Top of Mind Disclosure Matters - Ep 8

Transscript

Dipthi (Interviewer): Welcome to this episode of the Telco Talks podcast series focusing on topical issues in the telecommunications industry. I’m Dipthi Govind, a technical accounting manager in the PwC South African practice and I will be your host. Our aim is to keep you up to date on key accounting issues in the telecommunications industry.

Joining me on this podcast is Renitha Dwarika, my most popular guest. Welcome to the first Telco Talks episode for the year Renitha.

Renitha: Thank you Dipthi. I feel like a celebrity!

Dipthi: In this episode, we’re going to share some year-end accounting reminders that should be top of mind as many entities go into their next year-end or interim reporting cycles.

Well, let’s get right into it then. As a start, it is quite clear that COVID-19 has and continues to have an impact on a number of accounting areas, some more significantly than others.

Renitha, can you start off by reminding us about some of the topical accounting considerations as a result of COVID-19?

Renitha: 100%, there are many aspects to consider when it comes to COVID-19 but what I would like to remind listeners about is the amendment that was made to IFRS 16 - Leases.

Dipthi: Yes, the amendment which I understand is effective for annual reporting periods beginning on or after 1 June 2020, with earlier application being permitted.

Renitha: Yes, you’re spot on Dipthi. Given the challenging economic climate resulting from the impact of COVID-19, lessors may grant lessees rent concessions. These concessions can take a variety of forms, from payment holidays to deferral of lease payments.

The amendment to IFRS 16 provides an optional expedient for lessees from having to assess whether a rent concession related to COVID-19 is a lease modification. Basically lessees may elect to account for such concessions as if they are not lease modification. This will result in accounting for the concession as a negative variable lease payment.

What is important to remember is that the optional expedient is only available to lessees and not to lessors and that there are certain requirements that have to be met in order for a lessee to be eligible to use the the expedient.

Dipthi: Thanks Renitha. For more information on the details of the amendment and its application, our listeners can tune in to episode 6 of the Telco Talk podcast series which covers the amendment in detail.

Another area which is an ongoing consideration for many companies, including telco operators is the impairment of non-financial assets.

Renitha, what are your top 3 points on impairment of non-financial assets to share with our listeners?

Renitha: I will try for 3 Dipthi, but might add a few more in! Impairment has certainly been a topic of discussion over this past year and naturally so because of the impact that COVID-19 has had on entities.

I will start off with the cash flows used in the impairment model for example a discounted cash flow model or DCF. In times of greater uncertainty as we are now experiencing, in determining the recoverable amount it may be more reasonable for entities to use multiple cash-flow scenarios and apply relative probability weightings to those cashflows in order to get to a weighted average set of cash flows for the DCF model. This approach would be more useful than using a single cash flow forecast and a single discount rate which tends to place significant emphasis on the selection of the discount rate.

Dipthi: So a key takeaway here would be to incorporate as much of the uncertainties into the cash flows under different probability scenarios rather than through discount rate adjustments.

Renitha: Yes, that sums it up nicely.

The second reminder is in an area which can get quite complex and this is the interaction between IFRS 16 Leases and IAS 36 Impairment of assets.

Important to remember that the IFRS 16 right of use asset is subject to impairment testing under IAS 36 and here challenges do arise for discounted cash flow modelling.

A brief recap of a couple of items which operators should keep in mind when performing impairment tests:

• There will be more assets in the CGU as it now includes right of use assets.
• There could be a change in gross cash flows because the lease payments that are part of the lease liability are excluded as these are financing cashflows.
• The discount rate which often uses the entity's weighted average cost of capital as a starting point could be different due to the impact of lease liabilities when determining the debt:equity mix. The lease liability increases the debt of the entity.
• And lastly, if the increase in the present value of cash flows is lower than the increase in the CGU assets (which includes the right of use asset) being tested, headroom between the carrying amount and the recoverable amount of the CGU will reduce.
  
  Dipthi: Thanks Renitha. Listeners can tune into Telco Talks Episode 5 where the interaction between IFRS 16 and IAS 36 was unpacked in detail. You mentioned you had 3 items to chat through?

Renitha: Yes, the final and very important reminder on impairment is around assumptions used in the impairment test. Where an impairment test is performed at a cash generating unit level, key assumptions covering these cash generating units should be clearly disclosed. Where material, assumptions specific to each CGU should be identified. Significant changes from the prior year to assumptions used, such as the discount rate and the CGU’s cash flow projections, should also be explained.

Dipthi: The impairment disclosures in IAS 36 are quite extensive. But IAS 1 also requires disclosure of critical accounting judgements and of key sources of estimation uncertainty.

Renitha: You are quite right Dipthi. Impairment is a focus area for regulators who are looking for increased transparency in disclosure in this area. The COVID-19 pandemic has put this under the spotlight even more.

Dipthi: Listeners can refer to the PwC December year-end accounting reminders publication which is publicly available at Viewpoint.pwc.com. Additionally, our in-depth COVID-19 publication on various accounting issues may also be accessed via Viewpoint. So, moving on from COVID-19, what is next on the list of reminders to share with our listeners?

Renitha: The next topic is an interesting one which has been of interest to the IFRS Interpretations Committee as well, and that is supplier finance arrangements.

Dipthi: This sounds very interesting Renitha! Before we get into the accounting issue, could you briefly explain how a supplier finance arrangement works?

Renitha: Certainly Dipthi. So in these types of arrangements, an operator purchases inventory- generally mobile handsets from its supplier. The entity has an obligation to pay the supplier, which gives rise to a trade payable. The operator may want to take advantage of extended payment terms to improve working capital. In order to do this, the entity may enter into an arrangement with a financial institution. In these types of arrangements, the financial institution agrees to pay amounts the operator owes to the operator’s supplier and the operator agrees to pay the financial institution at the same date, or at a later date than when the supplier is paid. In practice, these arrangements are also quite prevalent as part of capex purchase arrangements.

Dipthi: This is an interesting topic! I recall that the Interpretation committee discussed this issue. Could you highlight the main discussion points?

Renitha: You are right Dipthi, this has been discussed by the IFRIC. Such arrangements raise the question as to whether the trade payables that are the subject of the supplier financing should be derecognised and replaced by a bank borrowing.

To make that assessment there is already existing guidance in IFRS 9, the financial instruments standard. A trade payable is a financial instrument at amortised cost which should be derecognised either when there is a legal extinguishment or when there is a substantial modification (for example a change in the terms of the instrument). If there is a substantial modification or legal extinguishment, the trade payable is derecognised and another type of financial liability i.e. a borrowing is recognised. If there is no substantial modification or legal extinguishment, the trade payable is not derecognised.

Dipthi: These arrangements sound quite complex and it seems that they could have a pervasive impact on a number of areas in the financial statements.

Renitha: That is a good observation Dipthi. Recently, supplier finance arrangements being entered into are increasing, and are attracting some attention with the regulators. The presentation of the relevant balances as bank debt or trade creditors will also drive the presentation of the subsequent cash flows in the statement of cash flows.

Dipthi: Could you expand on this in a bit more detail?

Renitha: Sure Dipthi. Assessing the nature of the liability in this arrangement would drive the cash flow classification. For example, if the entity considers the related liability to remain a trade or other payable that is part of the working capital, the entity presents cash outflows to settle the liability as operating activities in its statement of cash flows. In contrast, if the entity considers the related liability to be a bank borrowing, the entity presents cash outflows to settle the liability as financing activities in its statement of cash flows.

Dipthi: The next thought that comes to mind would be that transparent disclosure of these arrangements would be very important.

Renitha: Most definitely Dipthi. IFRS 7, the standard dealing with disclosure for financial instruments requires companies’ accounts to disclose information that allows readers to understand the nature of and risks around financial instruments, including liquidity risk. So in the case of supplier finance arrangements, the nature of the liability that the operator has, being a trade payable or another financial liability is an important disclosure.

Further IAS 1 requires companies to consider whether balances are financing or working capital in nature and present them accordingly.

Key disclosures would be the nature of any material supplier financing arrangements, the implications for the company’s liquidity and the relevant amounts, along with any significant accounting judgements.

Dipthi: Thanks for those reminders Renitha - very helpful!

Renitha: You’re very welcome Dipthi.

Dipthi: This brings us to the end of this episode of Telco Talks.

Stay tuned for the next episode where we will unpack sale and leaseback transactions.

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