Latest FRC guidance on reporting considerations during COVID-19
The Financial Reporting Council (FRC) has issued further guidance for companies during COVID-19. Acknowledging that we are in a period of extraordinary uncertainty, the FRC recognises that many entities are facing challenges and disruption to their normal management and governance processes.
The FRC guidance is complemented by guidance from the Prudential Regulation Authority (PRA), on the approach to be taken by banks, building societies and PRA-designated investment firms in assessing expected loss provisions under IFRS 9.
This latest guidance attempts to highlight some of the key areas of focus for boards in order that they maintain strong governance principles during their reporting processes. The FRC has also issued separate guidance auditors during COVID-19.
In such a period of uncertainty, the FRC is aware of the increased judgement that may need to be applied to forward-looking estimates and assessments during the preparation of the financial statements and other forms of corporate reporting. Their guidance seeks to help boards to focus on the areas that are of most importance to investors and to provide greater clarity over the use of key judgements applied to forward-looking information.
Matters included in the guidance are:
- The need for narrative reporting to provide forward-looking information that is specific to the entity including the board’s assessment of business viability and the methods and assumptions underlying that assessment;
- Going concern and any associated material uncertainties, the basis of any significant judgements and the matters to consider when confirming the preparation of the financial statements on a going concern basis;
- The increased importance of providing information on significant judgements applied in the preparation of the financial statements, sources of estimation uncertainty and other assumptions made; and
- Judgement required in determining the appropriate reporting response to events after the reporting date and the extent to which qualitative or quantitative disclosures may be appropriate.
This article summarises the specific issues included in the guidance relevant to both the preparation of financial statements and corporate reporting.
Going concern and material uncertainties
IAS 1 requires financial statements to be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. FRS 102 contains a similar requirement in that an entity is a going concern unless management intend to liquidate the entity or cease trading or has no realistic alternative but to do so.
The FRC believes that is it likely that more companies will disclose “material uncertainties” related to going concern in the current circumstances.
In the current climate, these assessments will be significantly more difficult to perform due to the uncertainty around the impact of COVID-19, the extent and duration of social distancing measures, the impact on the economy and asset prices generally. Boards should also consider their access to government support measures that have been announced.
If a material uncertainty does exist, then the company should disclose it in terms that are as specific to the entity as possible.
Significant judgements and estimation uncertainty
The FRC has stressed the need to disclose the underlying assumptions applied when preparing a viability statement, and any significant judgements made when assessing whether there are material uncertainties to disclose.
Similarly, companies should disclose significant judgements made in applying accounting policies that have the greatest effect on the financial statements. In addition, at this time, the FRC encourages companies to provide as much context as possible for the assumptions and predictions underlying the amounts recognised in the financial statements.
Relevant judgements and assumptions might include:
- the availability and extent of government support measures;
- the availability, extent and timing of sources of cash, including compliance with banking covenants or reliance on those covenants being waived; and
- the duration of social distancing measures and their potential impacts.
Events after the reporting date
IAS 10 and FRC 102 both distinguish between those events occurring after the balance sheet date that provide more information about the conditions that existed on the balance sheet date (adjusting events) and those that are indicative of conditions that arose after the balance sheet date (non-adjusting events). Adjusting events require an adjustment to the amounts in the financial statements. Only disclosures are required in response to material non-adjusting events.
There is a general consensus that the outbreak of COVID-19 in 2020 would be a non-adjusting event for the vast majority of UK companies preparing financial statements for periods ended 31 December 2019.
For later reporting dates, companies will need to apply judgement to their assessment of the extent to which the impact of COVID-19 arises from non-adjusting events. This will depend on the reporting date, the specific circumstances of the company’s operations and the particular events under consideration.
If an event is considered to be non-adjusting, then the nature of the event should be disclosed. Where an estimate of the financial effect on the company can be made, then this should be disclosed. Otherwise the fact that the financial effect cannot be estimated should be disclosed. A range of estimated effects is acceptable as is a qualitative description in the absence of any quantitative information.
Solvency and cash flow
Investors have highlighted that their key information needs relate to the liquidity, viability and solvency of companies. Boards cannot predict the extent and duration of the COVID-19 pandemic nor its consequences for the global economy. It is however reasonable for investors to expect companies to be able to provide details of the possible impacts on their specific business under different scenarios.
One area of particular importance is the availability of cash within a group of companies and the ability to transfer such resources around the group to where it is needed.
Strategic Report and Viability Statement
The Strategic Report should always have a future-oriented focus, especially so during the current crisis, and be entity-specific. COVID-19 is affecting all businesses and individuals but the implications for individual companies may differ, as will their plans to mitigate some of the effects.
In setting out its principal risks and uncertainties, a company should consider the specific areas that are most under threat and the steps being taken to protect them. This will include the protection and retention of staff to enable them to rebuild when the crisis ends. All stakeholders, including investors, are concerned about companies’ workforces and are looking for some insight into how they are being retained and supported.
In the current uncertain environment, many boards may be reluctant to state in the viability statement that they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over a period of assessment.
However, the FRC emphasises that:
- boards are required to have a “reasonable expectation” of the company’s viability over the period of assessment. The current emergency, and unprecedented pace of change, means that this reasonable expectation is likely to reflect a much lower level of confidence;
- clarity over the company’s specific circumstances and the degree of uncertainty about the future is vital; and
- when presenting a company’s viability statement, its board should draw attention to any qualifications or assumptions as necessary.
If any qualifications have been applied to the viability statement, the board should describe the limitations of their predictions, the level of confidence with which they have been made and any uncertain future events that could prove critical to the company’s viability.
Similarly, the key assumptions and the future scenarios considered should be explained as well as details of the scenario and stress testing undertaken. Above all the need for greater disclosure is key.
More information on the implications of COVID-19 for business and individuals can be found on the ICAS Coronavirus Hub.