Disclosing principal risks and uncertainties and material judgements related to COVID-19

This article is part of a series on financial reporting and auditing in the shadow of COVID-19.

Directors will need to consider how to reflect the impact of COVID-19 on not just the numbers but also the disclosures in the financial statements. In these times of significant uncertainty, it has never been more important to be transparent about risks faced and the assumptions used, and to make the disclosures as specific to the business as possible.

The directors’ report and strategic report

It is recommended that companies consider whether to refer to the possible impact of Coronavirus in their reporting of principal risks and uncertainties. A company should consider the specific resources, assets and relationships that are most under threat and the mitigating actions being taken to protect them. The principal risks and uncertainties would likely include the elements which may be crucial to a company’s ability to weather the storm and rebuild when the opportunity arises.

Small companies are exempt from the requirement to prepare a strategic report and, therefore, the requirement to report on principal risks and uncertainties. Small companies are also exempt from the requirement in the directors’ report to provide particulars of important events affecting the company which have occurred since the financial reporting date and an indication of the likely future developments in the business. However, the directors should consider this as an opportunity to communicate how the board is taking account of any challenges it faces as these disclosures may be of interest to other stakeholders such as customers, suppliers and lenders.

Significant judgements and key sources of estimation uncertainty

The preparation of the financial statements involves management’s judgements and assumptions at the reporting date. Companies should disclose significant judgements made in applying accounting policies that have the greatest effect on the financial statements. There is a significant degree of uncertainty associated with COVID-19 and companies are encouraged to provide as much context as possible for the assumptions and predictions underlying the amounts recognised in the financial statements and this information will help users to understand the amounts presented.

Both UK GAAP and IFRS contain disclosure requirements in relation to:

• significant judgements other than those relating to estimation uncertainty; and
• disclosure in relation to key sources of estimation uncertainty.

A significant judgement made by management could be that the company will continue to trade as a going concern. When preparing the financial statements, management is responsible for completing a full assessment of whether the organisation is a going concern, considering the impacts of COVID-19 and other events on the long-term viability of the organisation. See our article entitled “Going concern disclosures and audit implications” for further details.

In almost all cases, the financial statements will include areas subject to estimation uncertainty and the following are some examples of where these may be found:

• Asset valuations (in particular property valuations)
• Defined benefit pension scheme valuations
• Stock provisioning
• Recoverability of customer balances
• Revenue recognition (e.g. variable and contingent consideration issues)
• Completeness of liabilities (e.g. new liabilities could emerge due to legal cases, contractual obligations, commitments or changes in assumptions and policies)

The pandemic will require management to reassess their previous judgements and assumptions. A company shall disclose in the notes information about the key assumptions concerning the future, and other key sources of estimation uncertainty at the reporting date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. This will include details of their nature and their carrying amount as at the end of the reporting period.

Post balance sheet review period

Events after the end of the reporting period include all events up to the date when the financial statements are authorised for issue. It is important to incorporate a comprehensive post balance sheet review in the year-end reporting plan, particularly as information about the scale and the impact of the virus changes frequently.

Please do not hesitate to contact Peter Manser or Joe Timms to discuss any accounting or auditing questions related to COVID-19 that you may have.