Financial reporting developments
Companies are continuing to re-evaluate their disclosures as stakeholders seek to understand the impact of various external developments on the business. This includes the continued global economic uncertainty; climate and other environmental, social and governance (ESG) factors; and evolving geopolitical developments. We’ve highlighted some key financial reporting developments and trends to assist audit committees in overseeing audit quality and encouraging an environment and a culture that support the integrity of the financial reporting process.
IFRS Accounting considerations related to economic volatility
Climate-related matters in the financial statements
Other reminders
Inflation rates and interest rates globally remain high. With associated impacts on commodity prices, foreign exchange rates and other macroeconomic factors, entities need to carefully consider the impacts on financial reporting under IFRS.
Higher inflation has prompted central banks around the world to push up interest rates. Entities that have debt will face increased borrowing costs and, potentially, higher refinancing costs in the future. Furthermore, many IFRS standards use discounting to account for the time value of money in measuring
non-current assets and liabilities (for example, the fair value measurement of investment properties using discounted cash flows). When interest rates increase, the present value of those assets and liabilities will decrease. This may affect a number of areas of financial reporting including: impairment calculations; provisions; retirement obligations; leases; financial instruments; and revalued tangible and intangible assets.
There is now a general business risk that, with inflation at a multi-decade high in many economies, many entities may have fixed-price sales contracts which no longer cover the cost of fulfilling those sales, making their contracts onerous. Entities may also have contracts that are explicitly inflation-linked and this may mean assets and/or liabilities, for example, real estate leases, or inflation-linked bonds need to be adjusted for inflation.
There are a number of IFRS standards that specifically refer to inflation as one of the assumptions to be considered for measurement purposes. For example, inflation is particularly relevant in assessing asset impairments, which require estimates to be made about future revenue and expenditure. Inflation also affects many other areas of accounting, such as determining the residual value of property, plant and equipment and net realisable values of inventories. The measurement of provisions for obligations in the future (for example, decommissioning provisions), can also be significantly impacted by inflation.
Entities will also need to consider whether changes to disclosures are required including disclosure of additional risks, changes to significant accounting policies and changes to the disclosure of significant judgements and sources of estimation uncertainty, as required by IAS 1 Presentation of Financial Statements.
The specific financial reporting issues that entities may need to consider are:
Uncertain estimates and judgement disclosures
Asset Impairments
Financial instruments
Revenue recognition
Fair value measurement
Leases
Employee benefits
Foreign currency movements and hyperinflation
Provisions
Share-based payments
Going concern
Interim reporting considerations
The financial statement disclosure requirements will vary depending on the magnitude of the financial impact of volatile economic measures, such as inflation and interest rates. For example, there may be additional risks that the carrying amounts of assets and liabilities require material adjustments within the next financial year. Similarly, entities should carefully consider whether additional disclosures are necessary to help users of financial statements understand the judgement applied in the financial statements.
Refer to Accounting considerations related to economic volatility | EY - Global for more details regarding the above financial reporting issues.
The efforts to reduce society’s impact on climate change has never been greater. At the same time, there is unprecedented pressure from stakeholders for entities to communicate clear commitments which is set to continue for the foreseeable future.
Although there is no single explicit standard on climate-related matters under IFRS, climate risk and other climate-related matters may impact several areas of accounting. While the immediate impact on the financial statements may not necessarily be quantitatively significant, there are increasing expectations from stakeholders for entities to explain how these matters are factored into the preparation of the financial statements to the extent that they are material from a qualitative perspective. Stakeholders also expect robust disclosures on the most significant assumptions, estimates and judgements made related to climate change.
Given stakeholders' focus on climate-related matters being disclosed in the financial statements and the impact these matters may have on application of IFRS Accounting Standards, the International Accounting Standards Board (IASB) added a maintenance project on climate-related risks in the financial statements. The purpose of the IASB’s project is to explore whether and, if so, how targeted actions could improve reporting of financial information about climate-related risks in the financial statements. As part of the project, the IASB will consider the work of the International Sustainability Standards Board (ISSB) to the extent relevant to the financial statements. Together, the Boards intend their work to be complementary and facilitate connectivity in general purpose financial reports.
Entities are encouraged to consider and address climate-related risks in their financial statements. Significant judgement may be required to identify the accounting considerations that are relevant to the entity’s specific facts and circumstances. Areas to consider may include:
Disclosures of significant judgments and estimates
Asset impairment, including goodwill
Useful lives and residual values of long-lived assets
Fair value measurements
Changes in provisions
Changes in expected credit losses
Carbon credits and renewable energy certificates
Furthermore, entities should ensure consistency between the information communicated in the financial statements and the information communicated to stakeholders about climate-related risks outside the financial statements, such as in press releases, investor updates and disclosures in other parts of the annual report.
Additional support can be found in our recent publication:
Applying IFRS – Accounting for Climate Change
In December 2021, the Organisation for Economic Co-operation and Development (“OECD”) released the Model Rules on the Pillar Two Global Minimum Tax. The Pillar Two model rules apply to multinational enterprises with revenue in excess of EUR 750 million per their consolidated financial statements.
Earlier this year, the IASB issued International Tax Reform Pillar Two Model Rules – Amendments to IAS 12, in response to stakeholder concerns about the complexity of accounting for deferred income taxes arising from tax law enacted or substantively enacted to implement the Pillar Two model rules (“Pillar Two income taxes”).
The main provisions of the amendments are:
A mandatory temporary exception from accounting for deferred taxes in respect of Pillar Two income taxes;
Disclosure requirements for affected entities to help users of the financial statements better understand an entity’s exposure to Pillar Two income taxes arising from that legislation, particularly before its effective date.
As part of the disclosure requirements, the IASB introduced an overarching disclosure objective to help users understand an entity’s exposure to Pillar Two income taxes for periods in which Pillar Two legislation is enacted or substantively enacted, but not yet in effect. This objective would be satisfied by disclosing known or reasonably estimable qualitative and quantitative information about an entity’s exposure to such legislation.
To the extent that information is not known or reasonably estimable, the IASB decided that an entity should instead disclose a statement to that effect, as well as disclose progress made in assessing the entity’s exposure to Pillar Two taxes.
In periods when legislation is effective, an entity will be required to separately disclose its current tax expense (income) related to Pillar Two income taxes.
Refer to Applying IFRS – International Tax Reform - Pillar Two Disclosures | EY - Global for more details on accounting for amendments to IAS 12 International Tax Reform Pillar Two.
The final amendments to IAS 12 were published at the end of May 2023, and the exception accounting for deferred taxes is to be applied immediately, as is the requirement to disclose that an entity has applied the exception. The disclosures about an entity’s exposure would be applicable for annual periods beginning on or after January 1, 2023 and for interim periods ending after December 31, 2023.
The Canadian Department of Finance released draft legislative proposals relating to the implementation of Pillar Two income taxes in August but as of the end of December 2023, these had not yet been substantively enacted. Other countries across the world are also in various stages of progress on adopting Pillar Two model rules into legislation. Given the expectation in various jurisdictions that legislation will be substantively enacted or enacted by January 1, 2024, entities with calendar year ends should have some information about their exposure available to them by the time the annual disclosure requirements are applicable and should be prepared to disclose information to satisfy the disclosure objective. Multinational enterprises in scope of Pillar Two will need to consider what new information and processes may need to be developed, in preparation for both year-end disclosures and the first 2024 interim current tax calculations.
In October 2022, the IASB issued further amendments to IAS 1 Presentation of Financial Statements in response to the feedback received on previous amendments issued in 2020 that are not yet in effect. The main changes from current IAS 1 due to the 2020 and 2022 amendments are set out below:
Right to defer settlement. If an entity’s right to defer settlement of a liability for at least 12 months is subject to the entity complying with future covenants within that period, the entity has a right to defer settlement of the liability even if it does not comply with those covenants at the end of the reporting period.
Expected repayments. Classification of loan arrangements or other liabilities that provide financing on a long-term basis is unaffected by the likelihood that the entity will exercise its right to defer settlement, so long as it has the right to do so as at the end of the reporting period, for at least twelve months. Management’s intention to settle in the short run does not impact the classification. This applies even if the settlement has occurred by the time the financial statements are authorized for issuance.
Disclosures. Additional disclosures may be required to allow users to understand the nature and timing of future covenants and facts and circumstances, if any, that indicate the entity may have difficulty complying with the covenants.
Settlement by way of own equity instruments. Classification of liabilities as current or non-current will be affected by a holder’s right to demand settlement within 12 months by way of delivery of equity instruments, with one exception. If, and only if, the conversion option itself is classified as an equity instrument would settlement by way of own equity instruments be disregarded when determining whether the liability is current or non-current.
The amendments apply retrospectively, and are effective for annual reporting periods beginning on or after January 1, 2024. Early adoption is permitted.
The IASB expects to publish the new IFRS Accounting Standard 18 Presentation and Disclosure in Financial Statements in the first half of 2024 which will be effective for annual periods beginning on or after January 1, 2027 with early application permitted.
The new IFRS Accounting Standard will set out requirements on presentation and disclosures in financial statements and will replace IAS 1 Presentation of Financial Statements. The new IFRS Accounting Standard will:
require presentation of two new defined subtotals in the statement of profit or loss—operating profit and profit before financing and income taxes.
require disclosure about management-defined performance measures
enhance the requirements for aggregation and disaggregation of information based on similar and dissimilar characteristics
require limited changes to the statement of cash flows to improve comparability by specifying a consistent starting point for the indirect method of reporting cash flows from operating activities and eliminating options for the classification of interest and dividend cash flows.
The IASB recently published an exposure draft, Financial Instruments with Characteristics of Equity, with proposed amendments to IAS 32, Financial Instruments: Presentation, IFRS 7: Financial Instruments: Disclosures and IAS 1 Presentation of Financial Instruments. The comment period closes on March 29, 2024.
The IASB’s FICE project seeks to address the practice issues that arise in applying IAS 32 and seeks to clarify the classification requirements of the standard. In addition, the exposure draft proposes enhanced presentation and disclosure requirements for financial liabilities and equity instruments, aiming to improve the information provided about features of financial liabilities and equity instruments that would not otherwise be apparent from their classification.
Whilst the amendments are described as clarifications, since they revise the existing requirements, they represent changes to the corresponding accounting standards. Therefore, if, on first application of the amendments, entities have to change their accounting retrospectively, this will not represent the correction of a prior period error.
For more details on the FICE project, refer to our publication Applying IFRS – FICE Project Progresses (December 2023)
