Reporting – Needs to Improve!