The outbreak of the corona pandemic at the beginning of 2020 has far-reaching implications - also on accounting. Especially for companies that - legally or voluntarily - prepare their accounts according to international accounting standards, far-reaching changes are imminent for the coming annual financial statements. In the following, the effects of the corona pandemic on accounting in accordance with International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) will be presented on the basis of IFRS 16 (Accounting for Rental and Leasing Contracts), IAS 36 (Impairment of Assets) and IFRS 9 (Accounting for Financial Instruments).
IFRS 16 from the perspective of the lessee
The new IFRS 16 (Accounting for Rental and Leasing Contracts) has increasingly become the focus of companies and auditors as a result of the Corona pandemic. The standard stipulates that almost all leasing and rental relationships of a company must be fully disclosed in the lessee's balance sheet. In the course of the accounting process, a leasing liability is reported on the liabilities side of the balance sheet which represents the present value of future leasing payments. On the other hand, a right of use is reported on the asset side. The complete recording and valuation of rental and leasing contracts as of January 1, 2019 already posed a great challenge to many companies in the periods prior to Corona.
Problems with the application of IFRS 16 during the Corona pandemic
Due to the Corona pandemic, a high volume of temporary changes (e.g. deferrals or waivers of lease payments) in leasing and rental agreements can be observed. In principle, IFRS 16 stipulates that if the lessee changes the terms and conditions of a lease or rental agreement, it must be assessed whether these changes are modifications of the agreement. Modifications are deemed to exist if a change in the scope of the contract or the consideration is agreed which was not part of the original contract. In the event of a deferral or waiver of the lease, it would be a modification that does not have to be accounted for as a separate lease, as the scope of the right of use is usually not affected. The accounting treatment of the agreement must be adjusted in such a way that both the present value of the liability and the right of use are recalculated.
Measures of the IASB to facilitate accounting around IFRS 16
In order to avoid the complexity of modifications caused by the Corona pandemic, the International Accounting Standards Board (IASB) amended IFRS 16 on May 28, 2020. The lessee is granted an option under this corona-related amendment. Rental concessions in connection with the corona pandemic can still be treated as a modification of the lease in accordance with the previously applicable provisions of IFRS 16. Alternatively, the amendment provides for the recognition of corona-related lease concessions as negative variable lease payments in accordance with IFRS 16.38 (b). It is also possible to recognize a pro rata derecognition of the liability affecting net income, depending on the requirements of IFRS 9. The aim of this simplification is to save lessees from having to review the modifications of leasing agreements for each Corona-related lease concession.
Conditions for exercising the right to vote
The option to facilitate accounting is only possible if three conditions are met:
- The lessee has to prove that the contract changes are to be considered as a consequence of the Corona pandemic.
- No other changes may be made to the contract that do not affect the consideration (e.g. a reduction in the rental space).
- The right to vote is generally limited only to payments that are due up to and including June 2021.
The endorsement of the amendment to European law is expected in the fourth quarter.
The impairment test according to IAS 36
The impairment test pursuant to IAS 36 (Impairment of Assets) is intended to identify impairment losses on tangible and intangible assets at the balance sheet date. IAS 36 requires an assessment to be made at each reporting date for assets within the scope of application as to whether there are external and/or internal indications (triggering events) of impairment. This also applies to interim financial statements. Irrespective of possible indications, goodwill and intangible assets with indefinite useful lives must be tested annually.
Due to the outbreak of the Corona pandemic in spring 2020, it is to be expected that there will be indications of an impairment (during the year) for many companies. Examples of possible indications include
- extensive adverse changes in the market or economic environment.
- adverse change in the use of assets, e.g. due to planned shutdowns.
- the carrying amount of net assets exceeds its market capitalization.
An impairment test must be carried out if there are indications of impairment (during the year). In the course of this test, it must be determined whether the carrying amount of the asset concerned is higher than its recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. In order to determine the value in use as well as the fair value, in case of the valuation techniques normally applied, future cash flows have to be derived and discounted on the basis of expected cash inflows and outflows. If the carrying amount of the asset is higher than its recoverable amount, an impairment loss must be recognized in accordance with IAS 36.59 to reduce the carrying amount to the recoverable amount. The resulting impairment loss must be recognized in profit or loss in accordance with IAS 36.60.
Problems with the application of IAS 36 during the Corona pandemic
In the course of the Corona pandemic, many companies have experienced external and/or internal triggering events for an impairment test during the year. Due to the current economic uncertainties, many companies are faced with major challenges in determining the recoverable amount. This is due to the fact that both the already uncertain future cash flows and the discount rate, which is constantly being adjusted to current conditions, are even more difficult to estimate. If the recoverable amount falls significantly below the carrying amount, this results in an impairment loss, which can sometimes have a significant impact on the profit or loss of a company.
Possibilities of action for companies
In order to counteract the consequences of the Corona pandemic with regard to the impairment test, it can be helpful for companies to continuously analyze whether there are any indications of impairment, so that there is no unpleasant surprise at the reporting date. Furthermore, it appears useful to use scenario and sensitivity analyses to further analyze the headroom between recoverable amount and carrying amount.
The impairment of financial instruments according to IFRS 9
The impairment model of IFRS 9 (Accounting of financial instruments) is used to determine expected credit losses (ECL) for financial assets. The impairment model is to be applied to financial instruments measured at amortized cost and, among other things, to lease receivables and contractual assets within the scope of IFRS 15. In the course of the Corona pandemic, determining the ECL is challenging for many companies, especially banks. The three-step impairment model of IFRS 9 is based on a change in credit risk since the addition of the financial instrument.
- Financial assets whose default risk has not significantly increased since the addition are to be allocated to level 1. As a result, the present value of the expected payment defaults for the next twelve months after the balance sheet date must be determined for these assets (12-month expected credit loss).
- If the default risk deteriorates significantly, the asset in question must be allocated to level 2. In this level, risk provisioning is performed over the entire remaining term of the financial instrument (lifetime expected credit loss).
- If a financial asset shows objective evidence of impairment in addition to a significant increase in default risk, it must be allocated to level 3. In addition to calculating the ECL over the remaining term, the interest recognition for subsequent periods must also be adjusted. Accordingly, interest income must be calculated on the basis of the net carrying amount and not, as in level 2, on the basis of the gross carrying amount.
IFRS 9 permits a simplified procedure for lease receivables resulting from transactions under IFRS 16 as well as trade receivables and contractual assets within the scope of IFRS 15 that also have a significant financing component. As an option, the entire remaining term may be used as a basis, so that the complex tracking of changes in credit risk is no longer necessary. The simplified procedure is mandatory for trade receivables and contractual assets without a financing component.
Recommendations of the IDW Banking Expert Committee
On June 19, 2020, the Banking Committee of the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer [IDW]) issued a technical note regarding the impact of the Corona Pandemic on impairments of financial instruments of banks according to IFRS 9. According to this, the opinion remains that the Corona pandemic does not lead to an undifferentiated, automatic transfer of financial instruments from Level 1 to Level 2 or even Level 3, as this could significantly overstate the actual economic risks. In the course of this, it is recommended that banks, when using credit risk models to determine the ECL, place greater emphasis on long-term stable scenarios and attach less importance to short-term developments.
It should also be noted that the uncertainties of future economic development are gradually diminishing, so that a longer course of the crisis is becoming apparent. Against this background, it is to be assumed that the balance sheet provision for risks in accordance with IFRS 9 will increase as of June 30, 2020. If the current effects of the corona pandemic are not yet adequately captured in the current credit risk models, it would be necessary to adjust them in the form of post model adjustments. Government stabilization measures are to be taken into account to reduce risk.
It is recommended that banks report transparently on the consequences of the corona pandemic, stating the main assumptions made, in order to enable recipients to better understand management's considerations and assessments.
Possible effects for industrial companies
Industrial companies considering the entire remaining term due to the simplified procedure, are once again faced with the challenge of considering appropriate and reliable future information, whereby historical data alone may not be sufficient. In particular, industries with significant financing components and leasing arrangements in the sales model, such as mechanical engineering, will probably have to review their assumptions and adjust them if necessary.