Accounting in times of uncertainty

BDO recently updated its 2022 publication, ‘Accounting in times of uncertainty’. The 2023 edition provides expanded guidance on how factors such as the evolving geo-political risks, energy supply shortages, rising energy prices and inflationary pressures are leading to an uncertain economic environment, that have numerous accounting implications. The 2023 edition notes the following accounting areas that may be impacted:

Links in the Annexure to guidance published by various regulators have also been updated.

Items linked above represent new areas of guidance which are discussed briefly below. Please refer to the complete 2023 edition for more information.

Fair value measurement

Entities need to consider the effect of uncertain current macroeconomic conditions on fair value measurements, particularly with respect to Level 3 inputs and the disclosures provided.

When determining the fair value of investment properties, key points to note are:

  • Entities may use independent valuers to determine the fair value of investment property. However, it is the responsibility of the management to ensure that the fair value measurements comply with the requirements of IFRS 13 Fair Value Measurement.
  • Entities should explain how they determined the key inputs to the fair value measurement.
  • If the market approach (comparable transactions) is used and there is a decline in the activity in real estate markets, there may be limited information on comparable transactions in recent periods. Entities may need to apply additional valuation methods to conclude that the price estimated using the comparable transactions approach is within a reasonable range of values.

As a result of the current macroeconomic conditions, some entities may need to sell financial assets to generate additional liquidity. Such entities, may need to focus on the disclosures of fair value of financial instruments measured at amortised cost.

Effects of inflation (additional consideration added for rising interest rates and their effect on financing and refinancing)

The 2023 edition expands the list of financial reporting implications noted in the 2022 edition due to rising inflation. In addition to the ‘usual suspects’ such as the impact on discount rates which features in various standards, it specifically mentions the effect of rising interest rates on (re)financing for highly leveraged entities. Disclosures are key, and should include:

  • An explanation of how changes in the macroeconomic environment affect the entity’s risk exposures (distinguishing between floating rate and fixed rate financial instruments) and how the entity manages these risks
  • A sensitivity analysis for reasonably possible changes in interest rates, which may need to reflect their recent volatility

    Entities may provide different types of sensitivity analyses for different classes of financial instruments. Any changes to the methods and assumptions used in the preparation of the sensitivity analysis should be disclosed with the reasons.
  • The effect on the entity’s ability to meet covenant requirements

    High inflation and volatile interest rates may adversely affect the entity's ability to meet covenant requirements in long-term loan arrangements. Entities need to consider requirements to provide disclosures about covenants and the effect of potential breaches.

Climate-related matters

Regulators are closely scrutinising how entities consider climate-related matters in financial statements, with the Australian Securities and Investments Commission (ASIC) identifying climate as a focus area for its 31 December 2023 financial reporting surveillance. Preparers should therefore consider the following:

  • Consistency between IFRS financial statements and non-financial information to mitigate the risk of greenwashing
    Ensure that the assumptions used in estimations and measurements related to climate matters and the information provided across the different sections of the annual financial report (i.e. IFRS financial statements and non-financial information) and other public releases are consistent.
  • Accounting for emission trading schemes and renewable energy certificates
    The accounting policies used for recognising, measuring and presenting emission trading schemes and renewable energy certificates should be disclosed. Entities may need to recognise provisions and provide disclosures, in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, when local legal arrangements on GHG emissions give rise to obligations to purchase GHG emission rights exceeding any rights the issuer currently holds.
  • Impairment of non-financial assets
    Entities should consider risks arising from climate-related matters (physical or transition risks) when assessing the indicators of impairment of non-financial assets. When a parameter linked to climate-related matters is identified as a key assumption, entities should disclose:
    • The quantified assumptions used (e.g. CO2 prices, timing and amounts of replacement of certain assets)
    • The basis of such quantifications (i.e. internal or external estimates).
  • Specific considerations for financial institutions
    Financial institutions should disclose:
    • Information on how they engage in green financing to help users understand the impacts, and assess the nature and extent of the specific risks associated with these financial instruments
    • Significant accounting judgements used when accounting for such instruments. For example, their assessment of whether contractual cash flows on financial instruments with ESG-linked features meet the SPPI (solely payment of principal and interest) test.
    The effect of climate risk on banks’ expected credit loss (ECL) provisions should also be properly incorporated into the provisioning framework.

Need help?

Please contact BDO’s IFRS & Corporate Reporting team if you need help with any of these financial reporting matters.