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 affect fair value measurements, expected future cash flow 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 fixed rate investment securities or 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 on 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 therefore 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.
Spotlight on financial instruments
In light of continued uncertainty about the impact of rising interest rates and recent market volatility, extra attention should be given to:
  • the fair value measurements under IFRS 13,’Fair value measurement’
  • the measurement of expected credit losses applying IFRS 9 ‘Financial instruments’; and
  • all disclosures required for financial instruments applying IFRS 7, in particular those relating to liquidity risk, sensitivity to market risks such as interest rate risk as well as concentration risk.
For further details see UK In depth INT2022-12.

Climate change

The impact of climate change is a high-profile issue that investors and regulators are focusing on. See also the section below Reminders on climate change reporting requirements.
The climate change section of Viewpoint highlights key guidance on accounting, reporting and audit aspects of climate change. This section includes key useful documents on the impact of climate change risk to accounting and the financial statements, including:
UK In brief 2022-48 highlights the impact of climate risk on financial statements including areas expected to be impacted and what entities should consider with regards to this topic for disclosures within the financial statements.
UK In depth INT2021-11 considers the impact of the environmental, social and governance (ESG) matters, specifically focused on the effect of climate change, both from a qualitative and quantitative perspective, on the IFRS financial statements including:
  • Paris aligned financial statements.
  • Financial instruments: Accounting for green loans.
  • Financial instruments: Expected credit losses.
  • Financial instruments: Disclosures.
  • Fair value measurements.
  • Insurance contracts: measurement assumptions.
  • Property, plant and equipment and intangibles: Impairment considerations.
  • Property, plant and equipment and intangibles: Useful life and residual value.
  • Other non-financial assets: considerations related to recoverability.
  • Provisions and contingent liabilities.
  • Emissions trading schemes.
  • Disclosures about judgments and assumptions; going concern assumptions.
The FRC and the FCA, each issued a report regarding TCFD disclosures and climate in the financial statements see section below on  Additional topical issues for listed and / or large companies.

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 31 March 2023 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.
  • Change in settlement method of share-based payment award.
ESMA have issued a report on the Implications of Russia’s invasion of Ukraine on half-yearly financial reports.
For further guidance see In depth INT2022-05.

Budget updates and implications on tax accounting

In the November 2022 Autumn statement, the government confirmed that the increase in corporation tax rate to 25% from April 2023 will go ahead (this new law was substantially enacted on 24 May 2021).
The November 2022 Autumn statement will increase the Energy Profits Levy by 10 percentage points to 35% with an extension to the end of March 2028. Further, a new temporary 45% Electricity Generator Levy will be applied on the extraordinary returns being made by electricity generators. These changes were further confirmed in the March 2023 budget.
For the accounting implications of these changes refer to UK In brief 2022-67.
There is also a new requirement for large businesses to notify HMRC when they take a tax position in their returns for VAT, corporation tax, or income tax (including PAYE) that is uncertain. The new requirements apply to businesses for tax returns due to be filed on or after 1 April 2022. For the auditing and accounting implications refer to UK In brief 2022-64.

Cash flow statements

The cash flow statement is a primary financial statement and provides extremely valuable information to users, particularly in respect of an entity’s liquidity and going concern. However, cash flow statements continue to be an area of focus for regulators in the UK. In the 2021/22 FRC Annual Review of Corporate reporting, the FRC continues to raise  considerable concerns about the number of queries raised in relation to compliance with the requirements of IAS 7 ‘Statement of Cash Flows’. Errors relating to cash flow statements remain the most common reason for required references. Careful attention should be paid to cash flow statements, especially around the cash flow classification and the consistency between items in the cash flow statement and the notes. See also UK In brief 2022-66 for further guidance on cash flow classification.

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 where 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 / extinguishment 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.
  • If an exchange of debt instruments or modification of terms is accounted for as an extinguishment, any costs or fees incurred are recognised as part of the gain or loss on the extinguishment. If the exchange or modification is not accounted for as an extinguishment, any costs or fees incurred adjust the liability’s carrying amount and are amortised over the modified liability’s remaining term.

FRC thematic reviews

FRC thematic review on business combinations
In September 2022, the FRC published its thematic review of the accounting and reporting of business combinations. This thematic review draws out the features of better reporting and disclosures, highlights common pitfalls and addresses areas for improvement with regards to the IFRS 3, ‘Business Combinations’ requirements, but also the disclosure requirements in the Companies Act 2006 (the ‘Act’) and the Disclosure Guidance and Transparency Rules (‘DTR’) that could apply.
See UK In brief 2022-55 for a summary of the business combinations thematic review.
FRC thematic review on deferred tax assets
In September 2022, the FRC published its thematic review on deferred tax assets. The review sets out findings as well as the FRC’s expectations when companies are accounting for and disclosing deferred tax assets. FRC’s key expectations are:
  • Disclose company-specific information about the nature of convincing evidence supporting the recognition of deferred tax assets when there is a recent history of losses.
  • Base forecasts of future taxable profit on assumptions that are consistent with other forecasts used in the preparation of the annual report and accounts (subject to some specific differences).
  • Reassess the level of recognition of deferred tax assets when there are material changes to the deferred tax liabilities in the same taxable entity and tax jurisdiction.
  • Disclose company-specific information about deferred tax judgements and estimates, including relevant sensitivities and/or the range of possible outcomes in the next 12 months.
  • Explain the extent to which climate change risks have been reflected in deferred tax judgements and estimates, consistent with the degree of emphasis placed on those risks in the narrative reporting.
  • Provide disaggregated information about material components of the tax expense and deferred tax balances.
  • Provide transparent and informative tax disclosures that are consistent across the annual report and accounts.
See UK In brief 2022-51 for a summary of the deferred tax assets thematic review.
FRC thematic review on judgements and estimates
In July 2022, the FRC issued its thematic review on judgements and estimates as a follow-up to their 2017 report, due to the frequency with which issues on this topic have continued to be identified. This thematic review focussed on three relevant topics:
  • The use of sensitivity and range-of-outcome disclosures.
  • Mineral reserve estimates.
  • Judgements and estimates relating to climate change.
For the purpose of this thematic, the FRC also identified four areas where there is room for further improvement:
  • Companies should explicitly state whether estimates have a significant risk of a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
  • Sensitivity disclosures should be provided more frequently and in the way that is most meaningful to readers.
  • Companies should assess whether disclosure of climate-related significant judgements or assumptions and sources of estimation uncertainty are required by paragraphs 122 or 125 of IAS 1 and consider whether information about assumptions with a longer-term effect is required.
  • Where additional estimate disclosures are provided, such as those carrying lower risk, having smaller impact or crystallising over a longer timeframe, they should be clearly distinguished from those with a short-term effect.
For more PwC guidance on this thematic review see UK In brief 2022-42.
FRC thematic review on discount rates
In May 2022, the FRC issued a thematic review on discount rates with key observations as follows:
  • The use of sensitivity and range-of-outcome disclosures.
  • The assumptions used for discount rates and cash flows should be internally consistent.
  • An encouragement for companies to consider whether specialist third party advice may be required (in respect of material items where there is no internal expertise).
  • Stressing the importance of high-quality disclosures.
For more PwC guidance on this thematic review see UK In brief 2022-24.

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 climate change, rising of inflation or the current economic impact of the Russian invasion of Ukraine, are at greater risk of a regulatory challenge to their impairment assessments and in particular the related disclosures. See UK In brief 2023-02 for common mistakes on impairment of non-financial assets.
There is a growing demand from the users of the financial statements for clear disclosures on how climate related risks are being incorporated into the impairment models. For the impact of climate change on the cash flow projections and IFRS impairment disclosures see UK In brief 2021-56. For the impacts of Russia's invasion of Ukraine, see In depth INT2022-05 for further guidance. For the considerations relating to rising inflation, see In depth INT2022-12.
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 leased assets on expiry of the leases into the impairment models, for further guidance in this area 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.
  • 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 as the effect of general inflation either by:
    • 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
    • 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.
  • 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 as well as the specific changes in assumptions that would erode headroom to nil (for example + / – 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 that any such adjustment is reasonably possible.
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, where an impairment arises, 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 previous impairments should 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 decrease in 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.

Tax legislation

On 20 December 2021, the OECD published a draft legislative framework that sets out a two-pillar solution to address the tax challenges arising from the digitalisation of the economy. The rules define the scope and set out the mechanism for the so-called Global Anti-Base Erosion (GloBE) rules under Pillar Two, which introduces a global minimum corporate tax rate set at 15%. The minimum tax will apply to MNEs with revenue above EUR 750 million and is estimated to generate around USD 150 billion in additional global tax revenues annually. On 8 October 2021, expected changes to tax legislation agreement was reached between 137 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.
On 20 July 2022, HM Treasury released draft legislation to implement the 'Pillar Two' rules with effect for years beginning on or after 31 December 2023. Hence, the publication of the draft UK legislation with regard to the implementation of Pillar Two in the UK is an announcement of changes in tax laws for UK purposes. If the rules are announced or enacted before the financial statements are issued, entities will be required to disclose the significant effect of the change on current and deferred tax assets and liabilities. For further details on the UK draft legislation see UK In brief 2022-32.
At its meeting in November 2022, the IASB decided on standard-setting in response to the imminent implementation of the Pillar Two model rules.  In January 2023, the IASB issued the exposure draft proposing amendments to IAS 12, 'Income taxes'. The amendments aim to provide temporary relief from accounting for deferred taxes arising from the implementation of the Pillar Two model rules. Provided that IAS 12 will be amended in the manner proposed in the exposure draft, reporting entities will be exempt from recognising and disclosing information about deferred tax assets and liabilities related to Pillar Two income taxes.  It is likely that IAS 12, ‘Income taxes’, will be amended in 2023 to introduce a temporary exception from accounting for deferred taxes arising from application of the OECD’s Pillar Two model rules. For further details refer to In brief INT2023-01.
At the March 2023 reporting period, there would be no expected significant impact on current or deferred taxes if the Pillar 2 requirements have not been substantively enacted in any of the territories in which a group operates. This is the expected outcome for most groups. If the Pillar 2 requirements have not been substantively enacted in any of the territories in which a group operates, 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 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.

Hyperinflationary economies

Based on the current global economic environment and following the deteriorating economic condition and currency controls, Haiti, Turkey and Ethiopia are now considered to be hyper-inflationary for the purpose of IAS 29 for reporting periods ending on or after 31 March 2023. Haiti was considered to be a hyper-inflationary economy from 31 March 2023, Turkey from 30 June 2022 and Ethiopia from 31 December 2022.
IAS 29 requires financial statements of an entity whose functional currency is the currency of a hyper-inflationary country to be restated into the measuring unit at the end of the reporting period.
Therefore, transactions in the reporting period 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 Haiti, Turkey and Ethiopia 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 Haitian Gourde, Turkish Lira and Ethiopian Birr 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 see UK In brief 2022-29.
There have been no other changes in hyper-inflationary economies for the period 1 April 2022 to 31 March 2023. Refer to In brief INT2022-19.

Implementation of IFRS 17 Insurance contracts

Disclosures prior to application
IAS 8, ‘Accounting policies, changes in accounting estimates and errors’, requires entities to provide disclosures about the expected impact of new accounting standards which have not yet been applied. In particular, IAS 8 requires an entity to disclose known or reasonably estimable information relevant to assessing the possible impact that application of IFRS 17 will have on an entity’s financial statements in the period of initial application.
As IFRS 17 implementation continues to progress, information about its impact will become more reasonably estimable or known and therefore it is expected that entities will generally be able to provide progressively more entity-specific qualitative and quantitative information about the impact of IFRS 17. With reference to the requirements of IAS 8, we set out below our considerations with respect to matters that entities should consider when disclosing the expected impact of IFRS 17 in the March 2023 financial statements:
  • the date the entity will first apply IFRS 17.
  • the structure and status of the entity’s implementation project.
  • changes in accounting policy that will take effect, including the accounting policy choices that will be taken and any exemptions that will be applied.
  • the transition approaches that the entity will use under IFRS 17 and for the modified retrospective approach, a description of the modifications the entity will use.
  • the transition approach for IFRS 9 if applicable.
  • the key judgements and estimates the entity has made or will need to make.
  • the expected quantitative impacts of initial application (for example, quantitative impact at the transition date (e.g, January 1, 2022), income statement and balance sheet changes from the transition date through to the date of initial application (e.g. 1 January, 2023) and an explanation of how quantitative impacts have been determined or, if applicable, why particular quantitative impacts are not yet reasonably estimable).
  • if IFRS 17 is expected to have a significant effect on any alternative performance measures used by investors (such as ‘adjusted earnings’), the estimated quantum (or qualitative explanation) of that effect.
In May 2022, the European regulator (ESMA) issued a public statement setting out guidance on disclosures pre-application of IFRS 17. ESMA expects that the 2022 annual financial statements will 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 UK INT2022-03.
Not just for insurance companies
The existing requirements for insurance contracts (IFRS 4) allow flexibility to follow the measurement principles of other standards. IFRS 17 is more prescriptive. This means it is critical to identify insurance contracts, to determine whether they are within the scope of IFRS 17 and, if so, to determine the accounting implications.
For further information see In depth INT2022-14, which provides guidance to help non-insurance companies identify whether they have any contracts in the scope of IFRS 17.
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