2020/21 Reporting Season: impairment of assets and asset valuations in the COVID-19 era

Assessing the valuation and impairment of clients’ assets has always demanded accountants' toughest scrutiny and clearest judgment. But as COVID-19 disruption continues to shift the ground under companies' feet on an almost daily basis, those skills and insights have never been more critical.

"One important point to bear in mind is that when assessing asset values – including impairment – you're examining the situation that existed as at the balance sheet date.," explained Moore Kingston Smith partner Tessa Park on a recent ICAEW webcast. "So, for example, at year-end 2019, the pandemic was a non-adjusting, post-balance sheet event (PBSE). It had not been declared at that time."

However, on 31 March 2020, the UK was already in lockdown. Therefore, the pandemic exists pre-year end and is not a PBSE. "Going forward – and for all other 2020 year-ends – we will need to revise our assessment of the pandemic: what was actually going on, and how did it affect the specific entity at hand, as at the specific reporting date? That would include consideration of national or local restrictions."

Park explained that in carrying out these types of assessments, accountants would need to focus on six main areas:

If an entity operates, for example, in the hospitality sector, or territories significantly affected by COVID-19, any goodwill may have been impaired. Indications include event cancellations or postponements, cashflow difficulties, supply chain issues or actual losses.

In any such case, the first step is to calculate the recoverable amount, based on the higher of a) value in use and b) fair value less costs to sell. Value in use will be based on discounted cashflows, which will need to use a sensible and supportable discount rate.

It is broadly the same under FRS 102 and IFRS – but for IFRS reporters, the impact may be more significant: while FRS 102 mandates that goodwill is amortised over its useful economic life, under IFRS, goodwill is not amortised, but subject to annual impairment testing.

Auditors need to maintain professional scepticism. The audited business must produce detailed cashflow forecasts, potentially including more than one scenario – worst-case, best-case and some form of mid-case. The auditor will then need to evaluate those forecasts critically. Do the underlying assumptions tally with the auditor's knowledge of the client? Are they supported by evidence? Do they make sense? And does the critical judgment require disclosure?

Impairment indicators in this area give rise to issues similar to those around goodwill and intangibles. Has there been a cessation or change in use of PPE as a direct result of COVID-19? For example: has the office or plant space – or plant machinery – not been utilised? Such factors may affect asset values, plus the projected useful life and/or depreciation rates of the particular assets in question.

Auditors must again make a scrupulous assessment based on their knowledge of the client – and challenge critically the client's assumptions on whether PPE assets have been impaired. Are adjustments required?

"Under FRS 102," Park noted, "investment property is measured at fair value, with changes in value through profit and loss (FVTPL). Under IFRS, entities have a choice of whether to use FVTPL or the cost model. But in my experience, the majority of IFRS users tend to use FVTPL." Park explained that fair value is gauged as the price paid by a third party in an active market, as at the reporting date. If there are changes in value after that date, in whatever direction, preparers may wish to consider disclosing them, if that information would be helpful to the accounts users.

Valuations have been subject to what the Royal Institute of Chartered Surveyors (RICS) calls 'material uncertainty': during the first phase of lockdown, property wasn't selling, so there was a lack of comparable market data. Other factors that may influence reporting are rent concessions or deferrals (with deferrals having less of an effect), the activation of break clauses (for example, because the lessee requires less office space) or the renegotiation of leases. These factors could affect asset values as well as revenue streams.

In terms of auditing implications, it's essential to consider whether the fair value – as at the reporting date, and as recorded in the financial statements – is correct. And if there is a RICS caveat included in the valuations from external valuers, the auditor will need to consider the impact on the audit report. Similar consideration will need to be given if the valuation was performed by a non-RICS individual, such as the company's director? Were they qualified to make such assessments? Again, professional scepticism is paramount.

Under both FRS 102 and IFRS, investments in subsidiaries, associates and joint ventures (JVs) are typically measured at cost. However, the effects of COVID-19 may produce indicators of impairment. As such, preparers will face similar requirements to those around goodwill, in terms of reporting discounted cash flows. 

Park noted that investment portfolio values might also be affected – for example, portfolios of listed investments that may be held by charities or pension schemes. "As the valuation must be current to the reporting date and based on the market pricing as at that date, there is potential for it to be impacted by stock market valuations. This happened in March 2020 with the initial UK lockdown, and could happen again with any subsequent lockdown(s)."

If the valuation changes significantly between the reporting date and the approval of the accounts, the entity's directors may wish to consider disclosing that as a non-adjusting PBSE. As with goodwill, it is vital for auditors to assess the valuations critically. Are cashflow forecasts or assumptions appropriate? Has the correct value been used? Is there evidence for that?

Most businesses will be facing issues around the recoverability of trade receivables. In that context, FRS 102 applies an incurred loss model and IFRS an expected loss model. For each scenario, preparers must examine the situation as at the balance sheet date: was the loss incurred or expected by that point? As such, consider post-balance sheet evidence: does it account for conditions that existed at balance sheet date? For auditors, it may not be easy to tell, given the rapid pace of change inherent in the pandemic. In parallel, it is crucial to review after-date cash collections up to the point of signing off the audit report.

Under both FRS 102 and IFRS, inventory is measured at the lower of cost and net realisable value (NRV) – in other words, what it can be sold for. Therefore, the critical point here is: has NRV reduced as a direct result of the pandemic? Similar judgments must be applied to work in progress (WIP) and accrued income: is the carrying value appropriate and recoverable? Some firms may suffer from a reduced ability to sell goods or services because of factors such as local lockdowns.

"Pub brands had to throw away millions of pints of beer because of lockdown," Park said. "Could that happen again? Meanwhile, online retailers did quite well. So, it all depends on what the client sells, and to whom they sell it. A post-year end sales review is key, combined with knowledge of the client and their industry. How has the sector been affected, and how is it likely to be affected going forward? What was the situation as at the reporting date?"

Park stressed: "The only certain thing about the 31 December 2020 reporting season is that it will be uncertain. Scenarios are changing so quickly that we must expect uncertainty and address the effects as they come along. And in addition to COVID, there is Brexit. A great deal of judgment will be required on the part of preparers and auditors alike. Focused disclosure will be absolutely crucial for accounts’ users."

The webcast referred to in this article was recorded as part of a virtual event Going concern and resilience: lessons learned from COVID-19 hosted by ICAEW’s Financial Reporting Faculty and Audit and Assurance Faculty on 30 October 2020. The webcast can be viewed at [icaew.com/goingconcernevent]

The Financial Reporting Faculty has two factsheets outlining the basic principles of accounting for impairment under IFRS and UK GAAP, together with practical guidance to help with implementing the requirements in these challenging economic circumstances.

• Applying IAS 36 Impairment of Assets
• FRS 102 - Impairment of assets

More general guidance on the implications of COVID-19 on financial reporting is available here.

Some useful guidance, including examples, on how the impairment of assets is treated under UK GAAP is also available in the Bloomsbury Professional online service: Financial Reporting for Unlisted Companies in the UK and Republic of Ireland - Chapter 28.