Russia and Ukraine Conflict

The recent outbreak of the conflict between Russia and Ukraine has caused some uncertainty and possibly panic in the world today.  The world economy is taking quite a knock with energy and commodity prices increasing significantly.  These price increases are damaging the sprouting post-COVID-19 economic recovery, which the world has been long awaiting.

Many countries have imposed economic sanctions against Russia and Belarus as a result of the conflict.  Many international public and private companies have also withdrawn support and operations from Russia.  These actions include discontinuing operations, suspending listings and excluding Russian publically listed companies from market indices on certain stock exchanges, significant limitations on payments to foreign entities and restricting exports and imports with Russia and Belarus.

Along with the economic impact and sanctions being experienced and imposed, there are accounting impacts that must be considered when preparing International Financial Reporting Standards (‘IFRS’)/International Financial Reporting Standard for Small and Medium-sized Entities (‘IFRS for SMEs’) financial statements.  

Reporting considerations for 31 December 2021 year ends

The conflict broke out on the 24^th of February 2022; and companies who are reporting results on or after 31 December 2021 will need to consider the impact of this conflict in terms of IAS 10 Events After the Reporting Period (‘IAS 10’) (Section 32 of IFRS for SMEs (‘SME 32’)). 

Events between the reporting date and the date when an entitiy’s financial statements are authorised for issue must be considered as either adjusting events  or non-adjusting events.

This timeline very much emulates the COVID-19 pandeminc timeline when COVID-19 was discovered in December 2019.  Many companies with December year ends reported non-adjusting events.

There were indications of tension prior to 31 December 2021 with Russia mobilising troops around the Ukrainain border with certain sanctions being imposed against Russia.  This tension however is not viewed as the ‘event date’ as the direct response to the invasion (i.e. the co-ordinated and significant international sanctions and adverse world economic conditions) happened after 31 December 2021 i.e. 24 February 2022, the date Russia invaded Ukraine.  This is the specific event that united the international community to impose their co-ordinated significant sanctions against Russia and Belarus. 

Without using hindsight, looking at the available facts and circumstances at 31 December 2021, the accounting impact of the the invasion is considered a non-adjusting event. 

IAS 10 (SME 32) requires entities not to adjust their amounts recognised in their financial statements at 31 December 2021 when reflecting non-adjusting events, but rather provide the nature of the event and an estimate of the financial effect if it can be reliably measured (where it cannot be reliably measured, then a statement to that effect is to be included). 

South Africa may not be directly impacted by this conflict, but there is definitely an indirect impact with respect to the adverse economic conditions at play as a result of this conflict.

Circumstances expected to be disclosed for a non-adjusting event relating to this conflict will include (but is not limited to) adverse economic impacts on the entity’s operations, for example significant changes in commodity prices, foreign exchange prices, inflation rates and interest rates post 31 December 2021 which will impact the measurement of assets and liabilities in the next year. 

Entities that are directly impacted by this conflict would be expected to disclose relevant information to illustrate the direct impact on the operations and profitability of the entity where it has direct dealings with Russia and Belarus.  Examples would include (but are not limited to) disclosure of  intentions to discontinue operations in Russia/Belarus, impairment of non-financial assets and financial assets (taking events and new information after reporting date into account), increase in credit losses due to the sanctions on Russia/Belarus, significant expected decline in sales for the 2022 financial year, destruction of tangible assets and/or expropriation of such assets by government after reporting date etc.

In addition, financial statements must not be prepared on a going concern basis if this assumption is no longer realistic at the date where financial statements are authorised for issue.

Reporting considerations for February year ends

Some companies in South Africa will not be directly exposed to Russian/Belarusian companies or investments, but these companies that have a February reporting will have to consider the conflict.

As mentioned above, the ‘event date’ is the date the conflict began,  24^th of February 2022. An entity needs to take into consideration the impact of the conflict in the measurement and fair value of its affected assets and liabilities.  Some areas that have been topics of discussion include impairment and fair value measurement, credit losses, deferred taxes and inventories.

Impairment and fair value measurement

Intangible assets and goodwill, for example, might present impairment triggers as a result of the deteriorating global economic circumstances and sanctions that are being imposed.  Financial statement preparers will need to monitor these triggers closely and relook the various inputs utilised in the calculation of impairment in terms of IAS 36 Impairment of Assets (‘IAS 36’) or Section 27 of IFRS for SMEs. 

Fair value less costs of disposal and value-in-use calculations which are widely used in applying IAS 36 contain various elements that will be impacted.  Cash flow projections should be based on reasonable and supportable assumptions, these will need to be relooked and adjusted to reflect the impact of the conflict.  Budgets and forecasts will need to be revised, for example, where budget forecasts include contracts entered into with Russian and Ukrainian entities, such contracts will likely impact these cash flow projections, budgets and forecasts and the list continues… It will have a domino effect as one examines the potential impacts. Cash flow approaches based on the use of different probability-weighted scenarios may be more appropriate than a best estimate approach for estimating value in use.

Fair value measurement per IFRS 13 Fair Value Measurement, similar to IAS 36, will also need to be reassessed as to how assets are fair valued.  Levels of the fair value hierarchy are also expected to be impacted as certain inputs may move between levels as governments are sanctioning the Russian markets. Observable inputs should be maximised if these result from orderly transactions.

Credit losses on financial assets

Measurement of credit losses in accordance with IFRS 9 Financial Instruments takes into account forward looking macro economic factors and adjustments. These adjustments will have to be updated to take into account the impact of the conflict relating to the recoverability of debtors and loans outstanding.  Depending on the exposure to Ukraine and Russia, one expects there to be a range of impacts on recoverability on debtors and loans outstanding depending on the jurisdiction and economic circumstances of those debtors and loans outstanding.  Inputs will need to be reworked to accommodate for increasing commodity prices, inflation, foreign currency prices, GDP, pressure to increase employee compensation, unemployment rates etc.

Impairment in terms of Section 11 of IFRS for SMEs is based on an incurred loss approach.  Objective evidence is required to recognise credit losses once these losses have incurred.  The conflict is likely to increase incurred losses for which IFRS for SME preparers will account for in the year the losses are incurred.

Deferred tax assets

Deferred tax assets related to losses that were recognised in terms of IAS 12 Income Taxes or Section 29 of IFRS for SMEs may need to be reassessed as to their future recoverability.  Future deferred tax asset recoverability will be impacted as a result of the increased economic strain, either directly or indirectly.  The world economy is being significanty impacted, this will have a knock-on effect on companies globally, including, local South African companies. The impact on global and local companies is expected to make trading difficult due to the uncertainty of events to come as well as the ever rising commodity prices and inflation. The decision to exit a country may also lead to other unanticipated tax consequences, for example,the group will no longer be able to consider that a temporary difference will reverse in the foreseeable future, large deferred tax assets may need to be derecognised.

Inventories

The cost of inventories (in terms of IAS 2 Inventories or Section 13 of IFRS for SMEs) and production thereof are also expected to be impacted as a result of this conflict.  Preparers need to take into consideration how the costs of production are determined and if there will be constraints in production and supply chains as a result of the conflict which could impact the measurement of inventories. The measurement basis may need to be reassessed.

Assets Held for Sale and Discontinued Operations

Non-current assets held for sale under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations requires such assets to be immediately available in their present condition and the sale must be highly probable to meet these requirements.  With the conflict, the conditions for being immediately available and the sale being highly probable might need to be reconsidered if these assets are directly impacted by this conflict.  Entities will also need to consider whether any discontinued operations are indeed discontinued or if such operations will be abandoned.

Other considerations

Onerous contracts

The profitability of contracts may need to be reconsidered, not just for the rising costs of inputs involved in projects, but also where Russian/Ukranian team members are/ were planned to be involved in the delivery of such contracts.  Russians and Ukranians cannot get in and out of their respective countries to fulfil their roles in the business world for now.  Other team members may need to be trained up and brought in, all adding to the costs of delivery.

Breaches of covenants and current / non-current presentation of liabilities

Loan covenants will need to be reassessed for any breaches as well as their respective classification presentation in the statement of financial position. The JSE has been pushing for additional debt covenant disclosures, these would be very important where they are influenced by the conflict.

Definition of cash and cash equivalent when restrictions exists

Cash and cash equivalents that have restrictions placed on them will need to be re-evaluated in terms of the definition of cash and cash equivalents, with additional disclosures made, per IAS 7 Statement of Cash Flows or Section 7 of IFRS for SMEs. 

Consolidation issues

Consider if control has changed in terms of IFRS 10 Consolidated Financial Statements, i.e. reassessment of control may be needed in case of new government limitations such as nationalisation, lack of access to premises, loss of Board representation due to new laws etc.  Significant influence in terms of IAS 28 Investments in Associates and Joint Ventures might also need to be reconsidered if factors indicate that significant influence is lost due to the current circumstances the Associate or Joint Venture is operating under.

IFRS for SMEs does not have a comprehensive control assessment as IFRS 10 does, however IFRS for SMEs preparers would need to assess if their investment in subsidiary is perhaps impaired.

It is important to note that control does not automatically cease on entities within war-zones, it must be properly assessed in accordance with the requirements of the appropriate standards.

Other considerations

Other areas of accounting that could be impacted include hedge accounting, insurance recoveries, cyber-attacks and any additional disclosure requirements as a result of this ongoing conflict.

In closing…

The last two years have been challenging for financial statement preparers with the global COVID-19 pandemic bringing unprecedented changes to the way financial statements are reported. 2021 was impacted by the looting in Natal and parts of Gauteng. Unfortunately, 2022 has started off with a bang in regards to the Russia/Ukraine conflict and will continue to challenge financial statement reporters and regulators.  Preparers must factor in how to deal with the financial disclosure and quantification ‘message’, incorporating the impact of this conflict, a conflict that is unfolding into another unprecedented historcal world event. 

29/03/2022