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Russian invasion of Ukraine and Russian sanctions

The Russian invasion of Ukraine, alongside the imposition of international sanctions continue to have a pervasive economic impact, not only on businesses within Russia and Ukraine, but also globally where businesses engage in economic activities that might be affected by the recent developments. This necessitates careful consideration of the resulting accounting implications by entities who are affected by these developments. For 30 September 2022 year ends, there is a need to consider a number of areas including (but not limited to).
  • Russia’s restricted access to foreign currency reserves and restriction of certain Russian banks’ access to SWIFT,
  • Impairment of financial assets (such as loans, receivables and Russian bonds) as well as fair value measurement and hierarchy,
  • Impairment of non-financial assets,
  • Contingencies, onerous contracts and assessment of breaches of supply contracts to determine if an obligation exists,
  • Financing arrangements, including liquidity constraints and possible breaches of covenants,
  • Classification and availability of cash and cash equivalents which may now be restricted,
  • Foreign exchange exposure and translation of foreign currency transactions,
  • Level of influence or power over existing associates and subsidiaries within Russia and Ukraine,
  • Classification of businesses/operations as non-current assets held for sale,
  • Post balance sheet event considerations regarding measurement recognition and related disclosure for non-adjusting material events,
  • Going concern presentation and disclosure of Russia/Ukraine specific impacts on the primary financial statements and notes thereof,
  • Modification or termination of a contract with a customer and
  • Change in settlement method of share-based payment award and accounting for other benefits given to employees.
The European Securities and Markets Authority (ESMA) has issued a report on the Implications of Russia’s invasion of Ukraine on half-yearly financial reports. This is particularly relevant for entities within the European Union, however, the key messages and observations might be useful to any IFRS reporter.
Please also refer to In depth INT2022-05 for further guidance.

Impacts of rising inflation and interest rates

Many entities are experiencing the effect of rising inflation and interest rates which touch all aspects of an entity’s business including increasing costs such as raw materials and wages, changes in customer behaviour and credit risk, negotiations of contract terms and investment and financing decisions. In turn, the effect on the financial statements is likely to be equally widespread, and companies need to consider the accounting implications for this year-end.
Rising inflation and interest rates will affect fair value measurements, expected future cash flows estimates, discount rates used to determine present value of cash flows, impairment indicators and impairment tests. Some of the key IFRS Accounting Standards entities might consider in this regard include:
  • IFRS 9, ‘Financial instruments’, and the impact on expected credit losses.
  • IFRS 13, ‘Fair value measurement’, and the impact on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, for example the impact on market prices for investment properties.
  • IFRS 15 ‘Revenue from contracts with customers’, and the impact on contracts that include a significant finance component at inception.
  • IAS 12 Income taxes, and the impact on forecasts of future taxable income.
  • IAS 19, ‘Employee benefits’, and in particular the impact on measuring defined benefit pension liabilities.
  • IAS 21 The effects of changes in foreign exchange rates, and the impact on volatility of exchange rates when assessing whether using an average rate is appropriate.
  • IAS 23, ‘Borrowing costs’, and the potential increase in capitalised borrowing costs.
  • IAS 36, ‘Impairment of assets’, and the impact on impairment indicators as well as cash flows and discount rates (see section ‘Non-financial asset key reminders for impairment reviews) and
  • IAS 37 Provisions, contingent liabilities and assets’, and the impact of discount rates and inflation estimates on provisions including decommissioning obligations, and the recognition and measurement of onerous contracts.
Rising inflation and interest rates may cause significant estimation uncertainty for both short and long duration assets and liabilities. Entities may also need to consider new or expanded disclosures in this area. As a reminder IAS 1 requires disclosures about sources of significant estimation certainty. This includes disclosing information about assumptions that could result in material adjustments to the carrying amount of assets and liabilities within the next financial year, and how sensitive those carrying amounts are to those assumptions. IAS 1 also requires disclosures about judgements that have a significant effect on the financial statements. Attention should also be given to all the IFRS 7 disclosures for financial instruments, in particular those relating to liquidity and sensitivity. For further details see In depth INT2022-12.

Turkey hyper-inflation

Since the beginning of 2021, inflation in Turkey has increased significantly. Based on the current global economic environment and following the deteriorating economic condition and currency controls, Turkey is now considered to be hyper-inflationary for the purpose of IAS 29 for reporting periods ending on or after 30 September 2022.
IAS 29 requires financial statements of an entity whose functional currency is the currency of ahyper-inflationary country to be restated into the measuring unit current at the end of the reporting period. Therefore, transactions in 2022 and non-monetary balances at the end of the period would be restated to reflect a price index that is current at the balance sheet date. Comparatives of entities within Turkey are typically restated to reflect a price index that is current at the balance sheet date. This is because IAS 29 is applied as if the economy had always been hyper-inflationary. Entities are not, however, required to present an additional balance sheet as at the beginning of the preceding period.
Multinational companies that have subsidiaries with the Turkish Lira as their functional currency should consider paragraph 43 of IAS 21. This requires the financial statements of a subsidiary entity that has the functional currency of a hyper-inflationary economy to be restated, in accordance with IAS 29, before being included in the consolidated financial statements. Comparative amounts of these subsidiaries that were presented previously in the parent’s stable currency are not restated.
Transparency on implementation of IFRS 17 Insurance contracts.
ESMA has issued some guidance on disclosures around IFRS 17.
In respect of 2022 interims, ESMA expects that, for most issuers, reasonably estimable information relevant to assessing the possible impact of the application of IFRS 17 will be available at the time of preparation of their 2022 half-year financial statements and with increasing level of detail as the end of the 2022 annual reporting period approaches.
In terms of 2022 annual financial statements, ESMA expects that the 2022 annual financial statements provide the quantitative impact of the application of IFRS 17 and explain the changes compared to the amounts reported under IFRS 4, disaggregated as appropriate. For further guidance on disclosures prior to the 2023 year- end financial statements refer to In depth INT2022-03.

Climate change

Climate-related risks are a topic that might have an impact on an entity's operations and financial performance. IFRS does not explicitly address climate-related risks, but the principles that underlie various judgements and estimates made in the preparation of the financial statements will often incorporate climate-related risk factors. Examples of specific areas entities should consider as climate-related issues become more significant include ‘green’ loans (i.e. bonds/loans that are issued at an interest rate that is to a certain degree dependent on KPIs that are sustainability related), exchange traded climate-related credit schemes and estimates used in provisioning and recoverable amount calculations.
It is also important to note that IAS 1 has an overarching disclosure requirement; to disclose information if that information is needed to enable investors to understand the effect of particular transactions, other events and conditions on the company's financial position and financial performance. In many cases, an entity's exposure to climate-related risks might not have changed significantly since its last annual reporting period. However, climate-related risks are becoming a more important topic for many users of financial statements. Therefore, in light of the current focus on, and impact of, climate change, entities should ensure that they have undertaken a rigorous assessment to ensure that all of the material information affecting the financial statements in this respect is provided.
The IASB issued educational material that contains a non-exhaustive list of examples regarding how climate-related risk might affect the measurement and disclosure requirements of various standards and the various paragraphs of those standards that might be referenced in determining how to incorporate such risks. For further information see In brief INT2020-14, and In depth INT2021-11. Insurers can also refer to the following publication – For Climate related risks – what do insurers need to know?
Entities should also ensure consistency between financial and non-financial reporting on key climate-related assumptions where such consistency is necessary for compliance with IFRS. For example, where entities publicly discuss a best estimate about the impact of the Paris Agreement In brief INT2021-14 on the entity in a sustainability report and an IFRS standard requires a best estimate approach to be used in measurement, the company would need to consider consistency between the estimates used for financial reporting and those disclosed in the sustainability reporting. Where there are comments in the sustainability report that haven't been reflected in financial reporting (for example, because the entity is relying on a market participant's assumptions which differ) the entity should consider the need for additional commentary on why such items have been reflected on a different basis in financial reporting.
Additionally, in March 2022, the ISSB released its first two exposure drafts for comment for details see In brief INT2022-07 and In depth INT2022-08.

Supplier finance arrangements

Supplier finance arrangements raise the question of whether the trade payables that are subject to supplier financing should be derecognised and replaced by a bank borrowing. The accounting and reporting for supplier financing arrangements has attracted significant attention from regulators, with focus, amongst other areas, on a company's source of finances. This attention includes focus on whether a company has made material use of supplier finance, if this information is transparent from the annual report, whether related balances are appropriately presented as bank debt or trade creditors and whether subsequent cash flows are appropriately presented in the statement of cash flows.
In June 2021, the IASB decided to add a narrow-scope standard-setting project to its work plan on supplier finance arrangements. An exposure draft was published in November 2021 that proposes amendments to IAS 7 and IFRS 7. The exposure draft proposes to add disclosure requirements, and 'signposts' within existing disclosure requirements, that would result in entities providing qualitative and quantitative information about supplier finance arrangements. That information should help investors determine the effects of those arrangements on an entity's liabilities and cash flows. Although the IASB document is only an exposure draft, it might be helpful to entities in determining what type of information might be useful to voluntarily provide at this stage, in addition to what is currently required by IAS 7, IFRS 7 and IAS 1.
For further details, refer to the exposure draft: Supplier finance arrangements and In depth INT2021-04 Financial reporting considerations for supplier finance arrangements.

Expected changes to tax legislation

On 8 October 2021 agreement was reached between 136 countries for a two-pillar approach to international tax reform (‘the OECD agreement’). Amongst other things, Pillar One proposes a reallocation of a proportion of tax to market jurisdictions, while Pillar Two seeks to apply a global minimum effective tax rate of 15%. The OECD Agreement is likely to see changes in corporate tax rates in a number of countries in the next few years. The impact of changes in corporate tax rates on the measurement of tax assets and liabilities depends on the nature and timing of the legislative changes in each country.
At the September 2022 reporting period, there is no expected significant impact on current or deferred taxes and IAS 12 does not require any specific disclosure in regard to the above tax issue. However, entities that might be significantly affected by the OECD agreement might consider the requirements in IAS 1, where necessary to provide additional disclosures to enable users of financial statements to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance. If an entity concludes that disclosure should be provided related to the above tax issue, we would expect that disclosure to be qualitative at this point in time.
In addition, there have been some recent US tax reforms that were enacted in August 2022 that might impact IFRS reporters with operations in the US. For further details, refer to US In-Depth 2022-04

Debt restructurings

Debt restructuring is a complex area of accounting which can require significant judgement. Relevant guidance is provided in IFRS Manual of accounting paras 44.106 – 44.119. Some of the key accounting considerations are summarised below.
  • Determining whether the new and old debt have substantially different terms – applying IFRS 9, it is necessary for an entity to assess if the terms are substantially different when a financial liability is exchanged or its terms are modified but the liability remains between the same borrower and the same lender. If the terms are substantially different, the transaction should be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.
  • Treatment of gain or loss on modification of debt – when a financial liability measured at amortised cost is modified without the modification resulting in derecognition, an entity should recognise a gain or loss immediately in profit or loss. The gain or loss is calculated as the difference between the original contractual cash flows and the modified cash flows discounted at the original effective interest rate.
  • Treatment of fees incurred as part of the renegotiation – the fees should be recognised immediately or capitalised depending on whether the exchange of debt instruments or modification of terms is accounted for as an extinguishment or not.

Non financial asset key reminders for impairment reviews

Impairment is an ongoing area of concern for many entities in the current economic environment. Regulators remain focused on this area and continue to push for increased transparency in disclosures. Groups holding significant amounts of goodwill and intangibles, or those that are affected to a greater extent by the negative impacts of Covid-19, climate change or the current economic impact of the Russian invasion, are at greater risk of a regulatory challenge to their impairment assessments and in particular the related disclosures.
For COVID-19 specific considerations on impairment refer to this In depth INT2020-02 which remains relevant for 30 September 2022 year ends. Many of these considerations might equally apply to those entities with significant exposure to climate risks or those impacted by the Russian invasion of Ukraine and Russian sanctions see In depth INT2022-05 for further guidance.
The key points in impairment testing are:
  • For the value-in-use (VIU) model key assumptions should stand up against external market data. Cash flow growth assumptions should be comparable with up-to-date economic forecasts. The fair-value-less-costs-of-disposal (FVLCD) model, which is a post-tax model, must use market participant assumptions, rather than those of management.
  • In times of greater uncertainty, it is likely to be easier to incorporate the impact of the economic environment uncertainties in impairment testing by using multiple cash-flow scenarios and applying relative probability weightings to derive a weighted average set of cash flows, rather than using a single central forecast and attempting to risk adjust the discount rate to reflect the higher degree of uncertainty in the environment.
  • Specific challenges might relate to incorporating cash outflows for replacing the leased assets on expiry of the leases into the impairment models, for further guidance see FAQ 24.84.2.
  • IAS 36 requires that the VIU model uses pre-tax cash flows discounted using a pre-tax discount rate. In practice, post-tax discount rates and cash flows are used which theoretically can give the same answer but the need to consider deferred taxes makes this complicated. For guidance on how one might deal with deferred tax in a post-tax VIU model see EX 24.87.1 The fair value less costs of disposal model, which is a post-tax model, must use market participant assumptions, rather than those of management.
  • Rising costs are becoming a noticeable issue in many countries that have not suffered significant inflation for many years so it is worth noting that a VIU calculation should incorporate specific price changes as well the effect of general inflation either by:
- (a) estimating future cash flows in real terms (i.e. excluding the effect of general inflation but including the effect of specific price changes) and discounting them at a rate that excludes the effect of general inflation or
- (b) estimating future cash flows in nominal terms (i.e. including the effect of general inflation) and discounting them at a rate that includes the effects of general inflation.
Where inflation assumptions could have a material impact on the financial statements, additional disclosures may be required to explain how inflation has been incorporated into the VIU.
  • In assessing for impairment, the carrying value should be determined on a consistent basis as the recoverable amount. For example:
- Where the recoverable amount is determined using the FVLCD model, the carrying amount tested should include current and deferred tax assets/liabilities (but exclude deferred tax assets for existing tax losses, because these are generally not part of the CGU).
- Where the VIU model (i.e. pre-tax) is applied, deferred tax assets should not be added to the carrying value and deferred tax liabilities should not be deducted (i.e. are not included in the carrying amount of the CGU). Refer to EX 24.87.1 for details on how this calculation might be performed.
  • If impairment of goodwill is identified at the group level this will most likely trigger an impairment review of the parent entity's investment in the relevant subsidiaries in the parent's separate financial statements. VIU of an investment in a subsidiary would be determined by the present value of expected dividend receipts. The present value of the estimated post tax cash flows from the subsidiary's underlying assets might be used as a proxy for this if the subsidiary has no debt. Otherwise, the present value of expected cash flows should be reduced by the fair value of outstanding debt (both external and inter-company), in order to determine the net amount available for distribution see FAQ 24.165.2.
The required disclosures in IAS 36 are extensive. IAS 36 requires disclosure of the key assumptions (those that the recoverable amount is most sensitive to) and related sensitivity analysis. Note also IAS 1 para 125 requires disclosure of critical accounting judgements and of key sources of estimation uncertainty. Where a reasonable possible change in key assumptions would reduce the headroom (excess of the recoverable amount over the carrying amount) of a CGU to nil, it is required to disclose this headroom.
Where the headroom is sensitive to changes in key assumptions, an entity would need to disclose the specific changes in assumptions that would erode headroom to nil (+/- x% in sales growth or discount rates). However, in cases where no reasonably possible change would either erode headroom for CGUs when testing goodwill or give rise to a material adjustment to any carrying value in the next year, companies should take care that additional sensitivity disclosures do not give the wrong impression or become confusing to users.
Given the increased uncertainty and volatility in many markets at present, the range of reasonably possible changes has widened which means that more extensive impairment disclosures will typically be required.
Key assumptions and wider ranging assumptions covering multiple Cash Generating Units ('CGUs') should be clearly disclosed. Where material, assumptions specific to each CGU should be identified. Changes to assumptions used, such as the discount rate, which has changed significantly from the previous year should be explained. Furthermore, in an impairment case, entities would need to clearly disclose the cause of the impairment and whether this is based on external data or changes in the company's own estimates. An entity with a material impairment loss or reversal additionally needs to disclose the recoverable amount of the asset(s) or CGU(s) affected IAS 36 para 130 [e].
Regulators have observed that, whilst the long-term growth rate used to extrapolate cash flow projections (to estimate a terminal value) and the pre-tax discount rate are important; they are not 'key assumptions' on which the cash flow projections for the period covered by the most recent budgets or forecasts are based. Therefore, attention should also be paid to the discrete growth rate assumptions applied to the cash flows projected to occur before the terminal period. Accounting policy disclosures should always be consistent with the basis used in the according impairment test. The regulators have pointed out that they will continue to challenge companies where the recoverable amount is measured using VIU, but the cash flow forecasts appear to include the benefits of developing new business or to rely on future investment capacity. An additional issue to consider is whether an impairment would need to be reversed. For all assets that have been impaired, other than goodwill, paragraph 110 of IAS 36 requires entities to assess, at the end of each reporting period, whether there is any indication that an impairment loss might no longer exist or might have decreased. Determining whether there is an identifiable impairment reversal indicator might require the use of judgement. If there is any such indication, the entity has to recalculate the recoverable amount of the asset.
Paragraph 111 of IAS 36 sets out example indicators that should be considered when assessing whether an impairment loss recognised in prior periods might no longer exist or might have decreased. The indicators are arranged, as in paragraph 12 of IAS 36, into two categories: external and internal sources of information. These indicators of a potential reversal of an impairment loss mainly mirror the indications of a potential impairment loss in paragraph 12 of IAS 36. The passage of time alone (also known as the 'unwinding' of the discount) would not be a sufficient trigger for reversal or impairment. Further details are in FAQ 24.153.2 and FAQ 24.154.2.
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