04 May 2020
The outbreak of Coronavirus could have a significant effect on the assumptions, estimates and accounting judgements entities take, which will then need to be reflected in the disclosures.
This could impact reporting dates ending before as well as after the emergence and spread of coronavirus, for example, where critical judgements have been exercised in determining whether post balance sheet events are adjusting or not, or whether accounts should be prepared on a going concern basis.
What does FRS 102 say?
Entities reporting under FRS 102 must provide disclosures in their financial statements regarding key assumptions concerning the future, and other key sources of estimation uncertainty and significant accounting judgements.
“An entity shall disclose, along with its significant accounting policies or other notes, the judgements, apart from those involving estimations, that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements.” (FRS 102.8.6)
“An entity shall disclose in the notes information about the key assumptions concerning the future, and other key sources of estimation uncertainty at the reporting date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In respect of those assets and liabilities, the notes shall include details of:
a) their nature; and
b) their carrying amount as at the end of the reporting period.” (FRS 102.8.7)
For small entities reporting under section 1A of FRS 102, these same disclosures, whilst not mandated, may still need to be given to meet the overriding requirement for financial statements to give a true and fair view as well as to ensure the accounting policies adopted are clearly disclosed. (FRS 102 1A.5-6, 1A.16-17)
“The accounting policies adopted by the small entity in determining the amounts to be included in respect of items shown in the statement of financial position and in determining the profit or loss of the small entity must be stated (including such policies with respect to the depreciation and impairment of assets). (Schedule 1, paragraph 44)” (FRS102.1AC.3)
“Paragraph 8.5 addresses similar requirements for disclosing significant accounting policies. Including information about the judgements made in applying the small entity’s accounting policies, as set out in paragraph 8.6, may be useful to users of the small entity’s financial statements.” (FRS102.1AC.3)
Practical impact and interpretation for preparers
Significant accounting judgements
Disclosure of the most important judgements helps users of financial statements to understand how accounting policies have been applied and to make comparisons between entities. Accordingly, such disclosures are most useful when they are not ‘boilerplate’ and explain clearly the most important judgements made. Examples of significant accounting judgements that might arise and require disclosure as a result of the impact of coronavirus are:
- going concern considerations, including significant judgement exercised in assessing the existence of any material uncertainties;
- judgement exercised to determine if an event in the series of coronavirus related events provides evidence of a condition existing at the reporting date for the entity’s activities, or their assets and liabilities. This could be critical, for example, when assessing if financial assets should be impaired at the reporting date as a result of a customer going into liquidation after the reporting date; and
- judgement exercised to assess whether a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events, not wholly within the control of the entity, should be disclosed as a ‘contingent asset’ or recognised as an ‘asset’. eg coronavirus related insurance claim.
Key assumptions concerning the future, and other key sources of estimation uncertainty
Determining the carrying amount of some assets and liabilities requires estimation of the effects of uncertain future events eg in the absence of recently observed market prices, future-oriented estimates are necessary to measure: the recoverable amount of classes of property, plant and equipment; the effect of technological obsolescence on stocks; provisions subject to the future outcome of litigation in progress; and defined benefit pension obligations.
These estimates involve assumptions about such items as the risk adjustment to cash flows or discount rates, future changes in salaries and future changes in prices affecting other costs.
The assumptions and other sources of estimation uncertainty to be disclosed relate to the estimates that require management’s most difficult, subjective or complex judgements. Those judgements become more subjective and complex as the number of variables and assumptions affecting the possible future resolution increases. The potential for a consequential material adjustment to the carrying amount of assets and liabilities normally increases accordingly.
Disclosure is not required for assets or liabilities that are measured at fair value based on a quoted price in an active market for an identical asset or liability (even if there is a significant risk that their carrying amounts might change materially within the next financial year) because these changes would not arise from assumptions or other sources of estimation uncertainty at the end of the reporting period.
Disclosures should be presented in a manner that helps users of the financial statements to understand the assumptions management makes about the future and about other key sources of estimation uncertainty. The nature and extent of the information to be disclosed will vary according to the nature of the assumptions and the other circumstances. Although FRS 102 does not contain an explicit list of the types of disclosures required, IAS 1, which deals with the equivalent requirements under IFRS, provides a useful benchmark. The examples in IAS 1 are:
- the nature of the assumption or other estimation uncertainty;
- the sensitivity of the carrying amounts of assets and liabilities to the methods, assumptions and estimates underlying their calculation, including the reasons for the sensitivity;
- the expected resolution of an uncertainty and the range of reasonably possible outcomes within the next financial year in respect of the carrying amounts of the assets and liabilities affected; and
- an explanation of changes made to past assumptions concerning those assets and liabilities, if the uncertainty remains unresolved.
It is not necessary to disclose budget information or forecasts in making these disclosures.
It may be impracticable to disclose the extent of the possible effects of an assumption or another key source of estimation uncertainty at the end of the reporting period. The entity should consider disclosing that it is reasonably possible that outcomes within the next financial year will be materially different from the assumptions and could require a material adjustment to the carrying amount of the affected asset or liability. In all cases, the nature and the carrying amount of the specific asset or liability (or class of assets or liabilities) should be disclosed under FRS 102.
Examples of key assumptions concerning the future, and other key sources of estimation uncertainty, that might require disclosure include:
- the measurement of value in use for the purpose of determining impairment of non-financial assets;the assessment of future profits to measure deferred tax assets recognised in financial statements;
- fair value measurement of financial assets, where fair value is not based on prices quoted on an active market for an identical asset;
- fair value measurement of investment properties or property, plant and equipment accounted for under the revaluation model;
- the assessment of selling prices for the purpose of stock impairment calculations; and
- the measurement of provisions, for example, onerous contracts or restructuring provisions.
Judgements, estimates and disclosures are going to be more complicated and take time to prepare so it is advisable to start early.
Management should set out the judgements and estimates they normally make and additionally those arising from coronavirus so that these can be incorporated into the accounts. These should be specific to the entity and not boilerplate.
There is increased risk that the carrying amounts of various assets and liabilities may require material adjustments within the next financial year. All entities should carefully consider whether additional disclosures are necessary in order to help users of financial statements understand the judgement applied in their financial statements.
For small entities reporting under FRS 102 section 1A, although there are not the same detailed disclosure requirements, there is still the requirement to show a true and fair view and an assessment should be made of whether these disclosures are required.