Interim Reporting - Opportunity for Stakeholder Engagement
Financial Reporting Brief: June 2021
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COVID-19 devastated the global economy in 2020, with World GDP falling by 5%. By comparison, World GDP was essentially flat in 2009, the worst year of the financial crisis.
The green shoots of recovery are beginning to show in the Western world with vaccination programmes being rolled out, giving reason to believe that the turning point in the cycle has been reached. It is of major concern that recovery is uneven throughout the world, with India, Brazil and others far from being under control. Recovery can only be sustained if the fundamental cause of the crisis, with the ensuing panic and the resultant lockdown measures, is resolved or at least durably mitigated globally. Only then will commercial and financial activity be truly on a stable, consistent path to recovery.
COVID-19 has illustrated how quickly our environment can radically change. It has re-enforced the need for resilient business models and the importance of fostering relationships with all stakeholders beyond financial returns for shareholders. A major part of such fostering is the integrity and the transparency of the reporting process.
The vast majority of entities have by now been through at least one annual reporting process since Covid-19 began. Annual reports have been delivered in the midst of a raging pandemic when the availability, efficacy and momentum of vaccination programmes were largely uncertain. Entities have had to confront the challenges and disclose information in a very uncertain environment.
As time moves on and the Covid-19 cycle evolves, many entities are rapidly approaching interim reporting season. For most of them, it will be the next stage of engagement with investors. Companies will be afforded another opportunity to review estimates and forecasts, and other such matters, with a little less uncertainty prevailing. It may be possible for companies to provide messages to stakeholders with enhanced transparency and reliability, giving them a more robust foundation for investment and commercial decision-making processes. The ability to do this will vary between industries, reflecting their position in the recovery process.
IAS 34 Interim Financial Reporting applies when an entity prepares an interim report. The mandating of when an interim report is required is by legislative and regulatory measures, primarily, but not limited to, entities listed on Stock Exchanges.
An interim report may include either a complete or a condensed set of financial statements. IAS 34 sets out the minimum content of an interim report to conform to International Financial Reporting Standards (IFRS). At a minimum, the content of an interim report must include condensed primary statements and selected explanatory notes. For those reporting under Irish GAAP, FRS 104 is the applicable standard.
In addition, the EU Transparency Regulations extend requirements for those within its scope to include an Interim Management Statement and a Responsibility Statement.
Approach to Interim Report
The relevance and transparency of messages delivered in an interim report will be greatly influenced by the approach taken in the explanatory notes to judgements and estimates, and the description of material transactions and developments.
The best disclosures are those that are specific to the company and clearly explain how Covid-19 has impacted the company’s reported financial position and performance and how it may affect future prospects. Much will depend on where a company has reached in the cycle of recovery from the worst impact of the pandemic and how long the timescale to achieve recovery is likely to be. The continuing availability of State support structures is likely to be essential to the ultimate survival of many entities.
In these challenging times, matters that may have increased potential significance include:
- Explanation of how Covid-19 has continued to impact an entity’s reported financial position and performance, and how its future prospects may be impacted by its ability and timescale for recovery – together with the impact on projected cash flows;
- Disclosure of areas subject to significant estimation uncertainty to include sensitivity analysis and details where appropriate of a range of possible outcomes;
- Going concern disclosures should clearly explain the key assumptions and judgements taken in determining whether a company is able to continue to operate as a going concern;
- Explanation of any significant judgements taken in determining whether or not there is a material uncertainty in respect of going concern, including the compatibility of assumptions with those used in other areas of the financial statements;
- The use of consistent accounting policies in all material respects throughout a single financial year. Appropriate details of any changes in accounting policies and the reasons for making them should be provided.
There may be individually material items arising as a direct result of COVID-19 and the disclosure of these in the Income Statement should be considered in line with the entity’s existing accounting policies. The materiality of 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. It may be helpful to disclose them all in a single note or link them with cross references. Companies will in many cases be dealing with their second interim report and need to refresh their evaluation of these and other items in the context of where they are on the road to recovery.
The impact of COVID-19 on the Statement of Principal Risks and Uncertainties included in the Interim Management Statement needs to be considered. Matters identified in the annual report may have evolved during the interim period, and in challenging circumstances are likely to need more elaboration than in otherwise normal times. A description is also needed of specific actions taken by management to mitigate the impacts of risks identified.
Since the Pandemic began, there have been many publications from authoritative bodies providing guidance to those involved in the interim reporting process. The most recent publication is by the UK Financial Reporting Council - Thematic Review: Interim Reporting - which offers insights into best practice based on its thematic review of a wide range of interim reports. The FRC is also holding a webcast on the thematic review on 16th June.
Disclosure - Explanatory Notes
The explanatory notes are designed to provide an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of the entity since the last annual reporting date.
Some examples of areas in which explanatory notes may take on increased relevance in these challenging times are:
- Asset Impairment: The update of disclosures relating to the significant judgements and assumptions underlying impairment assessments and sensitivity analyses. The pervasive, primarily negative, effects of COVID-19 mean that indicators of impairment will be more common and, therefore, for many companies a more comprehensive impairment assessment will be required than would normally be the case for half-yearly financial reporting purposes. For assets in the scope of IAS 36, forecast cash flows previously used in value-in-use or fair value less costs of disposal calculations may no longer reflect conditions at the reporting date.
- Seasonality and Cyclicality: In businesses where this is a significant factor, explanatory disclosures are required. Given the volatility arising from COVID-19, it may be necessary to consider whether these disclosures need to be reconsidered or additional disclosures provided.
- Classification of Liabilities: If a company no longer has the unconditional right to defer payment for at least 12 months from the reporting date (for example, because a covenant breach has occurred), reclassification of a liability from non-current to current in the statement of financial position will be required. There is a specific requirement to disclose any loan default or breach of a loan agreement that has not been remedied on or before the end of the reporting period.
- Taxation: How discrete events such as one-off non-taxable events, a previously recognised deferred tax asset being deemed irrecoverable or substantive enactment of a change in tax rate or law are reflected in the interim effective tax rate. As such, an accounting policy choice should exist and be applied consistently to either (a) recognise the effect of the transaction on the effective tax rate in the period of the event; or (b) apply a constant tax rate throughout the year so that it is recognised evenly over the annual period.
Companies may face difficulties in performing interim tax calculations for each tax jurisdiction and each category of taxable income. If this is the case, companies are permitted to use a weighted average of rates across jurisdictions or across categories of income, if it is a reasonable approximation of the effect of using more specific rates.
- Defined Benefit Pension Schemes: Significant falls in asset prices observed during COVID-19 are likely to constitute a ‘significant market fluctuation’ for most defined benefit schemes, resulting in the recognition of a remeasurement loss in other comprehensive income. Other significant market fluctuations could arise, for example, a change in the discount rate applied to the defined benefit obligation.
- Leases: Consideration of the recent amendment to IFRS 16 which permits COVID-19-related rent concessions that result in a reduction in lease payments due on or before 30 June 2022 (provided they meet certain criteria) to be treated as variable lease payments by lessees, avoiding the need for difficult judgement in determining whether such change is a lease modification and, if so, having to apply the resultant accounting in IFRS 16.
- Government Support: Disclosure should be provided of government support (whether by means of a grant or otherwise) that is relevant to an understanding of the significant changes in financial position and performance of the company since the end of the last annual reporting period.
IAS 34 acknowledges that, whilst reasonable estimates are often used for both annual and interim reports, interim reports will generally require a greater use of estimation methods than annual financial reports. The specific requirements of IAS 1 on key judgements and sources of estimation uncertainty do not apply to condensed interim financial statements, but the uncertainties arising from COVID-19 may have increased the risk of a material adjustment to the carrying amounts of assets and liabilities. Disclosures may need to extend beyond the minimum requirements of IAS 34 if considered necessary to enable a user to understand the consequences arising from COVID-19. For some, this may therefore result in the inclusion of certain disclosures usually only provided in annual financial statements. Consideration may need to be given to whether additional disclosure is required in some instances, over and above the level required in annual reports in normal circumstances.
If an estimate of an amount reported in an interim period is changed significantly during the final interim period, but a separate financial report is not published for that period, the nature and amount of that change must be disclosed in the notes to the annual financial statements.
In fostering relations with their investor and stakeholder base, it is important that entities seize the opportunity an interim report presents to provide clear messages on financial position, performance and future prospects.
While some may not be so fortunate, many entities will be beginning to see and experience the benefits of the road to recovery from the pandemic. While the environment continues to be uncertain in many ways, it should one hopes be more feasible to report key messages with greater clarity and reliability.
Investors and stakeholders will appreciate entities ‘going the extra yard’ beyond a ‘checklist’ approach to provide more meaningful disclosure.
Deloitte publications that provide more insight and guidance include:
Need to know — Accounting considerations related to the coronavirus 2019 disease – in particular, the editions dated 5th May 2020 and 11th November 2020.
Monthly Reporting Pack - May 2021
Irish/UK GAAP & Related Developments
IFRS & Related Developments
Legal and Regulatory Developments