In our IFRS news for May, we provide more insights on IFRS 9 expected credit losses (ECL) of corporate entities during the COVID-19 pandemic as well as current financial reporting issues.
COVID-19 related IFRS topics:
IFRS 9 expected credit losses for corporate entities
IFRS News:
IFRS 16 accounting and disclosures – What to look out for
Translation of hyperinflationary foreign operations (IAS 29/IAS 21)
Other Switzerland:
SIX Exchange Regulation Areas of Focus for IFRS and Swiss GAAP FER 2020
For a banking industry focus on IFRS 9 expected credit losses read our article
The COVID-19 pandemic has had and will continue to have far-reaching implications. In many parts of the world, governments have brought in never-before-seen measures including mass quarantines, social distancing, border closures, shut-downs of non-essential services and considerable (in some cases, unlimited) commitments to provide financial support to affected businesses and individuals. Just as the medical implications are emerging and evolving at breakneck speed, so too are those related to the economic and credit environment.
COVID-19 will impact many areas of accounting and reporting for all industries, as outlined in our publication In depth: Accounting Implications of the Effects of Coronavirus. The IASB issued a short document on IFRS 9 and COVID-19 in March 2020. Regulatory authorities have also provided additional guidance for financial institutions. But companies in all industries are facing additional working capital pressure and a likely increase in the credit risk of their receivables. In this article we focus on the implications for corporate entities (that is, non-financial institutions) when measuring expected credit losses (ECL) on trade receivables, contract assets, lease receivables, intercompany loans and any other financial assets subject to IFRS 9’s ECL requirements.
While this article focuses on ECL, there will be other IFRS 9-related issues including the ability to continue hedge accounting and the implications of debt modifications or working capital improvement projects. Entities are reminded to consider all potential accounting issues. Further guidance on these and other issues is given in the In depth referred to above.
1. Key messages in the IASB document
As noted above, in March 2020 the IASB issued a short document on the application of IFRS 9 in the light of uncertainty arising from the COVID-19 pandemic. The IASB document is intended to support the consistent and robust application of IFRS 9. It acknowledges that estimating ECL is challenging in the current circumstances and that ‘it is likely to be difficult at this time to incorporate the specific effects of COVID-19 and government support measures on a reasonable and supportable basis.’ However, the IASB is also clear that ‘changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in their weightings.’
Key messages for all entities, including non-financial institutions, include:
We consider below the implications of this and other guidance for corporate entities.
2. Measuring and presenting expected credit losses (ECLs) – reminder of the core principles and implications of the changing environment
While the uncertainties arising from COVID-19 are substantial and circumstances are certain to change, we do not expect this to preclude entities from estimating their ECLs. Estimating ECLs is challenging, but that does not mean it is impossible to estimate an impact based on the reasonable and supportable information that is available. On transition to IFRS 9, few corporates recognised a material increase in their impairment provisions but ECLs are likely to be higher in the current environment. A few things that may be helpful to keep in mind are:
3. Implications for trade receivables, lease receivables and contract assets measured using the simplified approach
Financial instruments within the scope of IFRS 9’s ECL model include trade and other receivables, loan receivables and other debt investments not recognised at fair value through profit or loss (including intercompany loans), contract assets, lease receivables, financial guarantees and loan commitments.
For many corporate groups the main balances subject to ECL will be trade receivables. As required by IFRS 9, a simplified approach of using lifetime ECL is used for measuring the ECL for such trade receivables and contract assets if they do not contain a significant financing component. Entities often calculate ECLs by using a provision matrix. The simplified approach is also permitted for lease receivables and receivables with a significant financing component, but this is an accounting policy choice.
However, forward looking information (including macro-economic information) must still be considered in assessing the credit risk on those balances and in measuring ECL. As noted above, forwardlooking information might include one or more downside scenarios related to the spread of COVID-19.
Companies often stratify their receivables into different groupings before applying a provision matrix. For example, a company might sell to customers in different industries some of which are impacted by COVID-19 to a greater degree than others and therefore be exposed to different risks of default. Other factors that might be considered in such stratification would include geographical regions, product type, customer ratings, collateral, and the nature of the customer (for example, wholesale vs. retail).
In considering stratification, it is important to first understand the drivers of credit risk for the underlying receivables and how these may have changed in light of the current pandemic. The level of stratification required is often a matter of significant judgment and in developing segments an entity should consider where further segmentation might be needed. Stratification may go down to the individual customer level in some cases, often described as a specific bad debt provision. For example, where a particular customer is known to be in financial difficulty, it may require an increased provision compared to historical averages over all ageing categories. It is important to consider and avoid any double counting of losses in these situations.
In attempting to model the impact of the pandemic, companies might, as a starting point, look to the behaviour of their customers during previous recessions, thereby using historic credit loss experience as an estimate of future losses. However, given restrictions on both movement and economic activity of a similar magnitude are unlikely to have been experienced in most jurisdictions in modern times, adjustments will need to be made to that historical information to make it supportable in the current period. This could increase the expected risk of default for each time bucket in the provision matrix.
Similarly, some customers may take longer than normal to pay, thus increasing the volume of debtors in the overdue buckets. The extent to which this delay is due to credit risk or is merely an indication of operational issues (e.g. if employees are not able to access their offices) will need to be carefully considered. Many supplier arrangements include the right to charge interest on overdue payments, but in practice it is not always implemented in order to keep good customer relationships. If entities do not intend to charge interest, then it should not be accrued.
The likelihood of debtors paying, and the effect of any government initiatives will also need to be revisited in measuring ECL at the end of each reporting period.
Further information on calculating ECL in a corporate scenario is given in our publication on IFRS 9 impairment practice guide provision matrix: In depth UK2018-03.
4. Loan receivables, including intercompany balances and other assets not measured using the simplified approach – identifying significant increases in credit risk (SICR)
Where entities are not permitted to follow the simplified approach, or have opted not to, additional information may be needed in order to determine whether a significant increase in credit risk has occurred, and hence whether a lifetime, rather than 12-month, ECL is required. This will apply to all receivables to which the full IFRS 9 model is applied including loan receivables and most intercompany balances. Factors to consider include:
5. Interim reporting under IAS 34 and other disclosure considerations
Many regulators around the world are revising timelines and requirements for interim reporting. When entities do issue interim reports under IAS 34, it will be important to keep in mind the overarching requirement to explain events and transactions since the end of the last annual reporting period that are significant to understanding changes in financial position and performance. Key considerations in meeting that requirement, and when preparing other forms of interim reports, are likely to include:
COVID-19 has given rise to unprecedented challenges that have affected virtually every aspect of modern life. The economic implications of the virus will have a consequent impact on many aspects of accounting and financial reporting. We hope this article will help you and your advisers as you navigate the key issues as they relate to IFRS 9 ECLs for Corporate entities.
Listen to our podcast series about the impacts of coronavirus
The accounting implications of coronavirus (COVID-19)
Government grant and coronavirus (COVID-19)
COVID-19 Impact on IFRS 9, Expected Credit Loss
IAS 10, post balance sheet events and COVID-19
Here you can find our answers to frequently asked questions about the accounting implications of the effects of coronavirus:
At a glance
This applies to all entities that apply IFRS 16, ‘Leases’.
Transitioning to a new accounting standard is not straightforward. With the introduction of IFRS 16, there are several accounting and disclosure considerations which need to be taken into account.
Below are some common mistakes to look out for and questions to ask yourself when you are assessing IFRS 16 accounting and disclosures.
What is the issue?
This In brief provides you with a number of reminders on IFRS 16, the new accounting standard for leases, along with references to useful sections of Inform where you can find more information.
What is the impact and for whom?
Lease term
Useful life of non-removable leasehold improvements
Restoration costs
Presentation in the cash flow statement
Disclosures about future cash outflows that are not reflected in the measurement of lease liabilities and IFRS 7 disclosures
a. variable lease payments (as described in para B49);
b. extension options and termination options (as described in para B50);
c. residual value guarantees (as described in para B51); and
d. leases not yet commenced to which the lessee is committed.
IAS 7 financing activities reconciliation
Impact on other standards
Which entities does this guidance apply to?
The guidance in this In brief applies to all engagement teams performing audits of IFRS and FRS 101 annual reports.
When does it apply?
IFRS 16 is effective for annual reporting periods beginning on or after 1 January 2019.
Where do I get more details?
Further guidance on the application of the accounting standards for leases can be found in the IFRS manual of accounting chapter 15 (subscription required – apply for a free trial of Inform at pwc.com/inform.)
At a glance
The IFRS Interpretations Committee (IC) received a request asking: (1) how an entity with a non-hyperinflationary presentation currency should present differences that arise on restating and translating the opening financial position of a hyperinflationary foreign operation; and (2) whether the foreign currency translation reserve should be reclassified when a foreign operation becomes hyperinflationary.
The IC concluded that an entity should present translation differences in OCI and not in equity. The IC also concluded that an entity does not reclassify the accumulated foreign currency translation reserve to a component of equity that is not subsequently reclassified to profit or loss when a foreign operation becomes hyperinflationary.
The agenda decision is relevant to entities with foreign operations in hyperinflationary economies, particularly those that currently apply a different policy for recognising restatement and translation effects on opening equity. These entities should reconsider their existing policies in the light of the IC’s conclusion and determine whether any changes are required.
What is the issue?
IAS 21 requires an entity to restate the results and financial position of a hyperinflationary foreign operation by applying IAS 29 before applying the translation method set out in IAS 21. This will have two effects:
1. a restatement effect resulting from restating the entity’s interest in the equity of the hyperinflationary foreign operation (IAS 29); and
2. a translation effect resulting from translating the entity’s interest in the equity of the hyperinflationary foreign operation at a closing rate that differs from the previous closing rate (IAS 21).
However, neither IAS 21 nor IAS 29 explains specifically how these effects should be presented in the consolidated financial statements, and the IC observed that there was mixed practice.
IAS 21 also requires the results and financial position of a foreign operation that does not have the functional currency of a hyperinflationary economy to be translated into the presentation currency in each period, and any translation differences to be recognised in a foreign currency translation reserve within equity until the foreign operation is sold. However, neither IAS 21 nor IAS 29 explains specifically how this reserve is dealt with when the foreign operation becomes hyperinflationary.
The IC has issued an agenda decision on the interaction between IAS 21 and IAS 29 that addresses both of these issues.
How does an entity present any exchange difference arising from translating a hyperinflationary foreign operation?
The IC concluded that an exchange difference can be defined either as a translation effect alone or as the combined effect of restatement and translation. The way in which an entity defines exchange difference will determine the presentation of these effects.
IAS 21 requires the recognition of exchange differences in profit or loss or other comprehensive income (OCI). As a result, it would not be appropriate to recognise all translation differences directly in equity, even if a foreign operation has a functional currency of a hyperinflationary economy. The presentation of the restatement and translation effects will therefore follow one of two approaches:
Should an entity reclassify its currency translation reserve in equity when a foreign operation first becomes hyperinflationary?
The IC concluded that an entity would not reclassify the accumulated foreign currency translation reserve to a component of equity that is not subsequently reclassified to the income statement when a foreign operation becomes hyperinflationary. The accumulated foreign currency translation reserve is reclassified to profit or loss only when the foreign operation is sold (or partially sold).
What is the impact and for whom?
The agenda decision will affect entities with foreign operations in hyperinflationary economies, particularly those that currently apply a policy of recognising restatement and translation effects in equity. In particular, the agenda decision means that the accumulated foreign currency translation reserve at the date when a foreign operation becomes hyperinflationary, together with translation differences that arise subsequently, will remain in the translation reserve until the foreign operation is sold. The impact on the amount of translation differences reclassified on a subsequent disposal could be material.
Entities that currently apply a different policy should reconsider their existing presentation policies in the light of the IC’s comments and determine whether any changes are required.
When does it apply?
The agenda decision has no formal effective date. The IC has noted that agenda decisions might often result in explanatory material that was not previously available, which might cause an entity to change an accounting policy. The IASB expects that an entity would be entitled to sufficient time to make that determination and implement any change. Any change in policy should be applied retrospectively, and comparative amounts should be restated.
When reviewing financial statements (year end and and interim) for the 2020 financial year, SIX Exchange Regulation AG (SER) intends to focus in particular on compliance with the following IFRS and Swiss GAAP FER (FER) requirements (these also apply by analogy to US GAAP financial statements, where applicable):
a) IFRS
Statement of Cash Flows (IAS 7)
Income Taxes (IAS 12)
b) Swiss GAAP FER
Statement of Cash Flows (FER 4 / FER 30)
Income Taxes (FER 11 / FER 31)
The Board met remotely on 21 and 23 April 2020.
The topics, in order of discussion, were as follows:
This publication comprises a new chapter on insurance contracts under IFRS 17 and an updated chapter on leasing under IFRS 16 – order your hard copy here. The eBook and electronic versions of the IFRS Manual contain additional updates for chapters not reproduced in the printed IFRS supplement – apply for a free trial of Inform now.
For more information and to place an order, visit www.ifrspublicationsonline.com
David Baur
Partner, Investor Reporting and Sustainability Platform Leader, PwC Switzerland
+41 58 792 25 37