Some thoughts on adjusting events under IAS-10: Events after the Reporting Period

An accounting blog would ideally aspire to address a range of interesting accounting issues over time. It is a sign of our times, that the current standard-setting and practitioner space is heavily influenced by the singular event crowding present thought. See here and here for examples. One hopes this changes soon (for obviously more profound reasons) and variety can return to the accounting agenda.

IAS 10 (International Financial Reporting Standards) on ‘Events after the Reporting Period’ has always been a tricky standard to apply. Fortunately, in a normal business environment and under stable economic conditions, IAS 10 has limited applicability although that also means it runs the risk of being subjected to cursory review. Under current conditions, the standard has assumed heightened significance. Several transnational regulators and accounting bodies have recently emphasised the need for additional attention by financial statement preparers in considering whether the sequence of Covid-19 events constitute adjusting or non-adjusting events under IAS 10. For those interested in this, further context can be obtained from communications by the IFAC, the ICAEW and ESMA (the last in the context of IFRS 9 on the matter of Expected Credit Losses).

Both, adjusting and non-adjusting events under IAS 10, arise between reporting date and the date that financial statements are authorized for issue. But adjusting events are wider in scope at the level of the individual financial statement element given their impact on recognition, measurement and disclosure as on balance sheet date. Non-adjusting events provide additional information about conditions arising after balance sheet date and if material, usually only require disclosures. Conversely, adjusting events (although arising subsequent to balance sheet date) provide evidence of conditions related to financial statement items, that exist as on that date. For example, it is likely that a doubtful receivable due from a customer (and already partially provided for) as on balance sheet date is confirmed to be fully credit impaired subsequently (before authorising financial statements for issuance) due to a bankruptcy declaration by the customer in that period. IAS 10 requires the preparer to consider reducing the carrying amount of such a receivable despite the event (bankruptcy) occurring after balance sheet date as the event provides additional evidence of credit conditions existing on balance sheet date. Scale that up to an event that potentially affects a range of balance sheet items and you get the idea. In the case of Covid-19, the timing of when it was officially recognized as a global health incident assumes significance – the WHO declared Covid-19 a pandemic on the 11^th of March. Country-wide lockdown announcements quickly followed. General consensus among accounting bodies suggests that for companies with close dates of January 31^st and February 28^th, whether an adjusting event exists, would depend on preparer-specific circumstances and would in most cases expect to result in adjusting events only where there is significant direct exposure to China e.g. significant production or customer base in China.

It is interesting and perhaps more practically significant that for companies reporting annual and/or interim financial statements for quarter ended March 2020, pandemic declaration and consequently, Covid-19 becomes a current-period event (within the quarter). For all subsequent quarters, ongoing evaluation of this current event will be required. The issue of events arising after balance sheet date for periods ending March 2020 and thereafter, will therefore arise from other secondary developments related to the pandemic. Some important points. First, ongoing monitoring of credit quality will assume significance for a range of balance sheet items e.g. receivables, loans and cash equivalents. Consequently, post-balance sheet adjusting events may arise where credit deterioration lags balance sheet dates. Second, where governments have issued bail-out packages with a sufficient level of detail and well-defined eligibility criteria e.g. moratoria on specific debt repayments or suspension/remission of certain liabilities, and such packages were announced after balance sheet date i.e. March 31^st, these could constitute events that provide further evidence of the level or otherwise of credit impairment as on balance sheet date. Therefore, these could potentially give rise to adjusting events and will require ongoing monitoring and judgement even for subsequent quarters as bailout schemes are tapered or modified. Their effects on credit risk and recovery values could be both ways – additional losses, or reversals of earlier estimated impairments.

Third, and this is important as a principle. A deterioration in forecasts of cash flows or elevated risk premia subsequent to March 31^st or a reporting date thereafter, would not themselves constitute ‘events’ after balance sheet date unless they can provide direct and specific evidentiary value in asset measurement. So, for example, judgements regarding impairment of goodwill which require estimations of future cash flows and discount factors for determining fair values and value-in-use, would not necessarily result in adjusting events despite further deterioration in business or financial conditions after balance sheet date. Why? Because, these are usually long-term forecasts; it is implausible that impairment judgements would be based on scenario analysis without considering a range of possibilities and historic values. Many of these alternative possibilities would likely presume recovery and return to ‘normal’ at some point in the future. Of course, goodwill impairment outcomes also depend on other variables including acquiree industry conditions and extent of goodwill allocated.

Our interpretation of IAS 10 could be extensively tested in period-ends coming up over the next few months e.g. March and June 2020 (lets hope not!). That said, it is specific developments (credit events, identified guarantees, well-defined bail-out clauses, and litigation outcomes) that should result in adjusting events. Developments that increase estimation uncertainty or reduce visibility e.g. financial market volatility or business uncertainties should not themselves lead to adjusting events unless these can be more concretely linked to specific account balances. Finally, there is also the outside chance that extended regulatory deadlines for approving and publishing financial statements provide the opportune time window within which potential adjusting events of an adverse nature reverse themselves…that would be a blessing!