Highly experienced IFRS instructor Danny Tan recently helmed an MIA webinar on Contemporary Issues in Applying International Financial Reporting Standards. Beginning with a review of the conceptual framework and the key concepts of prudence, measurement and materiality, he then segued into the treatment of issues arising from the current COVID-19 crisis and the subsequent economic downturn, before taking several questions from webinar attendees.
The following are the key points of his webinar, which was oversubscribed.
Revision of the Conceptual Framework for Financial Reporting
The International Accounting Standards Board (IASB) has issued the Revised Conceptual Framework for Financial Reporting (Revised Framework), which became effective on 1 January 2020.
The Revised Framework introduced new concepts, elucidated several high-level concepts, and provided updated definitions for assets and liabilities, including clarifications on prudence concept (previously eliminated from the Accounting Framework), in response to global business developments.
The Revised Framework refers to prudence as ‘the inclusion of a degree of caution when exercising judgement under conditions of uncertainty’ along with its proscriptive principles on overstating assets and conversely, understating liabilities.
The Revised Framework further provides for two distinct measurement concepts. The first being the historical cost method which determines the price as at transaction date as its basis of measurement. The second, a stark contrast to the first, is the current value method which applies either the market-specific, entity-specific or equivalent cost basis of determining value as at measurement date.
Materiality, another core concept, was further enhanced through amendments to the International Accounting Standard (IAS) 1 and its alignment with accounting standards clinched. An information is deemed material if its omission, misstatement or obscurement could reasonably be expected to influence the decision of the primary users of financial statements. “The recognition of materiality also depends on the nature or the magnitude of the information in question, or sometimes both,” noted Danny. The IASB issued Practice Statement 2 on Making Materiality Judgement, a non-authoritative guidance document, to further promote a greater application of judgement to the concept of materiality.
The 2020 Coronavirus Pandemic (COVID-19)
No current webinar can omit the implications of COVID-19, with its devastating economic and social footprint. Government policies to contain COVID-19 and protect public health has had significant ramifications for most businesses and their ability to continue on a going concern basis.
What does this mean in terms of IFRS? Intelligent estimations of looming uncertainties, along with reasonable judgements in line with accounting principles, should be applied in such a way that clear and unbiased disclosures are the order of the day. Moreover, with the numerous time sensitive information affecting recognition and measurement such as impairments, obligations, fair values, expected credit losses, contingent liabilities, etc., it becomes not only vital to ensure transparency of these information as at reporting date, but to also disclose the effects of rapidly unfolding events occurring beyond the reporting date, be it adjusting or non-adjusting. Danny noted that the Malaysian Accounting Standards Board (MASB) may issue a set of Question and Answers (Q&As) to guide businesses with their reporting obligations.
Companies which publish interim financial statements are required to recognise and measure all items, events, and transactions on the presumption that the period in question were a discrete period, according to IAS 34. Therefore, it is imperative that the impact of COVID-19 be duly accounted for during interim reporting, which includes updates to the disclosures of significant estimates, the impact of COVID-19 on financial positions and performances, and the necessary action taken to maintain control over business operations during COVID-19 such as staff retention exercises and other relevant business innovations.
Furthermore, dividend distributions will only be allowed if the distributing company is solvent at the time of dividend declaration and immediately after the distribution is made. A company is regarded as solvent if it is able to pay its debts (as and when the debts become due) within 12 months from the date of dividend distribution. In this regard, although a company may have sufficient profits earned prior to and throughout the year 2019, the impact of COVID-19 may negatively affect its liquidity and consequently, negate the possibility of any dividend distribution.
All financial instruments that are subject to impairment accounting are expected to adhere to the IFRS 9’s expected loss model to estimate relevant credit losses. Estimations must be based on reasonable, supportable, and forward-looking information relating to past events, current conditions, and future economic forecasts. Given the volatility of the current economic condition, expected credit loss measurement procedures should first consider the risk of default, thereafter the exposure to default based on assessed risks, and finally the estimated amount of losses resulting from default. The Malaysian government, in its efforts to ease the cash flow of borrowers during COVID-19, introduced a 6-month loan moratorium on mortgage payments (interest compounded) and hire-purchase payments (interest not compounded). Although these relief packages may not indicate significant credit risk increase, lenders must nevertheless assess possible default exposures and probable estimated losses.
When it comes to investments in unquoted equity instruments, fair value is the mandatory measurement basis under IFRS 9. However, where there is insufficient recent market information or where there could be a wide range of possibilities to negate a proper application of fair value measurements, cost may be an appropriate estimate of fair value. Under the current volatile economic conditions caused by the COVID-19 pandemic, preparers and auditors are expected to exercise significant judgement to determine whether historical cost of the unquoted equity investment can still be an appropriate estimate of fair value at measurement date.
Hedge accounting, which represents the financial effects of an entity’s risk management activities, is an optional method. The use of hedge accounting – particularly cash flow hedge – under the current volatile business activities and with the unpredictable volume of sales or production, may cause a designated hedging instrument and a hedge item to not meet the hedge effectiveness requirements.
Lease contracts may be renegotiated by either reducing lease rentals, allowing for interest free periods, changing lease terms (lengthening or shortening the term), or even changing the purchase option. However, where there are lease concessions provided, it must be suitably determined if such concessions could be considered lease modifications with the principles of IFRS 9 accordingly applied to such modifications.
Lease modifications can be treated as a separate lease with new rights and obligations (including the new discounted rate) with the earlier lease arrangement derecognised through profit and loss account adjustments.
The IASB’s educational material released on 10 April 2020 covers the application of IFRS 16 to rent concessions granted during COVID-19. The key highlights to note are:
- Identification factors in order to determine whether identified rent concessions could be considered lease modifications.
- The applicable requirements relating to rent concessions that are not part of lease modifications.
- To consider whether any partial extinguishment of lessee’s obligation may fall within the ambit of derecognition requirements.
- To determine whether a rent concession could likely indicate that the assets in question may be impaired.
- To ensure relevant disclosure requirements are adhered to.
Danny further clarified that the IASB, duly aware of the current crisis, may allow a one-off and short-term relief exemption to lessees from having to consider whether a COVID-19-related rent concession could be a lease modification. And thereby, allowing for such rent concessions will be accounted for as if they were not lease modifications. Such an exemption would remove the monumental challenge of having to review numerous contracts simply to identify whether such rent concessions granted could fall within the ambit of lease modifications. This exemption, once granted, will also absolve the need to re-measure lease liabilities using a revised discounted rate.
Update: On 28 May 2020, the IASB issued an amendment to address the issue of COVID-19-Related Rent Concession to provide temporary relief from the burden of identifying and applying the complex requirements of lease modifications, with an effective date of 1 June 2020.
Other Assets and Liabilities
Specific forms of assistances provided by the Malaysian government during COVID-19 such as wage subsidies, although not within the ambit of government grants, should nevertheless be accorded similar treatment since it is a transfer of resources to the receiving entity. Furthermore, other general forms of assistance precluded from compliance with the above treatment should be disclosed at minimum.
Restructuring costs, bearing a direct consequence to COVID-19, should be accounted for as a provision but only to the extent that there is a present obligation and probable outflow of resources which can be reliably estimated. Additionally, future operating losses and post-COVID-19 recovery costs are specifically disallowed to be provided for in the financial report.
The effects of COVID-19 could also cause additional assessment of indications of impairment to property, plant and equipment. These assessments would require qualitative and quantitative data to assess the impact of COVID-19 on the potential of existing property, plant and equipment to generate future economic benefits. If there are indications that these property, plant and equipment are not capable of generating sufficient economic benefit over their useful life, the entity shall estimate the recoverable amount and compare this amount to the existing carrying amount to determine the amount of impairment caused by the adverse effect of COVID-19. Disclosures of such impairments along with changes to the useful life of the asset(s) concerned, its residual value and other relevant information must be duly documented in the financial report.