Question

Discuss three (3) accounting and financial reporting risks and their implications that have been heightened by the current pandemic situation. At least 2 relevant accounting standards (IASs /IFRSs) must be incorporated in your discussion.

Answer 1

Accounting and financial reporting risk as follows -

1- Adverse Economic Conditions. It is customary for banking institutions to include in their Form
10-K filings a risk factor discussing generally risks associated with economic conditions and
volatility in financial markets. Banking institutions should consider the adequacy of disclosure in
light of the spread of COVID-19, including increased volatility in financial markets and the possibility
of prolonged adverse economic conditions. These risk factors generally consider impacts due to
changes in economic and financial market conditions such as decreases in demand for products,
decreases in market value of loans and securities, impairments of intangible assets (such as
goodwill), decreases in income due to interest rate declines and increases in customer
delinquencies and defaults. Banking institutions should consider whether COVID-19 has caused
or is expected to cause these type of losses or has negatively affected or is expected to affect
growth and strategic plans, and supplement disclosure for any material changes or developments.
Banking institutions should also consider financial and other risks if government programs to
address the impacts of COVID-19, including additional lending facilities announced by the Federal
Reserve, prove to be ineffective.

2- Loan and Credit Losses. To combat the spread of COVID-19, and, in some cases, in response
to governmental mandates to close non-essential businesses, many businesses have ceased or
substantially reduced operations for an indeterminate period. In addition, individuals may have
been laid off, furloughed or be unable to work as a result of reduced business operations. Banking
institutions should analyze their loan portfolios to determine whether there has been a material

change in the credit quality of their loan portfolios due to the impact of COVID-19.

3- Capital and Liquidity. Market volatility and prolonged periods of economic stress may affect
banking institutions’ capital and liquidity. In addition, these factors may limit a banking institution’s
access to capital markets. Banking institutions should consider any risks to their capital and
liquidity due to current and longer-term economic effects of COVID-19, particularly if stress testing
or other models insufficiently predicted the potential impacts of a global pandemic event such as
COVID-19. Banking institutions should also consider limitations on the ability of their banking
subsidiaries to pay dividends. For example, risks to credit portfolios and/or increased draws on
outstanding lines of credit could affect capital and liquidity at, and/or result in decreased income or
increased losses for, bank subsidiaries, and this could in turn impede the bank’s ability to pay
dividends in light of applicable state and federal legal and regulatory requirements, such as those
under the National Bank Act and Regulation H. If the situation deteriorates, regulators may also
consider taking actions to limit a banking subsidiary’s ability to pay dividends, such as the European
Central Bank’s recommendation for credit institutions to suspend dividends and other capital
distributions in order to conserve capital and retain capacity “to support the economy in an
environment of heightened uncertainty caused by COVID 19.”3
Banking institutions should also
consider the regulatory impact of any changes to their own capital and liquidity, including the need
to cease or reduce dividend payments (as occurred during the 2008 financial crisis), and any formal
or informal actions regulators may take to address capital and liquidity concerns.

Relevant accounting standard:-

IAS 36 ‘Impairment of Assets’

IAS 36 seeks to ensure that the assets of a reporting entity are carried at amounts not in excess of their recoverable amounts.

IAS 36 defines the recoverable amount of an asset as the higher of its fair value less costs of disposal (FVLCD) to sell and its value in use (VIU). Fair value is defined as an amount obtainable in an arm’s length transaction between knowledgeable and willing parties. VIU is based on an estimate of the future cash flows the entity expects to derive from the use of an asset or associated cash generating unit (CGU) in its current form. COVID-19 is likely to impact both FVLCD and VIU.

If the carrying amount of an asset exceeds its recoverable amount the asset is impaired. IAS 36 then requires the entity to write down the asset to its recoverable amount and recognise an impairment loss.

IAS 36 requires that both intangible assets with an indefinite useful life (and any intangibles not yet ready for their intended use) and goodwill be tested for impairment at least annually. For other asset classes that fall under the standard, the entity is required to test the asset for impairment when indicators of impairment are present.

Below are some issues for management to consider in assessing impairment together with some direction as to how best to respond to them.

:- IAS 37 defines an onerous contract as one in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it Under current circumstances, it may prove necessary to recognise provisions against contracts that provide for liquidated damages for delayed delivery or non-delivery of products or services. Further, provisions may be required as a result of an increase in costs necessary to deliver a contract, for example if personnel in quarantine needs a replacement, or alternative raw material purchases are necessary at prices higher than budgeted. Service contracts concluded in the education or tourism industry, where services will be provided to a number of clients materially lower than economically sound, may also require provisioning.