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What to focus on in financial reporting this year-end

Photographic portrait of Victor Chan
Victor Chan

International Director, Global IFRS Services, Ernst & Young Global Limited

03 Nov 2023
Related topics
Assurance
IFRS

For year-end, companies need to address going concern, asset impairment, liability classification, climate disclosures and Pillar Two rules.

In brief
  • Economic challenges may impact companies’ financial stability and require disclosure of asset impairment, liability classification and going concern assessment. 
  • Companies need to address climate change concerns through transparent and entity-specific disclosures, considering both quantitative and qualitative factors. 
  • Complex Pillar Two model rules will impact 2024 current income tax expenses, necessitating compliance and disclosure. 

As year-end approaches, many companies have started planning for their annual financial statements and related filings. Considering the general economic environment and recent financial reporting developments, company executives and board members may find it helpful to focus on the following key themes for the forthcoming reporting season.

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Impairments, liability classification and going concern - high inflation and interest rates, volatile commodity markets, fluctuating foreign exchange rates and other macroeconomic factors have contributed to an economic downturn in many countries. Consequently, asset impairments are likely to occur more frequently. Apart from the general impairment model under IFRS, some assets such as financial instruments, inventories and investments in associates and joint ventures are subject to specific recognition and measurement requirements of impairment losses. Also, companies may need to recognize additional liabilities associated with onerous contracts.

 

The effects of the economic downturn may impact a company’s ability to meet the covenant requirements included in long-term loan arrangements and, therefore, the assessment of whether its liabilities are current or non-current may be impacted. When a company breaches a covenant on or before the period end with the effect that the liability becomes repayable on demand, it is classified as a current liability unless a waiver is obtained before period end which effectively rectifies the breach so that the loan is not repayable within 12 months from period end.
 

The current economic environment could have a significant negative impact on a company’s financial position and performance and, hence, affect the appropriateness of the going concern assumption. Disclosures are required when the going concern basis is not used or when management is aware, in making the assessment, of material uncertainty related to events or conditions that may cast significant doubt upon the company’s ability to continue as a going concern. Disclosures are also required when the judgement applied in determining the existence of a material uncertainty is significant.
 

Consideration of climate change matters - in recent years, there is increasing pressure for companies to communicate a clear commitment to reduce their impact on the environment. Such disclosures are often found in the annual report, and they tend to attract significant attention from investors, regulators and other stakeholders.
 

One common pitfall that companies need to avoid is the assumption that climate-related disclosures are not mandatory under IFRS. While there is currently no single explicit standard on climate-related matters in IFRS, climate-related risks and other similar uncertainties may impact a number of areas of accounting. Companies are also required to disclose significant assumptions, estimates and judgements made, which may be related to climate change.

One common pitfall that companies need to avoid is the assumption that climate-related disclosures are not mandatory under IFRS.

Added to this, there are emerging accounting issues associated with climate-change initiatives. For example, some companies may have decided to reduce, or offset, their carbon footprint using carbon credits or to enter into various power purchase agreements to acquire electricity from renewable sources. Without explicit guidance in IFRS that specifies the accounting, the appropriate treatment for such emerging issues will depend on the specific fact patterns and careful analysis to identify the relevant accounting requirements.

Another common pitfall is that there may be limited demonstrable connectivity between the disclosures made by companies inside and outside the financial statements. Regulators have recently taken enforcement actions against companies that failed to provide sufficient disclosure of climate-related matters in their financial statements. Therefore, companies need to make transparent and entity-specific disclosures, such as quantifiable information about assumptions and sensitivities, to illustrate the uncertainty embedded into estimates. Companies also need to ensure consistency in both the disclosure of climate-related matters outside the financial statements and how they incorporate climate risk in their financial information. While some companies may have previously concluded that the impact to the financial statements was not quantitatively material, materiality needs to be assessed based on both quantitative and qualitative factors.

While some companies may have previously concluded that the impact to the financial statements was not quantitatively material, materiality needs to be assessed based on both quantitative and qualitative factors.

Implementation of Pillar Two model rules - many countries are implementing the international tax reform Pillar Two model rules which will require large multinationals to be subject to a global minimum tax rate of 15% on their profits in each jurisdiction from 2024. In May this year, the International Accounting Standards Board (IASB) amended IAS 12 Income Taxes to provide a mandatory temporary exception to the accounting for deferred taxes arising from the jurisdictional implementation of the Pillar Two model rules. As a result, the impact of the international tax reform on a company’s financial performance will affect current income tax expenses in 2024.

In addition, companies are required to disclose, for periods in which the relevant legislation is (substantively) enacted, but not yet effective, known or reasonably estimable information that helps users of financial statements understand their exposure arising from Pillar Two income taxes.

Companies affected by the Pillar Two model rules need to monitor the implementation developments in each relevant jurisdiction. They also need to establish processes to calculate the 2024 current income tax expense and obtain the information necessary to present the disclosures required by the amendments in a timely manner.

Pillar Two model rules are complex and their overall impact on a company would depend on implementation at the jurisdictional level among other things. Therefore, companies affected by the Pillar Two model rules need to monitor the developments around their implementation and (substantive) enactment in each relevant jurisdiction. They also need to establish appropriate processes and procedures to calculate the 2024 current income tax expense and obtain the information necessary to present the disclosures required by the amendments in a timely manner.

Given the prevailing economic environment and recent developments, companies may need to allocate more resources and time for year-end financial reporting. Understanding the changing needs and requirements of both stakeholders and regulators would be key to effective communication and continuous improvements in financial reporting.
 

Summary 

Companies preparing for the forthcoming financial reporting season need to consider how economic challenges will affect going concern assumptions, how to ensure climate change disclosures are transparent while monitoring the impact of Pillar Two model rules. It's essential to monitor these changes, allocate resources effectively, and meet evolving stakeholder and regulatory demands for robust financial reporting in the evolving economic landscape.

About this article

Photographic portrait of Victor Chan
Victor Chan
International Director, Global IFRS Services, Ernst & Young Global Limited
Develops insights on applying IFRS to emerging accounting issues. Focuses on leases, crypto-assets, investment property and latest standard-setting activities. Enjoys relaxing with family.
Related topics
Assurance
IFRS

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