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Annual financial statements will always be a critical communication to investors and other stakeholders. But how effective will they be in explaining to your stakeholders how the global COVID-19 pandemic has affected your organisation?
While the focus over the last three years has been on explaining the introduction of new International Financial Reporting Standards (IFRS) dealing with revenue, financial instruments and leasing, readers of the financial statements will want to know how the global pandemic changed the business.
No matter what situation exists, preparers of financial statements need to get the content right. When drafting the financial statements that will be issued, management should be mindful of what others have done – particularly businesses in the same industry sector – when they tell their own COVID-19 story and they should never lose sight of what makes their business unique. This will take time and effort because the recognition, measurement and disclosure requirements set out in IFRS issued by the International Accounting Standards Board (IASB) can be complex and demanding.
Unfortunately, many users complain that IFRS generates financial statements that are cluttered, and important information is often hard to find.
Telling the COVID-19 story is not only about reflecting what the financial reporting standards require disclosure on. It is also about correctly applying the materiality concept to disclosure and not being fearful of regulatory and stakeholder challenge. A reluctance to deviate from well-established practices by adopting a ‘safety first’ mindset often results in duplication, irrelevance and many ‘boilerplate’ disclosures which is not what users, including many securities and audit regulators, want to see.
In light of COVID-19, those charged with the governance of reporting entities, particularly those that are listed, have another opportunity to reflect on how they want to tell their story of their business activities throughout 2020 and how they are responding to the pandemic. The art, rather than the science, of issuing high-quality financial statements in 2021 is to prepare those that will not only comply with all the technical requirements set out in IFRS, but also effectively communicate how the entity has adapted and reacted to the environment it has been operating in.
1. Comply but communicate
Telling the COVID-19 story effectively not only requires entities to comply with applicable accounting standards and regulations, their financial statements should also become an effective part of the wider communication to their stakeholders.
Be mindful that the financial statements are just one ‘piece of the puzzle’ when communicating with stakeholders. Make them more effective by considering the following:
- Holistic approach – ensure the overall communication is effective by having a holistic approach. This means the annual report, which includes the financial statements, read as a whole, should deliver a consistent and coherent message throughout.
- Be transparent with APMs – if using alternative performance measures (APMs), do so transparently, making sure users do not misinterpret them. Do this by providing useful additional information which supports and explains how COVID-19 has impacted the entity.
2. Omit the immaterial
Make effective use of materiality to enhance the clarity and conciseness of the financial statements.
Incorrectly applying the concept of materiality is perceived to be one of the main drivers for overloaded financial statements. Information should only be disclosed if it is material. It is material if it could influence users’ decisions which are based on the financial statements.
The materiality assessment is the ‘filter’ in deciding what information to disclose and what to omit. Once it has been determined which specific line items require disclosure, entities should assess what to disclose about these items, including how much detail to provide and how best to organise the information in the financial statements. This can be done using a two-stage filtering process as follows:
- firstly, filter #1 is to consider if the underlying item (ie the amount recognised or the unrecognised event or risk) is itself material because of its size or its nature, and
- if it is, filter #2 then applies to determine which specific disclosures (and level of detail) need to be provided for each item.
3. Re-think the notes
Re-evaluate how the notes to the financial statements are organised to improve their effectiveness as a communication tool.
Being the largest section of the financial statements, the notes can have the greatest impact on the effectiveness of the financial statements as a communication tool. Improve the effectiveness of the notes by:
- Re-organising the notes – move away from the traditional order of the notes. Group the notes into various categories, placing the most critical information upfront. COVID-19 has placed a renewed emphasis on various elements within the financial statements such as going concern, impairment and how revenue is being recognised. Be mindful of the importance of these topics to the readers of the financial statements by making these some of the first topics that are included in the notes to the financial statements.
- Signposting – assist users in navigating their way through the financial statements through the effective use of signposting, cross-referencing and indexing.
4. Prioritise the policies
The financial statements need only disclose the most significant accounting policies. The disclosures made should be relevant, specific to the reporting entity and in light of COVID-19 explain how the accounting policies have been applied throughout the reporting period.
The aim of accounting policy disclosures is to help users properly understand how the amounts included the financial statements were determined. To make accounting policy disclosures effective preparers should:
- Make them significant – remove non-significant disclosures that do not add any value, and make sure that new accounting policies are included if, for example, government grants have been received and the amounts involved are material. Use judgement to determine whether the accounting policies are significant and do not fall into the trap of automatically including what was reported last year. Consider not only the materiality of the balances or transactions affected by the policy but also other factors including the nature of the entity’s operations in light of the pandemic.
- Be clear and specific – reduce generic disclosures (for example those that summarise the recognition and measurement requirements in the accounting standards) and develop disclosures that explain in detail how the entity has applied the policies (eg revenues that are recognised over time as opposed to at a point in time).
- Articulate key estimates and judgements – effective disclosures about the most important estimates and judgements provide investors with a useful understanding of the amount included in the financial statements. So:
- for estimates, focus on the most difficult, subjective and complex estimates. Include details of how the estimate was derived, key assumptions involved, the process for reviewing the amounts disclosed and a sensitivity analysis, and
- for judgements, provide sufficient background information on each judgement, and explain how they were made.
Technical support and assistance
We can help you get up to date with current trends in financial reporting by providing:
- thought leadership insights
- examples of best practice disclosures
- commentary on emerging practices
- support you to enhance the content and impacts of your annual reports.
FINANCIAL STATEMENTS
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In making these changes, one thing does not change. Financial reporting is a regulated activity and compliance with these requirements is essential. Getting the content of the financial statements right, particularly in light of the COVID-19 pandemic will require the application of professional judgement, care and attention to detail, proper planning and project management, and making sure fit-for-purpose systems and controls support the amounts included in the financial statements.
Whatever stage you are at in making improvements to the content and presentation of your annual reports, our specialists offer pragmatic solutions, whilst still complying with IFRS.
The requirements set out in IFRS are often very detailed and technical. To the untrained eye, they can appear hard to navigate. But at Grant Thornton, we have people who are well versed in their intricacies and can translate them into language that you can understand and apply to your financial statements.
We hope you found this publication useful when thinking about how to tell your COVID-19 story. If you would like to discuss any of the points raised, talk to our experts Christoph Zimmel and Rita Gugl.
