IFRS accounting implications of recent civil unrest within South Africa

Transcript

Shreeya: Hello, and welcome to the third  podcast in our series “On the top shelf”, which deals with topical issues in IFRS that impact clients operating in the retail and consumer industry. 

My name is Shreeya and I am a Senior Manager in PwC’s Accounting Consulting Services. I am joined today by Saaleha Moolla, who is part of the PwC South African Accounting Consulting Services Retail Industry Team. Welcome! 

Saaleha: Thank you Shreeya. I am glad to be back here again.

Shreeya: The circumstances that led to today’s discussion are rather unpleasant, but quite important for entities operating in the retail industry. The civil unrest that took place in South Africa at the beginning of July resulted in major disruption and destruction for retailers.

Saaleha: It is really devastating Shreeya. The unrest resulted in violent protests, looting and damage to many retail stores, warehouses, distribution centres and factories and it will most likely take all those impacted months to recover financially.

Shreeya: Accounting follows business - and since these events have been so impactful on business, let’s think about the accounting consequences.

Specifically, let us focus on the contentious part of the accounting implications, which is retailers with year ends of 30 June 2021. I understand that IAS 10 provides guidance on events that occur subsequent to an entity’s year end, which are either adjusting or non-adjusting events. Given that the civil unrest took place so soon after 30 June, would retailers be expected to account for the unrest in their 30 June 2021 financial results?

Saaleha: In order to answer that question, let us consider some of the key dates leading up to the protests. During April, there were indicators of potential protests. On 29 June, the Constitutional Court sentenced the former president to a 15-month jail term. Then the first key date after 30 June 2021 is 8 July, which saw the commencement of civil unrest in some provinces of our country, which spanned over a few days. 21 July 2021 was then the release date of the latest stats of the economic and financial losses, which is estimated to be in excess of billions of Rands.

Keeping in mind the series of events relating to the protest action, let’s consider whether these events would be adjusting or non-adjusting under IAS 10.

IAS 10 applies to the accounting and disclosure of events that happen between the balance sheet date and the date when the financial statements are authorised for issue, and then distinguishes between adjusting and non-adjusting events as you’ve mentioned.

Shreeya: Yes, thank you - I’m following you there.

I’d like to pause for some background theory for our listeners: The classification of an event as an adjusting or a non-adjusting event depends on whether it provides additional information about conditions already existing at the balance sheet date, or it indicates conditions that arose after the balance sheet date.

Now, taking this theory and applying our minds to the facts at hand…. in determining whether the civil unrest is an adjusting or non-adjusting event we would need to consider whether information relating to the key dates you’ve mentioned was known or knowable as at 30 June year ends.

Saaleha: Precisely.

On 29 June, which was before year end, there were reactions to the prison sentence of the former president.

The information of this event as at 30 June 2021 was known and knowable; however at 30 June, there was no indication or public information on the extent as well as the severity of the civil unrest that took place post 30 June.

The civil unrest and nationwide protests that occurred in July were events that were not reasonably anticipated on 30 June. Neither could the extent and severity of the losses in Rands have been estimated or anticipated.

Taking this into account, the civil unrest is a non-adjusting subsequent event impacting non-financial assets of entities with year ends of 30 June 2021.

Shreeya: Interesting thought process in reaching that conclusion. So Saaleha, since it is a non-adjusting event for entities with a June year end, my understanding is that entities would not be required to adjust their financial statements for the impact of the civil unrest.

I do believe, however, that IAS 10 requires entities to disclose the impact of the unrest on their business in their 30 June financial statements, if the impact is material.

This disclosure should be transparent and specific to the entity, and it should include the nature of the event and an estimate of its financial effect.

Where the civil unrest has materially impacted an entity, the entity should consider disclosing the financial impact of the civil unrest on the carrying amount of assets and liabilities (for example, the need to impair assets or remeasure fair values), or the impact on revenue or on borrowing covenants.

If the financial impact on the civil unrest cannot be practically quantified by an entity, it is recommended that entities disclose qualitative information that may provide an indication of the concentration of the impact.

Is there anything else retailers may need to consider in preparing their 30 June financial statements?

Saaleha: Another important aspect to consider is whether the entity can still continue as a going concern.

The going concern basis of preparation is not applied to financial statements if events after the balance sheet date indicate that the going concern assumption is no longer appropriate!

In other words, any information relating to an entity’s ability to be a going concern, whether the conditions existed at the reported date or not, is an adjusting event and should be considered when making the going concern assumption.

Entities should therefore consider whether developments subsequent to the reporting date have any implications for the going concern assumption. Similar to financial periods post the onset of Covid-19, there will likely be scrutiny with regard to going concern disclosures.

Shreeya: Oh yes, thanks for reminding me about this “concerning” point.

So where an entity is no longer a going concern, the entity should disclose this 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.

Saaleha: That’s right.

Shreeya: So if I sum up this discussion thus far, the impact of civil unrest would be a non-adjusting event for entities with year ends of June, as the extent and severity of the unrest at 30 June was not known and knowable.

We’ve been focusing on non-financial assets thus far - but what about financial assets? What is the impact on financial assets? I believe one word springs to mind there: expected credit losses, also known as “ECL”!

Now just to recap some of the background principles on expected credit losses, or ECL. IFRS 9 requires ECL to be measured in a way that incorporates information available at the reporting date about past events, current conditions and forecasts of future economic conditions. The forecast of future economic conditions adds an additional layer of complexity when calculating expected credit losses (ECL) because it becomes very judgmental on whether and what events that occur after the reporting date should be adjusted for.

Let’s start things off a bit ‘simpler’ and talk about the effect of the civil unrest on the simplified ECL model that applies to trade receivables, contract assets and lease receivables. The provision matrix is the most common approach under the simplified ECL model, which reflects the historical loss rate per class of customer adjusted for reasonable and supportable forward looking information.

What are your thoughts there, Saaleha?

Saaleha: As previously mentioned, the impact of the unrest on financial assets is a non-adjusting event.

So the real question you might ask is whether we should be taking the impact of the unrest into account as forward looking information when estimating their ECL provision at 30 June 2021.

The answer here is no, once again!

Shreeya: Why is it no?

Saaleha: It’s a no because we have concluded that the extent and severity of the unrest was not known or knowable at 30 June 2021 and forward looking information would need to be based on information that was known or knowable at the reporting date.

Another way to look at this is if you consider the perspectives as at 30 June 2021, the extent and severity of the unrest could not be deemed to be reasonable and supportable information that one would have considered based on all the evidence and events leading up to 30 June 2021.

Shreeya: Let’s take a step back and think about those big picture forward-looking factors within the model. One of the most common forward-looking factors used in models is the GDP outlook, right? How would that interact with our forward-looking information?

Saaleha: The GDP outlook at 30 June 2021 would have factored in multiple economic conditions such as the impacts of the Covid-19 third wave and its related lockdown restrictions, load-shedding, inflation, the impact of unemployment. It would have also factored in, to some degree, the risk of social/political unrest due to the probability of social unrest increasing over the past year due to political instability.

However, what’s important to note is that at 30 June 2021, the extent and severity of the civil unrest was not anticipated and as such the magnitude of the unrest was not factored into the GDP forecast.

Shreeya: Ok, so if I follow you - practically, this would mean that if one factored GDP into your ECL model as forward-looking information - you would have most likely incorporated the risk of social/political unrest without specifically having a scenario for this risk.

Saaleha: Yes, it’s a bit of a nuanced point - but that is the essence.

Shreeya: Ok so let’s try to make this practical and think about a contrasting scenario.

Let’s say I have a June year-end company that sells goods on credit. At June 2021 I want to estimate my ECL. Assume that within this ECL estimate, I have already considered various forecasts for GDP to incorporate forward-looking information into its estimate. I have also already assigned a base case, downside case and an upside case in forecasting GDP.

So, having done all that - what would be your view, Saaleha, if I were to propose an amendment to my downside scenario to reflect a harsh...or more severe downside risk due to the civil unrest?

Saaleha: No – it would not be appropriate in that case to reflect more severe downside risk.

This is because you are then effectively applying hindsight to an estimate by taking into account the events of the civil unrest that only took place from 8 July 2021 that were not known or knowable as at 30 June 2021.

Shreeya: Lots of “nos” coming from you today Saaleha - but all of it is very good to “know”

So if I sum up this discussion, the impact of civil unrest would be a non-adjusting event for both financial and non-financial assets for entities with year ends of 30 June 2021 as the extent and severity of the unrest at 30 June 2021 was not known and knowable. With regard to financial assets, and ECL - hindsight should not be applied in adjusting forward-looking information for events not known or knowable at 30 June 2021.

Secondly - although the unrest would be non-adjusting, entities will still be required to include some disclosure if the impact was material.

And the last point to remember is that entities should assess whether they can continue as a going concern because if subsequent events indicate that the going concern assumption is no longer appropriate, that event would then become an adjusting event and the financial statements would need to be adjusted to take this into account.

It was great chatting to you today Saaleha.

Saaleha: Thanks for having me Shreeya.

Shreeya: “This podcast is brought to you by PwC. All rights reserved. PwC refers to the South African member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This podcast is for general information purposes only, and should not be used as a substitute for consultation with professional advisors”