Since the Russian invasion of Ukraine on 24 February, the world has responded in many ways to assist Ukraine and to hold the Russian and Belarussian governments accountable for their actions. This response has taken many forms including aids aimed at assisting the Ukrainian people during the humanitarian crisis and also penalties in the form of sanctions against Russia, Belarus and some individuals and entities deemed to be closely linked to government officials in both countries. These sanctions have been levied by many countries and, in addition to this, companies trading with, or associated with Russia and Belarus have engaged in boycotts and trade embargos with Russia and Belarus.
The events of recent weeks have led to many additional considerations for accountants. This includes additional AML considerations and the increased prominence of sanction lists. There are also additional audit considerations and financial reporting issues to take into account. Given the global nature of businesses, many entities in Ireland and the UK may be directly or indirectly impacted by the invasion. The purpose of this article is to discuss some of the key financial reporting considerations that accountants may be exposed to if their entity or their client has a Russian or Belarusian connection. The below is not an exhaustive list and care should be taken by preparers to ensure that the accounting treatment and related disclosures are in accordance with the financial reporting framework applied.
The main focus of this article is the accounting implications of entities applying full FRS 102, however, preparers of financial statements under other standards may also find the commentary useful. This article is not a substitute for reading the standard in full.
Going Concern
Accounting Standard
The requirements of accounting standards relating to going concern have not changed as a result of the war in Ukraine. Management’s and auditor’s responsibilities remain the same. However, the economic impact and uncertainty caused by the war will mean that going concern considerations are likely to be more topical for both preparers and auditors.
Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. When the use of the going concern basis of accounting is appropriate, assets and liabilities are recorded on the basis that the entity will be able to realise its assets and discharge its liabilities in the normal course of business.
Specific requirements regarding assessing an entity’s ability to continue as a going concern and disclosures regarding going concern are dealt with primarily in Sections 3 and 32 of FRS 102.
FRS 102 provides that when preparing financial statements, the management of an entity is required to make an assessment of the entity's ability to continue as a going concern. In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the date when the financial statements are authorised for issue. It notes that an entity is a going concern unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so (FRS 102.3.8).
FRS 102 also provides that when management is aware, in making its assessment, of material uncertainties related to events or conditions that cast significant doubt upon the entity's ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it is required to disclose that fact, together with the basis on which it has prepared the financial statements and the reason why the entity is not regarded as a going concern (FRS 102.3.9).
Where management’s conclusion that there is not a material uncertainty has involved significant judgement, regard should be had to the requirement to disclose significant judgements made in applying the entity’s accounting policies (FRS 102.8.6).
Section 32 deals with events after the end of the reporting period, which include all events up to the date when the financial statements are authorised for issue (FRS 102.32.3). Paragraph 7A says that an entity shall not prepare its financial statements on a going concern basis if management determines after the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so (FRS 102.32.7A).
Further, Section 32 provides that deterioration in operating results and financial position after the reporting period may indicate a need to consider whether the going concern assumption is still appropriate. If the going concern assumption is no longer appropriate, the effect is so pervasive that a fundamental change in the basis of accounting is required, rather than an adjustment to the amounts recognised within the original basis of accounting and therefore the disclosure requirements of paragraph 3.9 of the standard apply (noted above) (FRS 102.32.7B).
Application of the Accounting Standard
The war in Ukraine will have substantially different impacts on companies depending on their levels of exposure. Entities should consider how the war will impact them both directly and indirectly and they should prepare budgets based on the financial information available to them at the time and using their professional judgement. This process will not be easy as it will likely be unclear to the company what the full extent of the financial effect of the war will be, or indeed how long the war will last. The extent to which the war in Ukraine will impact on going concern assessments will depend on entity specific circumstances, including existing financial health and the degree to which the business is exposed to operational and financial risks relating to the sanctions imposed, supply chain and the broader impact on the global economy.
In the absence of clarity, the entity will be required to apply professional judgement, document this judgement, update budgets, cashflows and other relevant financial projections when facts and circumstances change and ensure that there is adequate disclosure of this in the financial statements which complies with the financial reporting framework used.
If an entity believes that it is not a going concern then they should not prepare their financial statements on a going concern basis.
Management should also consider whether there is a material uncertainty related to events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern.
The assessment as to whether the going concern basis is appropriate takes into account events after the end of the reporting period. For example, for 31 December 2021 reporters that are severely affected by the economic effects of the war, even though the significant impact on operations occurred after year-end, will need to consider the appropriateness of preparing financial statements on a going concern basis.
In making the assessment, management will need to consider all information available up to the date of authorisation of the financial statements.
Financial Statement Disclosures
Going Concern disclosures will depend on the facts and circumstances in each case, because not all entities will be affected in the same manner and to the same extent (and some entities may not be impacted at all). It is important that issues relating to going concern are adequately disclosed in accordance with the requirements of the financial reporting framework under which the financial statements are prepared. Management should also ensure that financial statements give a true and fair view.
Given the potential economic impact and uncertainty caused by the war, however, it is likely that some entities will consider that there is a material uncertainty relating to going concern, although this will depend on the specific entity concerned. If a material uncertainty does exist, then the company should disclose it in terms that are as specific to the entity as possible, and in terms that users will know how and when the uncertainty might crystallise and its possible impact on the resources, operational capacity, liquidity and solvency of the company.
Where management conclude that there is not a material uncertainty but significant judgement has been used in establishing this conclusion, then regard should be had for the need to disclose significant judgements made in arriving at this conclusion.
When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.
Trade Receivables impairment
Accounting Standard
Most entities applying FRS 102 will apply the rules of section 11- Basic Financial Instruments to trade receivables as they normally satisfy the conditions in section 11.9 of FRS 102 for recognition as basic financial instruments and are measured at amortised cost using the effective interest method (FRS 102.11.14).
It should be noted that an entity applying FRS 102 can choose to apply the measurement and recognition requirements of IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9 Financial Instruments instead of the requirements of sections 11 and 12 of FRS 102 (FRS 102.11.2). This article has been prepared on the basis that the entity has chosen to apply the measurement and recognition requirements of section 11 and 12 of FRS 102 and does not address the alternative options available under section 11.2 of FRS 102.
At the end of each reporting period, an entity must assess whether there is objective evidence of impairment of any financial assets (including trade receivables) that are measured at cost or amortised cost. If there is objective evidence of impairment, the entity must recognise an impairment loss in profit or loss immediately (FRS 102.11.21)
Section 11.22 of FRS 102 lists the following events which may lead to observable data that a financial asset is impaired;
“(a) significant financial difficulty of the issuer or obligor;
(b) a breach of contract, such as a default or delinquency in interest or principal payments;
(c) the creditor, for economic or legal reasons relating to the debtor’s financial difficulty, granting to the debtor a concession that the creditor would not otherwise consider;
(d) it has become probable that the debtor will enter bankruptcy or other financial reorganisation; and
(e) observable data indicating that there has been a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, even though the decrease cannot yet be identified with the individual financial assets in the group, such as adverse national or local economic conditions or adverse changes in industry conditions.”
Section 11.23 goes on to expand on the previous list by indicating that there may also be other factors containing evidence of impairment, including significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates.
Any impairment loss should be measured as the difference between the asset’s carrying amount and the present value of estimated cash flows discounted at the asset’s original effective interest rate (FRS 102.11.25). The standard also states that "If such a financial instrument has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract".
Application of the Accounting Standard
Entities holding debtors relating to customers in Russia, Belarus and Ukraine will have to assess the recoverability of these debtors and consider whether there is “objective evidence of impairment” which results in the carrying amount of the asset exceeding the present value of estimated cashflows discounted at the asset’s original effective interest rate.
In addition to this, entities should consider other debtors not located in Russia, Belarus or Ukraine but who are potentially exposed to the economic effects of the war and may be impaired as a result.
It should also be noted that general provisions for bad debts should not be made under FRS 102 and all trade receivable provisions should be based on objective evidence of impairment as outlined above.
Financial Statement Disclosures
Section 11 of FRS 102 contains a substantial amount of detail on the specific disclosure requirements relating to financial instruments & this includes a requirement to disclose the amount of any impairment loss for each class of financial asset (FRS 102.11.48(c)).
Cash & cash equivalents
Accounting Standard
FRS 102 defines cash & cash equivalents as follows (Appendix I to FRS 102: Glossary);
Cash- “Cash on hand and demand deposits.”
Cash equivalents- “Short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value.”
FRS 102 requires an entity to disclose the amount of significant cash and cash equivalent balances held by the entity but not available for use (FRS 102.7.21). This includes cash and cash equivalents not available for use by the entity because of, among other reasons, foreign exchange controls or legal restrictions.
Application of the Accounting Standard
Where entities hold funds in Russian or Belarussian banks they should consider whether these funds can be accessed and whether they represent cash held by the entity but not available for use. If these types of funds are held then there should be disclosure of this.
In these circumstances, the entity should also consider if there are any other financial reporting implications arising (such as going concern issues).
Financial Statement Disclosures
If an entity holds cash or cash equivalents which are not available for use then it must disclose this, together with a commentary by management (FRS 102.7.21).
Impairment of inventory
Accounting Standard
Inventories are required to be measured at the lower of cost and estimated selling price less costs to complete and sell (FRS 102.13.4).
In relation to impairment of inventories, an entity is required to assess, at each reporting date, whether any inventories are impaired. The entity makes the assessment by comparing the carrying amount of each item of inventory (or group of similar items) with its selling price less costs to complete and sell. If an item of inventory (or group of similar items) is impaired, the entity must reduce the carrying amount of the inventory (or the group) to its selling price less costs to complete and sell. That reduction is an impairment loss and it is recognised immediately in profit or loss (FRS 102.27.2).
If it is impracticable to determine the selling price less costs to complete and sell for inventories item by item, the entity may group items of inventory relating to the same product line that have similar purposes or end uses and are produced and marketed in the same geographical area for the purpose of assessing impairment (FRS 102.27.3).
Application of the Accounting Standard
Entities must assess whether the inventory they hold at the reporting date is valued at the lower of cost and estimated selling price less costs to complete and sell. If an entity holds inventory that is specifically held for sale in Russia, Belarus or Ukraine, this may be an indicator of impairment. Changes in consumer behaviour may occur as a result of the war or entities may choose to boycott the Russian or Belarussian markets which may impact inventory values. Entities should also consider whether they can access inventory held in Russia or Belarus which may result in impairment. Inventory held in Ukraine may also be affected if it needs to be shipped internationally and the order may be difficult to fulfil if the ports through which they travel have been captured or destroyed.
Entities should carefully monitor inventory held for evidence of impairment.
Financial Statement Disclosures
An entity should present the following information in relation to impairment losses incurred on inventory during the period (FRS 102.27.32).
the amount of impairment losses recognised in profit or loss during the period and the line item(s) in the statement of comprehensive income (or in the income statement, if presented) in which those impairment losses are included; and
the amount of reversals of impairment losses recognised in profit or loss during the period and the line item(s) in the statement of comprehensive income (or in the income statement, if presented) in which those impairment losses are reversed.
An entity is also required to disclose a description of the events and circumstances that led to the recognition or reversal of the impairment loss (FRS 102.27.33A).
Impairment of assets other than inventory
Accounting Standard
Along with inventory, section 27 of FRS 102 also addresses the impairment of “assets other than inventories”. The scope of this section of FRS 102 includes impairment losses relating to all assets with the exception of some asset types excluded and dealt with in another section of FRS 102 (such as financial assets in the scope of section 11 and 12 of FRS 102- which are discussed above as part of trade receivables) (FRS 102.27.1). Entities must always be alert to the fact that assets they hold may be subject to impairment.
The standard requires that if the recoverable amount of an asset is less than its carrying amount, the entity must reduce the carrying amount of the asset to its recoverable amount. That reduction is accounted for as an impairment loss (FRS 102.27.5). Any impairment loss must be recognised immediately in the profit and loss account, unless the asset is previously revalued, in which case, the impairment should be treated as a revaluation decrease in accordance with the section of FRS 102 that the revaluation occurred (FRS 102.27.6).
Accounting standards require preparers to assess at the end of each reporting period whether assets may be impaired. If such an indication exists, then the entity must estimate the recoverable amount of the asset. If there is no indication of impairment, it is not necessary to estimate the recoverable amount (FRS 102.27.7).
The standard also allows that if it is not possible to estimate the recoverable amount of an individual asset, an entity must estimate the recoverable amount of the cash-generating unit to which the asset belongs (FRS 102.27.8).
The standards include some specific indicators to consider at a minimum which include the following indicators that entities may encounter (a more comprehensive list of these is available in FRS 102.27.9) as a direct or indirect result of the war in Ukraine;
“During the period, an asset’s market value has declined significantly more than would be expected as a result of the passage of time or normal use”
“Significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated”
“Evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected. In this context economic performance includes operating results and cash flows.”
An impairment indicator being present may also indicate that the entity should also review the remaining useful life of the asset, the depreciation method, or the residual value of the asset (FRS 102.27.10).
An impairment review involves the entity comparing the “recoverable amount” of an asset or cash generating unit with its “carrying amount” and if the carrying amount exceeds the recoverable amount, then the entity should reduce the carrying amount to the recoverable amount by way of an impairment.
The amount used as the “recoverable amount” is the higher of its “fair value less costs to sell” and “value in use” (FRS 102.27.11). The former of these two measures is based on the amount that could be achieved if a sale of the asset happened between knowledgeable, willing parties and the latter is based on the present value of future cashflows from continuing to use the assets. FRS 102 contains detailed rules in relation to how these amounts are calculated and it is not the intention of this article to go into the specific rules (Refer to sections 27.14 to 27.20A of FRS 102).
Application of the Accounting Standard
Entities should consider whether the war in Ukraine provides evidence of an impairment indicator that an asset (or cash generating unit) is impaired. The presence of an impairment indicator does not automatically mean that an asset is impaired, however, it does mean that the entity must calculate the recoverable amount of the asset or cash generating unit. Entities with assets in Russia, Belarus and Ukraine will most likely need to undertake an impairment review along with other entities with assets exposed to impairment indicators as a result of the economic impact of the war.
In relation to the two measures used to determine recoverable amount (fair value less costs to sell and value in use), it is possible that both of these measures could be reduced by the economic impact of the war. Fair values may be negatively impacted by the economic consequences of the war and the market for Russian and Belarussian assets may be squeezed which may impact fair values. Similarly, value in use calculations may be adversely affected with a reduction in projected present value of future cashflows of assets. It is also possible that the uncertainty relating to the overall impact of the war or the overall cost will mean that greater judgement will need to be applied when determining the recoverable amount of assets.
Financial Statement Disclosures
An entity should present the following information in relation to impairment losses incurred on assets during the period (FRS 102.27.32).
the amount of impairment losses recognised in profit or loss during the period and the line item(s) in the statement of comprehensive income (or in the income statement, if presented) in which those impairment losses are included; and
the amount of reversals of impairment losses recognised in profit or loss during the period and the line item(s) in the statement of comprehensive income (or in the income statement, if presented) in which those impairment losses are reversed.
The information required above should be disclosed for each of the following classes of asset (FRS 102.27.33).
Property, plant and equipment (including investment property accounted for by the cost method)
Goodwill
Intangible assets other than goodwill
Investments in associates; and
Investments in joint ventures
An entity is also required to disclose a description of the events and circumstances that led to the recognition or reversal of the impairment loss (FRS 102.27.33A)
Post Balance Sheet Events
Accounting Standard
FRS 102 recognises that Events after the Balance Sheet Date are those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are authorised for issue (FRS 102.32.2). When carrying out a post balance sheet events review, the accounting standards recognise that there are 2 types of events;
Events that provide evidence of conditions that existed at the end of the reporting period (adjusting post balance sheet events); and
Events that are indicative of conditions that arose after the end of the reporting period (non-adjusting post balance sheet events).
Events after the balance sheet date include all events up to the date when the financial statements are authorised for issue, even if those events occur after the public announcement of profit or loss or other selected financial information (FRS 102.32.3).
If events are deemed to be adjusting events then the entity is required to adjust the amounts recognised in its financial statements, including related disclosures, to reflect adjusting events after the end of the reporting period (FRS 102.32.4).
If events are not deemed to be adjusting events then the entity is not required to adjust the amounts recognised in its financial statements to reflect non-adjusting events after the end of the reporting period (FRS 102.32.6).
In addition to this, Section 32 of FRS 102 sets out the accounting rules for entities that are not deemed to be a going concern. This is discussed in the going concern section above.
Application of the Accounting Standard
While there were political tensions in the months leading up the invasion, the actual act of invading Ukraine occurred in late February 2022. Therefore, for December 2021 and January 2022 year ends, it would appear reasonable to treat events relating to the war as non-adjusting post balance sheet events. This would mean that entities would not have to adjust their December 2021 and January 2022 accounts to reflect the impact of the post balance sheet event. However, disclosures may be required of the non-adjusting event, as discussed below.
For February 2022 and later year ends, entities should consider the impact that the war has had on all areas of the accounts up to the year-end date and whether adjustments are required. This may prove difficult and may require judgement by management of the timing, extent and impact of any effects of the war on its business.
Financial Statement Disclosures
Even if management deem the war in Ukraine to be a non-adjusting post balance sheet event, they should ensure that the disclosure requirements of the financial reporting framework are complied with, and that the nature of the non-adjusting event is disclosed along with an estimate of the financial effect, or a statement that such an estimate cannot be made (FRS 102.32.10).
The assessment as to whether the going concern basis is appropriate takes into account events after the end of the reporting period. For example, 31 December 2021 reporters that are severely affected by the economic effects of the war, even though the significant impact on operations occurred after year-end, will need to consider the appropriateness of preparing financial statements on a going concern basis, as discussed in the going concern section above.
Directors' Report & Strategic Report
Whilst not part of the requirements of FRS 102, it is also useful to consider the implications of the war on Directors' Reports and Strategic Reports contained within entities’ annual reports. Such reports should comply with the relevant legislative requirements, such as the requirement to provide a fair review of the company’s business and the requirement to be balanced and comprehensive.
Depending on a company’s size and whether they are preparing their financial statements under the Companies Act 2014 in Ireland or the Companies Act 2006 in the UK, they will have different reporting requirements in relation to their Directors' Report and Strategic Report. The impact of the Ukrainian war may require disclosure and discussion in the some sections, including;
Principal risks and uncertainties
For many companies, the Ukrainian war presents risks and uncertainties to their ongoing business model, future viability, supply chain and staff welfare. When required to be disclosed by a company, any analysis of principal risks and uncertainties should give a meaningful and accurate description of the specific risks and uncertainties that it faces. Companies should not use “boilerplate” disclosures in this regard.
Risks and uncertainties will be different for different companies. These may include;
Economic risks related to anticipated reduced turnover with customers in sanctioned countries, increased energy costs etc.
Credit risks relating to recoverability of debtors who are also impacted by the war.
Supply chain risks relating to a disruption in supply of goods that are key to a company’s operations. There may also be concerns relating to the future pricing of goods used by the company.
Valuation risks related to the expected future impairment of assets held by the company either in sanctioned countries or impacted by the economic effect of the war.
Reputational risks through association with Russian or Belarussian entities or specific individuals.
Going concern risks relating to one or a combination of the above.
It is important to readers of the financial statements that the principal risks and uncertainties are clearly laid out and understandable.
Future developments
Some Irish and UK entities are required to include “an indication of likely future developments in the business of the company”. Whilst this will often focus on expected future growth and anticipated developments, this should also be weighed up against the potential impact of the war on future developments if the directors believe that they will be impacted.
Events after the balance sheet date
The Directors' Report should provide details of important events affecting the company which have occurred since the year end. If the entity has been affected by the war since the year end then this should be disclosed in the Directors' Report.
Conclusion
It is unclear how long the war in Ukraine will last and what the full extent of the crisis will be. The war will present new challenges for accountants and entities to report on. Despite this new challenge, it is important to remember that accounting standards have not changed. Where doubt exists on the accounting treatment to apply, entities should ensure that the accounting requirements of the financial reporting framework are followed.
Given the uncertainty relating to how long the war will last and what the full humanitarian and economic cost will be, there may be more circumstances where judgement and estimates will be required in applying accounting policies. It is important that any such judgements are made with professional judgement, are updated when new information comes to light, are supported by documented workings to support the judgement and are appropriately disclosed in the financial statements when required.
Where financial statements are prepared in accordance with a fair presentation framework, such as FRS 102, it is important for entities to include any additional disclosures necessary to give a true and fair view.
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