Accounting implications of the effects of COVID-19: Frequently Asked Questions

1. Is the coronavirus (COVID-19) pandemic an impairment indicator?

Many businesses will be impacted to some degree by the COVID-19 pandemic. IAS 36, ‘Impairment of assets’, requires that management consider at each report date whether there is any indication that an asset may be impaired. IAS 36 includes both internal and external indicators to identify if an impairment review is required. 

The following impairment indicators might be particularly relevant in the current economic climate: 

• actual financial performance is significantly lower than the original budget;
• cash flow is significantly lower than earlier forecasts;
• material changes in mid-term and/or long-term growth rates as compared to the previous estimates;
• market capitalisation less than book value of net assets;
• announced change in business model, restructuring, discontinued operations, etc;
• restrictions on operations such as inability to import, export, or travel;
• increase in the entity’s cost of capital;
• change of market interest rates or other market rates of return;
• fluctuations in the foreign exchange rates or commodity prices that impact the entity’s cash flows;
• deferral of investment projects; and
• significant or prolonged decrease in the entity’s stock price.

This list is not comprehensive and other indicators might present themselves. The indicators above and in the standard are examples only.

2. Should the business plan prepared by management be revised to incorporate the impacts of COVID-19?

Yes. Cash flows used for impairment testing should be based on a business plan that reflects the expected and most current impacts of COVID-19. It is expected that all entities will be updating forecasts and plans in response to current conditions. When measuring value in use, an entity should base cash flow projections on the most recent financial budgets/forecasts approved by management. Reliance on a previously approved forecast might  not be appropriate in the current market conditions. There should be consistency of assumptions and forecasts applying to impairment tests of different assets required by this and other standards.

The assumptions used in determining a recoverable amount (value in use or fair value less costs of disposal) need to be reasonable and supportable. In the current context of uncertainty:

• Management assumptions should be consistent with market evidence such as independent macroeconomic forecasts, industry commentators or analysts, brokers’ analysis and other third party experts. Greater weight should be given to credible external evidence that is available. 
• Any differences between the business plan’s underlying assumptions and market evidence should be analysed and understood. Management might find it helpful to explain these differences in the financial statement disclosures or other material accompanying the financial statements. 
• Management should understand any differences between fair value less costs of disposal and value in use, and it should ensure that they are supportable.

3. How can impairment tests that incorporate cash flow forecasts be more reliably performed in periods of uncertainty?

Two approaches to constructing the cash flow model supporting an asset or cash-generating unit (‘CGU’) can be considered:

• The ‘traditional’ approach, which consists of using a ‘single set of estimated cash flows and a single discount rate’ taking into account the ‘appropriate’ discount rate (para A4 of IAS 36). Uncertainties are reflected through the risk premium included in the discount rate.
• The ‘expected cash flow’ approach, which consists of using ‘all expectations about possible cash flows instead of the most likely cash flow’ (para A7 of IAS 36). Uncertainties are reflected through probability-weighted cash flow scenarios.

A basic assumption in calculating discount rates is that the expected cash flows fully reflect the uncertainties related to the current economic environment. Theoretically, the above two approaches should provide the same result. However, this relies on a degree of precision in the estimates under the ‘traditional’ approach that might be difficult to achieve.

Management should consider probability-weighting different scenarios to estimate the expected cash flows. This should enable an understanding of the range of potential outcomes for an asset or a CGU and its attached risks – for example, a ‘business as usual’ scenario, a scenario with short-/medium-term disruption, and a scenario with a broader and longer period of negative impact.

The ‘expected cash flow’ approach has, among others, the following advantages in an environment of higher uncertainty:

• The sensitivity of the recoverable amount to uncertainties is explicit in the measurement, compared to the ‘traditional’ approach where it is factored into the discount rate.
• It enables management to assess the uncertain assumptions that might have the most significant impacts on the recoverable amount.
• It calculates a range of expected cash flows instead of only considering the most likely case.
• It might be more aligned with the way in which management prepares forecasts for the purposes of responding to the pandemic.
• It lessens the impact of the judgemental exercise inherent in adding a single specific risk premium to the discount rate, which might be difficult to quantify and support in documentation.

Management might seek to apply the ‘traditional’ approach in response to an unexpected change in circumstances in a short space of time, which means that they cannot rigorously adjust cash flows in a timely fashion. In these situations, additional analysis might need to be performed to consider and assess the reasonableness of the cash flow impacts implied by the risk premium.

For these reasons, we recommend that discount rate adjustments to correct for optimistic cash flow scenarios are not best practice; this is because, without additional analysis, the concluded risk premium might under or over state the correction.

4. What are the consequences of the COVID-19 pandemic on the discount rate?

The discount rate should reflect the current market assessments of time value of money for the periods until the end of the useful life of the asset/cash-generating unit (‘CGU’), market risks, country risks, and any other risks specific to the asset/CGU for which the future cash flow estimates have not been adjusted, as well as other factors that market participants would reflect in pricing the expected future cash flows. As a starting point in calculating such a rate, management might use the weighted average cost of capital.

Despite the uncertainties in the current economic environment, the established methods for calculating the cost of capital should continue to be used. However, a re-assessment of each input into the calculation and assessment of the overall result is needed. In the current environment, certain observable inputs that go into the calculation of the cost of capital (such as risk-free rate) have declined. For many companies, the cost of debt will have increased, but this needs to be considered on a company-by-company basis. Companies with the highest credit ratings might, by contrast, have seen a decline in their cost of debt in line with sovereign debt. At the same time, increased volatility and other indicators point to an increase in the cost of equity. In addition, the heightened focus on liquidity might, for some industries, result in an optimal capital structure that is more weighted towards equity than in the past. Taken together, this means that, for most companies and sectors, the cost of capital is presently higher than it was in 2019. Companies should consider this when completing impairment assessments in 2020.

The discount rate does not, however, simply result from the application of a formula. It requires the exercise of judgement based on the overall valuation exercise. In particular, if the cash flows are not believed to incorporate a sufficient level of risks (for instance, by probability-weighting different scenarios to estimate the expected cash flows) and therefore cannot be considered as the expected cash flows, the discount rate might need to be adjusted upwards. However, management should first attempt to adjust the cash flows prior to making any adjustments to the discount rate, because it is generally difficult to estimate and support the amount by which the discount rate should be adjusted (see FAQ 3.). To the extent that uncertainties are not reflected in cash flows (for example, through probability-weighting), they might have to be reflected as an additional specific risk premium in the discount rate. The premium needs to be calibrated to the nature and amount of uncertainty not fully captured in the forecast.

5. Which disclosures will be of particular interest to users of financial statements this year?

Users such as investors, financial analysts and regulators are focusing on obtaining detailed and current information in this period of market turbulence. IAS 36, ‘Impairment of assets’, IAS 1, ‘Presentation of financial statements’, IAS 10, ‘Events after the balance sheet date’ and IAS 34, ‘Interim financial reporting’ all prescribe relevant disclosures. Also, there are often specific requirements of regulators that should be incorporated in the financial statements to the extent that they provide meaningful information to the readers of the financial statements and reflect management’s views and judgements when assessing recoverable amounts.

The critical disclosures for upcoming interim and annual reporting cycles will be related to sensitivity analyses (that is, key assumptions that have a significant risk of causing a material adjustment to the carrying amount of assets, including goodwill). These key assumptions should not be restricted to discount rates or growth rates, but they might also include expected profit margins and other highly sensitive assumptions that could have a significant impact on future cash flows. Other disclosures that are relevant, where a reasonably possible change in assumptions would lead to an heightened risk of impairment, include:

• a description of the asset/cash-generating unit (‘CGU’) being tested;
• the amount by which the recoverable amount exceeds the carrying value;
• the values assigned to the key assumptions used in the sensitivity analysis;
• the amount by which the key assumptions would have to change where the change would result in the recoverable amount equalling the carrying amount (for example, an entity might disclose that a 1% increase in the pre-tax discount rate would reduce its recoverable amount to equal its carrying amount); and 
• the aggregate carrying amount of goodwill allocated to the CGU(s) and the aggregate carrying amount of intangible assets with indefinite useful lives allocated to the CGU(s).

IAS 34 generally requires relatively less disclosure than would be required in an annual set of financial statements. However, the principle in IAS 34 is to provide an explanation of the events and changes that are significant to an understanding of the changes in financial position and performance of the entity since the end of the last annual reporting period. In view of the significant developments as a result of COVID-19, an entity's interim financial statements would likely be more detailed than in previous years.

6. In light of the uncertainties related to COVID-19, is it possible for management to determine the fair value of an investment property in accordance with IFRS 13?

Yes. IFRS 13 addresses the situation where observable inputs are not available. 

The carrying value of investment property held at fair value is often determined by way of engaging an external valuer. In the context of COVID-19, valuation reports received from external valuers may contain an uncertainty or qualifying clause in relation to certain aspects of the valuation. For example, the uncertainty may relate to the lack of empirical data upon which to determine a quantitative estimate for a key input.

Nonetheless, IFRS 13 requires an entity to develop unobservable (Level 3) inputs using the best information available in the circumstances, which might include an entity’s own data. This data should be adjusted if reasonably available information indicates that other market participants would use different data. However, an entity need not undertake exhaustive efforts to obtain information about market participant assumptions.  

While under IFRS 13, an entity should apply valuation techniques consistently, a change in valuation technique or its application is appropriate if the change results in a fair value measurement that is equally or more representative of fair value under the circumstances.  Changes in market conditions is an example of such a change. Further guidance for dealing with uncertain cash flows is included in FAQ 7. on uncertain cash flows.

Finally, IFRS 13 deals with uncertainty in relation to Level 3 fair value measurements through providing users with appropriate disclosure. For example, including a description of the valuation techniques used, how decisions are made in relation to valuation procedures and the sensitivity of fair value measurements to significant unobservable inputs.

7. How should uncertainties associated with COVID-19 be factored into a level 3 fair value measurement for non-financial assets?

For reporting dates in the first half of 2020, COVID-19 has given rise to many significant uncertainties including: the length of time and severity of the impact of COVID-19, how effective measures taken to control the spread of the virus will be, and how quickly activities may return to more normal conditions once the pandemic is over. It might not be possible for companies to factor all of these uncertainties into a single set of cash flow forecasts. Rather, there might be a range of potential outcomes that need to be included as different scenarios with appropriate weightings applied to each. Management would need to document its basis for the factors that have been built into each scenario, including the probability weights applied to each of the scenarios.

When valuing businesses and most non-financial assets, entities in practice use an expected cash flow model. Even if management is not explicitly modeling scenarios, it is implicitly probability weighting the possible scenarios to arrive at a single forecast. Another approach is to use a forecast that is not an expected cash flow forecast, for example, management’s best estimate. IFRS 13 requires the use of a discount rate that is consistent with the risk inherent in the cash flows. This means that the discount rate applied to the expected cash flows and “best estimate” cash flows are not the same. If the cash flow forecasts do not fully reflect multiple scenarios capturing the range of relevant outcomes, an entity may need to add a company-specific risk premium, also known as an alpha, to the discount rate. This will result in a higher discount rate that reflects the risks in the forecast. More guidance on the interplay between the discount rate and cash flow forecast can be found  in the International Valuation Standards issued by the International Valuation Standards Council (specifically in paragraph 50.38). A multiple scenario approach may eliminate the need for the alpha since discount rates should not be adjusted for risks that are already reflected in the cash flows.

If management moves from a single set of cash flows to a probability weighted set of cash flows, this represents a change in accounting estimate in accordance with IAS 8, which should be accounted for as such. However, in accordance with IFRS 13 paragraph 66, the disclosures in IAS 8 for a change in accounting estimate are not required for revisions resulting from a change in a valuation technique or its application. IFRS 13 paragraph 65 cites changing market conditions is an example of a circumstance where a change in valuation technique or its application may be appropriate.

Additionally, IFRS 13 deals with uncertainty in relation to Level 3 fair value measurements through providing users with appropriate disclosure. For example, including a description of the valuation techniques used, how decisions are made in relation to valuation procedures and [for recurring fair value measurements] the sensitivity of fair value measurements to significant unobservable inputs".

8. What other considerations for discount rates are relevant for Level 3 fair value measurements of non-financial assets, such as a business, given the impact of COVID-19 on economic conditions?

The considerations for discount rates are two-fold in light of the impact of COVID-19 on economic conditions:

1. Systematic risk (beta)

One component of the discount rate is compensation for bearing the systematic risk inherent in the cash flows. The amount of an asset’s systematic risk is measured by its beta, which is measured in relation to the market as a whole. This represents risk that cannot be reduced through diversification, and it is rewarded with a risk premium or higher level of expected return. This risk is derived from external macroeconomic factors that affect all companies in some way, although in different magnitudes. The beta is a component of the cost of equity included in the discount rate and is unrelated to whether (and to what extent) the unsystematic risk (alpha) should be included in the discount rate. As to the specific implications that COVID-19 has on interest rates, see FAQ 4.

2. Unsystematic risk (alpha)

The other component of the discount rate is unsystematic (diversifiable) risk, which is the risk specific to the particular asset. Since this risk can be diversified away, investors do not require to be compensated for it. 

Examples of unsystematic risk include customer concentration risk, keyman risk and regulatory risk. Unsystematic risk might be reflected in the asset’s cash flows (for example, by using different scenarios with appropriate weightings).

IFRS 13 requires the use of a discount rate that is consistent with the risk inherent in the cash flows. This means that the discount rate applied to the expected cash flows (measured using multiple possible scenarios that are probability-weighted) and ‘best estimate’ cash flows (measured at the most likely amount) are not the same. If the cash flow forecasts do not fully reflect multiple scenarios capturing the range of possible outcomes, an entity might need to add a risk premium, also known as an alpha, to the discount rate; however, alpha is not included in the discount rate for aspects other than cash flow projection risk. This will result in a higher discount rate that is commensurate with the risks in the forecast. See FAQ 7. for further discussion.

9. What factors should be considered in assessing whether a loan granted a payment holiday related to COVID-19 should be classified in stage 1, stage 2 or stage 3?

Background

Prior to the COVID-19 pandemic, payment holidays or ‘forbearance’ were typically initiated by a borrower known to be in financial difficulty. The lender obtained detailed financial information from the borrower that the lender used on a case-by-case basis to assess the financial position of the borrower and tailor the payment holiday to their individual circumstances. In those circumstances, the exposure was classified either as stage 2 as a minimum, or stage 3.

Following the COVID-19 pandemic, the circumstances in which payment holidays are typically granted have changed significantly. They have been initiated both by borrowers but also governments as blanket measures, with very little, if any, financial information provided by individual borrowers. That has typically resulted in standardised payment holidays being offered to all customers in a class (for example all home mortgages) without a borrower-level assessment. 

As highlighted by the IASB in its document issued on 27 March 2020, in these changed circumstances it is not appropriate to apply previously established approaches to assessing significant increase in credit risk (‘SICR’) for payment holidays in a mechanistic manner.

Answer

There are a wide range of factors that may be relevant in making this assessment. The relevance of each factor will depend upon the particular facts and circumstances, as well as the materiality of the possible impact. The key considerations include the following.

IFRS technical considerations

• ‘Blanket’ vs customer-initiated: As highlighted in the IASB document, where a payment holiday is granted to an entire class of financial instruments, that alone should not automatically result in all those financial instruments moving to stage 2. That is because if the ‘blanket’ nature of the holiday does not discriminate between borrowers, it does not provide relevant information to staging at the individual loan level. An example would be a government requiring that payment holidays are granted to an entire class of loans (for example all home mortgages) without regard to the borrower’s individual financial circumstances. However, affected loans would still need to be assessed for other indicators of SICR and where the blanket payment holiday is motivated by the deterioration in the economic outlook, a portion of those loans would generally be expected to move to stage 2.
• Collective assessment: Due to the common absence of detailed information from borrowers regarding the individual cause of their payment holiday request and their broader financial circumstances, it is highly likely that initially a collective approach will be needed to determine which loans with payment holidays should be moved to stage 2.
• Short-term liquidity issue vs SICR: Where a borrower is only experiencing short-term liquidity difficulties and those difficulties will be mitigated by the payment holiday, perhaps in conjunction with other government reliefs that reduce the risk of default, the loan may not experience a significant increase in the risk of default and validly remain in stage 1. In addition, where the application process asks only very high-level questions, some borrowers granted payment holidays may be pre-emptively maximising their cash and not currently experiencing liquidity issues or a significant increase in the risk of default. But other borrowers will not be experiencing only short-term liquidity difficulties, for example where they are in a sector likely to suffer longer-term difficulties, they will not benefit from government reliefs or reliefs will not reduce their risk of default (for example, a guarantee that only reduces the lender’s loss given a default). For that reason, assuming all loans granted a payment holiday remain in stage 1 is not appropriate.
• Modification vs existing clause: Some loans may contain pre-existing clauses permitting the borrower a payment holiday, so no modification to the original loan contract is needed to allow this. This guidance on payment holidays obtained via contractual modifications is likely to similarly apply to these cases.
• Credit impaired or stage 3: A loan that is granted a payment holiday will only move to stage 3 when the loan is identified as credit impaired on an individual basis. This is because the IFRS 9 definition of credit impaired does not include assets assessed only on a collective basis where the impact cannot yet be identified for individual assets. 
• Regulatory vs accounting: Where the regulatory treatment or regulatory reporting of payment holidays is changed, this will not automatically affect the accounting analysis under IFRS 9. The impact of such changes, if any, on IFRS 9 accounting would need to be separately analysed and assessed.

Practical considerations

Significant judgement may be needed in applying the above technical considerations and determining which loans should move to stage 2, where a bank has limited data on customers’ specific circumstances. The availability of that information will also vary by bank, by territory and over time. However, as more information naturally becomes available, the approach taken should be updated appropriately. The following considerations may be relevant:

• Impact of Multiple Economic Scenarios (MES): Practically, when assessing which loans with payment holidays move to stage 2, a lender might first apply updated macroeconomic scenarios and weightings to reflect the change in economic outlook. Attention can then be focused on those loans with payment holidays that would remain in stage 1.
• Relevant risk factors: When assessing loans with payment holidays to determine which / what portion should move to stage 2, the following risk factors may be relevant to the extent data is available:

a. Industries and sectors: Dependent on the territory, borrowers in some industries or sectors, such as a nurse or a company in the health sector, might have significantly stronger future prospects than borrowers in others, such as the tourism sector.

b. ‘Headroom’: Loans that prior to COVID-19 had credit risk (for example. a probability of default or ‘PD’) closer to the threshold for moving to stage 2, or other risk indicators such as recent payment arrears, are more likely to have had a significant increase in credit risk since initial recognition once the additional factor of the payment holiday is also taken into account.

c. Indebtedness: Even where a borrower’s income returns to its pre-COVID-19 level, their level of indebtedness might continue to grow during the payment holiday and so increase their future debt servicing costs and risk of default. This might be the case where the borrower cannot access government reliefs, where the relief only provides short-term liquidity that needs to be repaid, or where that relief does not fully address their income shortfall (for example, as enhanced government unemployment benefit is capped so borrowers with income levels significantly in excess of the cap will see their level of indebtedness increase more significantly during COVID-19 disruption).

d. Other products: Where a borrower has other financial products with the lender, such as investments, revolving credit facilities etc, where that information is not already incorporated into the SICR criteria, information about those other products may be helpful in evaluating the risk of the borrower. 

• Forward planning: Lenders might consider how the situation will evolve over time and what data will become available when. That may help identify additional data, or more granularity on existing data, that can be gathered to improve identification and support of riskier customers, provide more accurate estimation of the effect on staging and ECL, and manage expectations of both internal and external stakeholders. Examples might include:

a. Adding additional questions, such as the industry a retail customer works / worked in, to those that new applicants are required to answer;

b. Contacting a sample of customers to better understand their circumstances and how they have changed since the payment holiday was initially granted; or 

c. Gathering existing unstructured data (for example, the precise nature of the customer’s employment on their paper application form) so it can be analysed. 

Other considerations

Given the extent of judgement involved, at least in the shorter term, the staging approach adopted for customers with payment holidays is likely to be the subject of significant scrutiny by users of financial reports. Clear disclosure will therefore be essential. The nature and extent of that disclosure will vary dependent on the reporting (e.g. annual vs interim, IAS 34 interim vs other types of interim reporting) but regardless, the following will likely be key:

• A clear description of the approach taken to the staging of loans with payment holidays. 
• The key assumptions and judgements that have been made.
• Explanation of the potential impact if different judgements had been made. 
• Analysis of the credit risk concentration of loans granted payment holidays, for example by PD banding or Loan To Value (LTV) ratio for secured exposures, as well as by stage. 
• Explanation of any changes made to previously applied SICR criteria (also refer to the publication ‘Spotlight: Changes to SICR criteria’).
• Any expectations of the timescale over which the uncertainties might be resolved.

10. How should modified loans, such as loans subject to ‘forbearance’, be classified within the IFRS 9 expected credit loss (‘ECL’) impairment model?

When a borrower is in financial difficulty, to maximise recovery of the contractual cash flows of a loan, a bank might offer to modify the contractual terms. For example, the borrower might be offered a payment holiday. This is done with the objective of helping the borrower during their period of financial difficulty but still maximising recovery by the bank of the loan’s contractual cash flows. For loans such as retail mortgages, this also helps to avoid the need to repossess the borrower’s home. Such modifications are sometimes referred to as ‘forbearance’, although definitions of this term might differ between banks, between different regulatory regimes and over time if definitions evolve.

When a bank grants a modification to a borrower due to their financial difficulty and this does not result in derecognition, in which ‘stage’ of the IFRS 9 ECL impairment model (that is, stage 1: ‘performing’; stage 2: ‘underperforming’; or stage 3: ‘credit-impaired’) should the loan be classified 1. at the time of modification, and 2. subsequently? The loan was not purchased or originated credit-impaired.

This FAQ assumes that the borrower is in financial difficulty. Refer to the separate FAQ 9. for discussion of the ‘Impact of COVID-19 payment holidays on ECL staging’.

Solution

1. At the time of modification

The appropriate classification of the loan will depend on the specific facts and circumstances of the modification granted to the customer. The definition of a ‘credit-impaired financial asset’ (that is, stage 3) in Appendix A to IFRS 9 states that:

“A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include observable data about the following events: …

(c) the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider; …”

Considering each of the three possible stages:

• Stage 3 – In many cases, the loan will meet the definition of ‘credit-impaired (stage 3), because the forbearance concession has only been granted due to the borrower’s financial difficulty, the lender would not otherwise grant such a concession, and the concession has a detrimental effect on the estimated future cash flows (for example, a portion of the interest or principal payments are waived).
• Stage 2 – Where the loan does not meet the definition of ‘credit-impaired’, it should be classified in stage 2. This might be the case, for example, where a customer is not in significant financial difficulty and:

a. a short-term payment holiday is granted where payments are only deferred (rather than waived) and interest accrues on the unpaid deferred amounts, with the result that there is not a detrimental impact on the estimated future cash flows of the loan.

b. a loan covenant is amended or waived, which is not considered to have a detrimental impact on the estimated cash flows.

• Stage 1 – At the time of granting a modification to a borrower that is a concession due to their financial difficulty, it would not be appropriate to classify the loan in ‘stage 1’.

As well as considering the ECL implications of the modification, paragraph 5.4.3 of IFRS 9 requires the gross carrying amount of the loan to be recalculated, and a corresponding modification gain/loss to be recognised in profit or loss when the contractual cash flows of a loan asset are renegotiated or otherwise modified and this does not result in derecognition of the loan.

2. Subsequent classification

As described in paragraph B5.5.27 of IFRS 9, following such a modification, a loan is not automatically considered to have lower credit risk. Typically, a borrower would need to demonstrate consistently good payment behaviour over a period of time before the credit risk is considered to have decreased and the loan moves from stage 3 to stage 2, or from stage 2 to stage 1. A history of missed or incomplete payments would not typically be erased by simply making one payment on time.

The stage classification under IFRS 9 is a separate matter from whether or not a loan still meets a definition of ‘forbearance’, because the latter could reflect a regulatory definition which requires a different ‘probation’ period. That is, it should not be assumed that a regulatory ‘probation’ period can be used as the period of good payment behaviour needed to move an asset from stage 3 to stage 2, or from stage 2 to stage 1, for IFRS 9 purposes.

Disclosure

Appropriate disclosure should also be given in accordance with IFRS that describes how an entity determines whether:

• the credit risk of financial instruments has increased significantly since initial recognition (para 35F(a) of IFRS 7);
• financial assets are credit-impaired (para 35F(a), (d) of IFRS 7); and
• modified financial asset moves from stage 3 to stage 2, and from stage 2 to stage 1 (para 35F(f) of IFRS 7).

11. What factors should be considered when determining whether a market is still active in a period of market disruption?

Paragraph B37 of IFRS 13 provides a list of factors to consider in determining whether there has been a significant decrease in the volume or level of activity in relation to normal market activity.

The factors that an entity should evaluate include (but are not limited to):

1. There is a significant decline in the activity of, or there is an absence of, a market for new issues (that is, a primary market) for the asset or liability or similar assets or liabilities.
2. There are few recent transactions.
3. Price quotations are not developed using current information.
4. Price quotations vary substantially, either over time or among market makers (for example, some brokered markets).
5. Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
6. There is a significant increase in implied liquidity risk premiums, yields or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, taking into account all available market data about credit and other non-performance risk for the asset or liability.
7. There is a wide bid-ask spread or there are significant increases in the bid-ask spread.
8. Little information is publicly available (for example, a principal-to-principal market).

If an entity concludes that there has been a significant decrease in the volume or level of activity in the market for an asset or liability, the entity should perform further analysis of the transactions or quoted prices observed in that market. A significant decrease in activity on its own is not indicative that the transaction prices observed do not represent fair value. Nevertheless, further analysis is required, because the transactions or quoted prices might not be determinative of fair value, in which case adjustments might be necessary when using the information in estimating fair value.

12. Can a company disregard market prices of financial assets in an inactive market in periods of market volatility when determining the fair value of a financial asset?

Paragraph B44 of IFRS 13 provides guidance to be considered in evaluating observable transaction prices under different circumstances:

• The transaction is not orderly – If the evidence indicates that the transaction is not orderly, an entity is required to place little, if any, weight (compared with other indications of fair value) on that observable transaction price when estimating fair value.
• The transaction is orderly – If the evidence indicates that the transaction is orderly, an entity is required to consider that transaction price when estimating fair value. The amount of weight placed on that transaction price (when compared with other indications of fair value) will depend on the facts and circumstances of the transactions and the nature and quality of other available inputs.

FAQ 12. addresses how to determine whether a transaction is orderly. Where a market is considered inactive, pricing inputs for referenced transactions might be less relevant. The determination of whether a transaction is (or is not) orderly is more difficult if there has been a significant decrease in the volume and level of activity for the asset or liability.

If management does not have sufficient information to conclude whether an observed transaction is orderly (or is not orderly), it is required to consider that transaction price when estimating fair value. In those circumstances, that transaction price might not be determinative (that is, the sole or primary basis) for estimating fair value. There might be circumstances in which less weight should be placed on transactions where a reporting entity has insufficient information to conclude whether the transaction is orderly when compared with other transactions that are known to be orderly.

IFRS 13 does not prescribe a methodology for making significant adjustments to transactions or quoted prices when estimating fair value in inactive markets. Instead of applying a prescriptive approach, management should weigh indicators of fair value.

13. When are transactions considered orderly?

Paragraph B43 of IFRS 13 provides a list of circumstances that might indicate that a transaction is not orderly, including (but not limited to):

• There was no adequate exposure to the market, for a period before the measurement date, to allow for marketing activities that are usual and customary for transactions involving such an asset or liability.
• There was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant.
• The seller is in or near bankruptcy or receivership (that is, distressed) or the seller was required to sell to meet regulatory or legal requirements (that is, if the seller was forced). However, not all requirements to divest result in a forced sale, since many requirements to divest are made in circumstances that allow sufficient time and marketing effort to result in an orderly disposal.
• The transaction price is an outlier when compared with other recent transactions for the same (or a similar) asset or liability.

Although IFRS 13 provides a list of factors to consider that might indicate that a transaction is not orderly, we believe that there is an implicit rebuttable presumption that observable transactions between unrelated parties are orderly. In our experience, such transactions are considered to be orderly in almost all instances. Therefore, the evidence necessary to conclude that an observable transaction between unrelated parties is not orderly should be incontrovertible.

14. If there is a quoted price in an active market (that is, a Level 1 input), can a company adjust or disregard the quoted price in a period of significant market volatility when determining fair value?

The objective of ‘fair value’ is to determine a price at which an orderly transaction would take place between market participants under conditions that existed at the measurement date. It would not be appropriate to adjust or disregard observable transactions, except in the extraordinarily rare circumstances where those transactions are determined to not be orderly. Generally, there is an extremely high bar to conclude that a transaction price in an active market (that is, a Level 1 input) is not orderly under IFRS 13.

Accordingly, we expect the fair value of a financial asset to be calculated as the quoted price of that financial asset in an active market multiplied by  the quantity held (commonly referred to as ‘P times Q’). This would continue to be the case even in times of significant market volatility.

15. COVID-19 disruptions could cause delays in the availability of information used to measure the fair value of an investment. If a company uses estimates of such information in its initial valuation assessment, how should it consider updated information that becomes available before its financial statements are issued?

Initial estimates used in fair value models should be updated for any delayed information that becomes available prior to the release of the company’s financial statements if, and only if, the information provides additional evidence about known or knowable conditions that existed at the measurement date.

16. Should events that occur after the close of a market but before the end of the measurement date be considered when estimating fair value?

As discussed in paragraph 79(b) of IFRS 13, in some situations, significant events (such as principal-to-principal transactions, brokered trades, or announcements) might occur after the close of a market but before the end of the measurement date. In that case, a quoted market price might not be representative of fair value on the measurement date. Entities should follow and consistently apply a policy for identifying and incorporating events that could affect fair value measurements. In addition, if an entity adjusts the quoted price, the resulting measurement will not be classified as Level 1, but it will be a lower-level measurement.

In general, the measurement date, as specified in each accounting standard requiring or permitting fair value measurements, is the ‘effective’ valuation date. Accordingly, a valuation should reflect only facts and circumstances that exist on the specified measurement date (these include events occurring before the measurement date or that were reasonably foreseeable on that date), so that the valuation is appropriate for a transaction that would occur on that date.

17. When assessing whether there is objective evidence of impairment for an available-for-sale equity investment, what is considered a ‘significant’ or ‘prolonged’ decline in fair value below cost?

Assessing what is a ‘significant’ or ‘prolonged’ decline in fair value below an investment’s cost requires judgement. A ‘significant’ decline in fair value should be evaluated against the original cost at initial recognition, and ‘prolonged’ should be evaluated against the period in which the fair value of the investment has been below that original cost.

Whether a decline in fair value below cost is considered ‘significant’ must be assessed on an instrument-by-instrument basis. In our view, the assessment of ‘significant’ should be based on both qualitative and quantitative factors.

The expected level of volatility for an instrument might also be a factor that entities should take into consideration when assessing what is ‘significant’. For example, a larger decline in a more risky stock might be tolerated before an entity records an impairment loss, given the stock’s greater volatility compared with a less volatile company. Importantly, volatility should be determined over a relatively long period. For example, a market downturn due to the decline in the overall economy over a short period of time would not be considered adequate to establish an estimate of expected future volatility.

What is a ‘prolonged’ decline in fair value also requires judgement. In general, a period of 12 months or longer below original cost is likely to be a ‘prolonged’ decline. However, the assessment of ‘prolonged’ should not be compared to the entire period that the investment has been or is expected to be held. For example, if a security’s fair value has been below cost for 12 months, whether that security has been held or is intended to be held for two or 20 years is irrelevant. The assessment is whether the period of 12 months accords with the entity’s chosen policy.

An entity should continue to apply its existing guidance for assessing a ‘significant’ or ‘prolonged’ decline in fair value. The fact that a decline in the value of an investment is in line with the overall level of decline in the relevant market does not mean that an entity can conclude that the investment is not impaired. The existence of a significant or prolonged decline cannot be overcome by forecasts of an expected recovery of market values, regardless of its expected timing.

18. Is COVID-19 a 'rare circumstance' that allows reclassification of bonds from trading to amortised cost under IAS 39.50B?

Non-derivative financial assets that do not meet the definition of loans and receivables can be reclassified from held-for-trading only in rare circumstances, provided that these financial assets are no longer held for the purpose of selling or repurchasing in the near term and meet the definition of the target category. Financial assets that were designated at fair value through profit or loss upon initial recognition shall however not be reclassified.

’Paragraph BC104D of the Basis for Conclusions of the amendment to IAS 39 defines a rare circumstance as arising “from a single event that is unusual and highly unlikely to recur in the near-term”. In our view, the declaration of a COVID-19 global pandemic by the World Health Organization on March 11, 2020 meets the definition of  ‘a rare circumstance’.

19. How should lease concessions related to COVID-19 be accounted for?

On 17 April 2020 the IASB tentatively decided to propose amendments to IFRS 16 that would provide lessees (but not lessors) with an optional exemption from assessing whether a rent concession that is a direct consequence of the COVID-19 pandemic is a lease modification. This FAQ does not take into account any amendments to IFRS 16 that might result from this decision.

As a result of the COVID-19 pandemic, concessions have been granted to lessees. Such concessions might take a variety of forms, including payment holidays, cash rebates and deferral of lease payments. On 10 April 2020, the IASB issued a document intended to support the consistent application of IFRS to lease concessions related to COVID-19 (see link), referred to below as ‘the IASB document’.

Judgement might be needed to determine the appropriate accounting treatment for lease concessions that are made in the context of COVID-19. Depending on the facts and circumstances, the substance of the concession might be appropriately accounted for as (negative) variable lease payments, forgiveness of some of the lease payments, deferral of some of the lease payments, or a lease modification. Factors to consider in exercising this judgement include the following:

• Pre-existing clauses in lease contracts. Some lease contracts contain pre-existing force majeure or similar clauses. Where such a clause applies to COVID-19 and results in reduced payments, the substance might be appropriately accounted for as negative variable lease payments that are not dependent on an index or a rate. Under IFRS 16, the effect is recognised by both the lessee and the lessor in the period in which the event or condition that triggers the reduced payments occurs. FAQ 20. gives further guidance on the accounting for such force majeure and similar clauses.
• Actions of governments. Paragraph 2 of IFRS 16 requires an entity, when applying IFRS 16, to consider both the terms and conditions of contracts and all relevant facts and circumstances. The IASB document observes that relevant facts and circumstances might include contract, statutory or other law or regulation applicable to lease contracts. The IASB document also observes that, when applying IFRS 16, an entity treats a change in lease payments in the same way, regardless of whether the change results from the contract itself or from applicable law and regulation. Accordingly, the impact of a lease concession imposed only by law, regulation or government actions might be similar to the impact of a concession required by a pre-existing clause in the lease contract. This might also be appropriately accounted for as negative variable lease payments that are not dependent on an index or a rate, with the effect being recognised by both the lessee and the lessor in the period in which the event or condition that triggers the reduced payments occurs.
• Forgiveness of lease payments. Where the concession takes the form of a forgiveness of some of the payments required by the lease contract, with no change in the scope of the lease, the substance might be that the lessor is forgiving a part of the lease liability rather than the parties agreeing to modify the lease contract. Paragraph 2.1(b) of IFRS 9 requires IFRS 9’s requirements for derecognition to apply to both lease liabilities (for lessees) and lease receivables (for lessors). A concession in the form of a forgiveness might therefore be appropriately accounted for by applying IFRS 9’s derecognition requirements, with the result that a portion of the lease liability or lease receivable is derecognised. The lessee would reduce the recognised lease liability by the present value (discounted using the rate used to measure the lease liability – that is, the rate implicit in the lease if that rate can be readily determined, or the lessee’s incremental borrowing rate.) of the payments that have been forgiven, and it would recognise a corresponding gain in the income statement at the time when the forgiveness occurs. Similarly for the lessor, to the extent that a previously recognised lease receivable has been forgiven, that portion of the lease receivable is derecognised and a loss is recognised in the income statement. Lessors should also apply IFRS 9’s impairment requirements to lease receivables in accordance with paragraph 2.1(b) of IFRS 9.
• Deferral of lease payments. Some concessions might be in the form of the lease payments being rescheduled rather than reduced – such that, in nominal terms, the consideration for the lease has not changed. An entity might judge that, where such a deferral is proportionate, it is not a lease modification, since there is no change in either the scope of the lease or the consideration for the lease. This would not be inconsistent with the IASB document in the case where the deferral is judged to be proportionate (the relevant paragraph in the IASB document states, “For example, if a lessee does not make lease payments for a three-month period, the lease payments for periods thereafter may be increased proportionately in a way that means the consideration for the lease is unchanged”.). However, unless additional interest is charged for the period of the deferral at the rate used to measure the lease liability or lease asset, there will be an effect on the present value of the lease payments. This effect might be accounted for by adjusting the lease liability (for the lessee) or lease receivable (for the lessor in a finance lease) and the recognition of a corresponding gain (for the lessee) or loss (for the lessor) at the time when the deferral is granted.
• Other concessions. If management concludes that the substance of the concession is not appropriately accounted for using the methods set out above, it should consider whether the substance is a lease modification. An example might be a concession that is negotiated between the lessor and the lessee and that results in a change to the terms of the lease contract. A lessee applies paragraphs 44 - 46 of IFRS 16 to account for lease modifications. The conditions for accounting for the concession as a separate lease will likely not be met, and the IASB document notes that a rent holiday or rent reduction alone is not a change in the scope of a lease. Accordingly, the lessee applies paragraph 45(c) of IFRS 16 and remeasures the lease liability by discounting the revised lease payments at a revised discount rate, with a corresponding adjustment being made to the ‘right of use’ asset. The ‘right of use’ asset should also be tested for impairment in the usual way. It should be noted that, if the concession is accounted for as a lease modification, there will be two principal accounting effects for the lessee (the lessee would also re-assess whether there is a lease (para 11 of IFRS 16) and re-allocate the consideration where the contract contains both a lease and non-lease components (para 45 of IFRS 16): the first as the lease payments have changed; and the second as the discount rate is revised. The magnitude of the effect of revising the discount rate will depend on:

a. the transition method used when the lessee first adopted IFRS 16; and

b. how each component of the discount rate has changed over time and in the light of COVID-19. For example, in some cases the change in the risk-free component of the discount rate might be approximately offset by the other components (in particular, credit risk).

A lessor applies paragraphs 79 - 80 or 87 of IFRS 16 and accounts for the lease modification as if it were a new lease or, where paragraph 80(b) of IFRS 16 applies, by applying the requirements of IFRS 9.

Entities should also consider what disclosures are required to enable users to understand what the accounting consequences have been and any judgements made.

20. What are the accounting implications of a force majeure clause in a lease contract in the context of COVID-19?

Background

Some lease contracts contain force majeure clauses that apply in the case of serious unforeseen circumstances beyond the control of the parties to the contract. In addition, actions of governments taken in response to COVID-19 might be accounted for in a similar way to some force majeure clauses. The nature of such clauses can differ. For example, in some cases the clause might relieve the party suffering from the force majeure of all or certain obligations in the contract in the event of explicitly specified circumstances that include a global pandemic as declared by the WHO. In other cases, it might be unclear what rights are established in the case of a pandemic and whether the clause applies at all to the circumstances that have arisen from COVID-19.

What are the accounting implications of such force majeure clauses in the context of COVID-19?

Answer

It depends. Entities should seek to understand how such clauses apply in the context of COVID-19, taking into account both the wording of the clause and the relevant laws and regulations. In addition, actions of governments taken in response to COVID-19 might be accounted for in a similar way to some force majeure clauses (see FAQ 19.). In some cases, legal advice might be required.

Where it is determined that the clause establishes specific rights and obligations that apply in the current COVID-19 situation (for example, rent reductions of specified amounts or for a specified period), these amounts should be treated as negative variable lease payments not dependent on an index or rate. As a result, in line with paragraph 38(b) of IFRS 16, the benefit of a reduction in payments is recognised in the period in which the event or condition that triggers the reduced payments occurs. Whilst this guidance applies specifically to lessees, we believe that it would be equally applicable to lessors, given that the overall definition of variable lease payments in IFRS 16 applies to both lessees and lessors.

For example, if a lease agreement for a retail store provides for a payment holiday for the period when the store is closed as a result of a force majeure event, the payment holiday is recognised by both the lessee and the lessor over the period when the store remains closed. This is because the event triggering the payment holiday (that is, the store closure) occurs over time as the force majeure occurs. To illustrate, where monthly lease payments are C100, the lessee would derecognise C100 of its lease liability during each month of the payment holiday, with a corresponding gain recognised in the income statement. For the lessor, if it has previously determined that the arrangement is a finance lease, it would derecognise C100 of its lease receivable during each month, with a corresponding loss recognised in the income statement. Where the lessor has determined that the arrangement is an operating lease and that lease income of C100 is recognised each month, for each month of the payment holiday it would also recognise negative variable lease payments of C100. That is, the lease income recognised during the payment holiday period would be zero.

On the other hand, where it is determined that the clause only allows the party suffering from the force majeure to enter into a negotiation with the other party, any changes to the lease payments that are made after such a negotiation will likely not meet IFRS 16’s definition of variable lease payments. In these cases, entities will need to consider whether the negotiated changes might, for example, be appropriately accounted for as the forgiveness of some of the lease payments, which might be treated as a partial extinguishment by applying IFRS 9’s derecognition requirements, or as a lease modification. (See FAQ 19. for considerations of lease concessions in the light of COVID-19.)

In any event, where such clauses are triggered, entities will need to consider what disclosures are required to enable users to understand what the accounting consequences have been and any judgements made.

21. What type of lease receivables are subject to IFRS 9’s expected credit loss requirements?

Lease receivables (that is, net investments in finance leases and operating lease receivables) are within the scope of IFRS 9’s expected credit loss (ECL) model.

Such receivables include a lessor’s accrued rent receivables on operating leases. These accrued rent receivables might be recognised as a result of lease incentives such as rent-free periods or periods of reduced rental payments, as well as payments made by a lessor to a lessee – for example, an upfront payment in relation to fit-out costs, which is recognised as accrued rent receivable by the lessor and amortised over the lease term to the income statement. 

If the leased asset is an investment property, any lease incentive recognised as a separate asset is not included in the investment property carrying value, in accordance with paragraph 50(c) of IAS 40. The lease incentive asset would also be subject to IFRS 9’s ECL requirements.

22. If a lessor expects a lessee to pay all amounts due under the lease, but later than the contractual due date, does this give rise to an ECL?

Yes. Even where a lessee is expected to pay all amounts due, but later than the contractual due date, there will be an ECL if the lessor is not compensated for the lost time value of money (that is, if the lessor does not charge interest for the late payment).

See In the Spotlight – How corporate entities can apply the requirements of IFRS 9 expected credit losses during the COVID-19 pandemic for further details on expected credit losses for corporate entities.

23. Should lease terms be reassessed as a result of COVID-19?

A retailer entered into a contract to lease a shop for a five-year period, with an option to extend for five additional years. At the commencement date, the retailer considered all relevant facts and circumstances that create an incentive to extend the lease, and assessed that it was reasonably certain to exercise the extension option, and so concluded that the lease term was 10 years. As a result, it included the lease payments of the optional period in the initial carrying amount of its right-of-use asset and lease liability, and it depreciated the right-of-use asset over 10 years.

At the beginning of year 4, COVID-19 lockdowns occur. Should the retailer reassess the lease term?

Analysis

It depends. After the commencement date, a lessee should reassess whether it is reasonably certain to exercise an extension option, or not to exercise a termination option, on the occurrence of either a significant event or a significant change in circumstances that:

a. is within the control of the lessee; and

b. affects whether the lessee is reasonably certain to exercise an option not previously included in its determination of the lease term, or not to exercise an option previously included in its determination of the lease term.

One example of such a significant event or change in circumstances is a business decision of the lessee that is directly relevant to exercising, or not exercising, an option (for example, a decision to extend the lease of a complementary asset, to dispose of an alternative asset or to dispose of a business unit within which the right-of-use asset is employed).

COVID-19 is not an event that is under the control of the lessee. Therefore, COVID-19 by itself does not lead to a reassessment of the lease term.

However, COVID-19 lockdowns might lead the retailer to revise its business plans and commercial strategy, and to undergo a detailed review of its shop portfolio in the context of this revision. This is a significant event or a significant change in circumstances that is within the control of the lessee.

If, as a result of this commercial strategy revision, the retailer concludes that it is no longer reasonably certain to exercise the extension option, it must reassess the lease term.  

When the lease term is reassessed, the lessee should:

• remeasure the lease liability by discounting the revised lease payments using a revised discount rate;
• recognise the amount of the remeasurement of the lease liability as an adjustment to the right-of-use asset; and
• depreciate the right-of-use asset over the revised remaining lease term (that is, two years in the example above).

A reassessment can have a significant impact on the carrying amount of right-of-use assets and lease liabilities at the date of the reassessment. As a result, this could have a consequential impact on the amount of depreciation and interest expense recognised subsequently. In addition, the lessee should consider whether the right of use asset is impaired.

A lessor does not reassess, after the commencement date, whether or not an option is reasonably certain to be exercised by the lessee.

24. Should the effects of COVID-19 impact the measurement of assets and liabilities for entities with a reporting date in the first quarter of 2020?

The impact of COVID-19 has been an evolving situation since late 2019. Given the events and circumstances that existed at 31 December 2019, the impact of COVID-19 would likely not be considered a factor that would have had a material effect on the measurement of assets and liabilities. However, since then, both the impact and the available information about that impact have changed. On 30 January 2020, the World Health Organisation declared a global health emergency amid thousands of new cases in China and, in March 2020, it declared the spread of COVID-19 as a global pandemic. Consequently, for entities with a 31 March 2020 reporting date, the need to consider the impact of COVID-19 is likely substantial and should be considered a factor that might have a material effect on the measurement of assets and liabilities.

For entities with a January or February reporting date, judgement is required to determine whether the condition (that is, COVID-19) that existed at the reporting date is material and hence should be incorporated into the measurement of assets and liabilities at the reporting date.

The question that an entity should ask when making this judgement is whether, at the reporting date, it was known or knowable that COVID-19 could materially impact the measurement of assets and liabilities. Factors that an entity might consider in making this judgement include:

1. the reporting period date (for example, COVID-19 is more likely to be considered to materially impact the measurement of an entity’s assets and liabilities where the entity has a 29 February 2020 reporting date compared to an entity with a 31 January 2020 reporting date);
2. the territory (for example, COVID-19 is more likely to be considered to materially impact the measurement of an entity’s assets and liabilities where the entity is operating in China compared to an entity in a territory in which the spread of the virus occurred later);
3. the industry (for example, COVID-19 is more likely to be considered to materially impact the measurement of an entity’s assets and liabilities where the entity’s business crosses borders, involves travel by customers, staff or suppliers, and would not have been considered 'essential' to the public); and
4. the customer base and supply chains specific to the entity.

If an entity has determined that it was known or knowable that COVID-19 would materially impact the measurement of assets and liabilities, a further question arises: ‘Should the entity incorporate developments after the reporting date when measuring the assets and liabilities at the reporting date?’. This might, in some cases, depend on the asset or liability in question, the relevant accounting standard, and the measurement basis for that asset or liability. The following FAQs, 25. and 26., might be helpful in this regard.

25. Adjusting events affecting impairment calculations related to non-financial assets with a measurement basis other than fair value

A number of non-financial assets are measured on a basis other than fair value when they are impaired. The most common examples are assets measured using ‘value in use’ under IAS 36 or at net realisable value under IAS 2.

Management might have judged that the impact of COVID-19 existed at the reporting date and should be incorporated into the measurement of assets and liabilities at the reporting date (see FAQ 24.). An entity has to determine whether developments after the reporting date provide management with better information about a condition that already existed at the balance sheet date. This requires judgement and an analysis of the facts and circumstances in order to distinguish between adjusting and non-adjusting information. The impairment test should be updated after the reporting date if material developments provide better information relating to the reasonably expected impacts of COVID-19 than existed at the reporting date.

A continuation of a previously observed trend does not usually warrant further adjustment, because the trend should have been incorporated into the most recent impairment calculation. However, material developments subsequent to the reporting date relating to COVID-19, that provide better information about the conditions that already existed at the reporting date (that is, the reasonably expected impact of COVID-19), might require management’s assumptions to be updated in the impairment calculations.

For example, an entity might make the following assessments:

1. An entity with a 31 March 2020 reporting date had not anticipated a material government relief programme as one of the possible scenarios in its cash flow modelling. During the period after the reporting date but before the financial statements are authorised for issue, the government provides the relief. Management judges that the government relief programme is a material development which could have reasonably been expected at the reporting period. This development provides additional information about a condition (that is, the reasonably expected impact of COVID-19) that existed at the reporting date. Therefore, management updates the cash flow model to include the scenario, with an appropriate probability weighting.
2. An entity with a 31 March 2020 reporting date has used an ‘expected cash flow’ approach in its value in use model, with three scenarios. One of those scenarios incorporates a government lockdown and the other two do not. After the end of the reporting period but before the financial statements are authorised for issue, the government imposes a lockdown. The entity might consider updating its scenarios to reflect the higher probability of the lockdown.

26. Adjusting events affecting remeasurement/impairment calculations related to assets with a measurement basis of fair value

A number of assets are measured at fair value, either through remeasurement (investment properties) or through impairment (fair value less cost of disposal).

A fair value measurement is based on information available at the date of measurement. An entity should not make any adjustments for events after the reporting period for fair values that are based on only Level 1 or Level 2 inputs. This is because using Level 1 or Level 2 inputs means that the entity has already incorporated all of the information that a market participant would have considered at the date of measurement. 

Even where Level 3 inputs are used to measure fair value, the fair value measurement objective remains the same (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability). Therefore, unobservable inputs should reflect the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. Level 3 inputs should be developed using the best information available in the circumstances, which might include an entity’s own data. However, the entity’s own data should be adjusted if reasonably available information indicates that other market participants would use different data. Information that becomes known after the measurement date is only taken into account where reasonable and customary due diligence would have identified the additional information at the measurement date. An entity should revise its fair value estimates if reasonably available information indicates that other market participants would use different data.

For example, an entity might make the following assessments:

1. An entity with a 31 March 2020 reporting date had not anticipated at all a material government relief programme as one of the possible scenarios in a Level 3 discounted cash flow model during its period-end process. After the end of the reporting period, but before the financial statements are authorised for issue, the government provides a material relief programme. Management should consider the facts to determine whether a market participant would likely have incorporated some expectation of a government relief programme into its discounted cash flow modelling. However, the fact that the government provided a relief programme does not, in itself, mean that a market participant would have included this as a possible scenario. The entity should not use hindsight to give this scenario a 100% weighting, but it should estimate the likelihood of a government relief programme being implemented, consistent with what a market participant would have assumed at the reporting date.
   
2. An entity with a 31 March 2020 reporting date has used an income approach to measure fair value. The model includes three scenarios that use Level 3 inputs. One of the scenarios incorporates a government lockdown and the other two do not. After the end of the reporting period but before the financial statements are authorised for issue, the government imposes a lockdown. At the reporting date, a market participant would not have known that a lockdown was a certainty, and so the entity should not adjust its model to have only one scenario with a 100% weighting.

27. Implications of goodwill impairment in interim financial statements

Entity A, with a 31 December year end, prepares interim financial statements using IAS 34 for the first quarter of 2020. At 31 December 2019, it had goodwill with a carrying amount of C1,000. The coronavirus (COVID-19) pandemic and general economic downturn caused a trigger to test for impairment in the first quarter of 2020. Entity A completed an impairment review at 31 March 2020 which resulted in the goodwill being written down to C600 and an impairment of C400 recognised in the income statement. By 31 December 2020 the pandemic is under control and the economy has recovered; if an impairment test was performed at 31 December 2020 on the original goodwill of C1,000, no impairment would be required.

Can entity A reverse the C400 goodwill impairment at year end?

Answer

No. Entities preparing interim financial reports using IAS 34 are required to apply IFRIC 10, which does not allow an entity to reverse an impairment loss of goodwill recognised in a previous interim period prepared under IAS 34. Even if the economic outlook improves before year end, such that the recoverable amount of the cash-generating unit is higher than the carrying value including goodwill of C1,000, the entity would not be permitted to reverse the impairment of goodwill. The C400 will be reported as goodwill impairment in the full year’s financial statement.

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