Amidst the fiscal landscape of 2023, macroeconomic uncertainties, geopolitical shifts, and the escalating repercussions of climate change exert a notable influence on financial reporting, ACRA’s Financial Reporting Practice Guidance No. 1 takes centre stage. This document accentuates pivotal areas that require meticulous consideration by directors in their financial statement evaluation.
Recognizing audit quality as an integral component of the financial reporting ecosystem underscores the necessity for Audit Committees (ACs) to engage external auditors and actively monitor the audit process.
Collaborative efforts are pivotal in identifying and resolving any areas of concern. The significance of high-quality audits extends beyond compliance; they play a crucial role in fostering confidence and trust within financial markets.
This blog thus explores these interconnected dimensions, offering insights into the evolving intricacies that directors and audit committees must navigate to shape resilient financial narratives in the coming year.
Inside This Article:
Financial Implications Arising from Macroeconomic Uncertainties
Singapore’s economy grew by 1% in Q3 2023, improving from the previous quarter. The economic outlook is cautiously optimistic, expecting gradual improvement by late 2024. However, the projected growth for 2023 is lower than in 2022. Inflation has eased, with a forecast of around 4% for 2023, and it is expected to decrease in 2024. Unexpected events globally could impact prices.
These economic uncertainties can affect how well businesses perform, emphasizing the need for careful planning in response to changing conditions.
In light of the above, Directors should give careful attention to the following accounting considerations while preparing financial statements:
Impairment
- Inflation Impact: Persistent inflation challenges revenue and costs, potentially leading to recession risks and affecting cash flow forecasts for impairment assessments.
- Interest Rates Effect: Higher interest rates may elevate the discount rate in the discounted cash flow model, thereby reducing the net recoverable amount.
- Sensitivity Disclosure: When evaluating recoverable amounts of cash-generating units (CGUs) containing goodwill or intangible assets with indefinite useful lives, disclose sensitivity if a reasonable change in critical assumptions could surpass the carrying amount.
Debt Covenants
- Interest Rate Risks: Rising interest rates may decrease asset values, potentially causing breaches in debt-to-equity or asset-to-liability ratios.
- Monitoring Existing Debt: Regularly monitor existing debt/loan agreements for possible breaches, securing waivers before year-end if debt covenants are not met and the intent is to continue classifying the debt as non-current.
Going Concern
- Assessment for Highly Leveraged Companies: Audit Committees (ACs) of highly leveraged companies should conduct a robust assessment, including scenario analysis, to gauge the impact of higher interest rates and other factors on the company’s ability to operate as a going concern.
- Cash Flow Projection Updates: Keep cash flow projections up to date, considering current interest and discount rates, market conditions, and business expectations up to the authorization date of financial statements.
- Disclosure of Material Uncertainties: If there are material uncertainties regarding going concern or the assessment involves significant judgment, disclose these uncertainties and judgments. Include management’s plans to address conditions casting doubt on going concern.
Financial Implications Arising from Climate Change Movements
With climate change effects intensifying, a global push for action is prompting initiatives like mandatory climate reporting by the Singapore Exchange (SGX). In 2023, it applies to finance, agriculture, food, forest, and energy industries, expanding to materials, buildings, and transportation in 2024. Other industries follow a “comply or explain” approach.
Singapore’s carbon tax, starting at $5 per tonne until 2023 and increasing to $50-$80 by 2030, adds another layer. Audit Committees (ACs) must assess how climate-related risks could impact a company’s operations, finances, and cash flows, recognizing the evolving regulatory landscape and the focus on environmental sustainability.
Expected Credit Loss (ECL):
- Evaluate if the 12-month probability of default remains reliable amid climate-induced credit risk changes.
- Consider disaggregating homogeneous groupings, like customer ratings, to reflect diverse impacts on loss patterns and default probabilities.
Impairment:
- Climate change may alter expected revenues, forecast periods, discount rates, and growth rate assumptions, affecting asset value-in-use and recoverable amounts.
- Incorporate increased costs from adopting eco-friendly initiatives, such as carbon taxes or cleaner energy, into cash flow forecasts for impairment assessments.
- Reassess useful lives and residual values of existing fixed assets if greener assets are planned, potentially leading to write-downs.
Green Financing:
- Scrutinize the use of proceeds from sustainability bonds, ensuring alignment with specified climate projects to avoid potential breaches or defaults.
- Address accounting complexities in sustainability-linked bonds tied to meeting ESG targets, considering changes in expected cash flows if targets are not achieved.
Provisions:
- Recognize provisions for potential revenue loss, increased costs (e.g., from carbon tax), or contract terminations due to shifting preferences toward sustainable practices.
- Acknowledge restructuring provisions if a detailed plan exists for significant operational changes to achieve climate-related targets, creating valid expectations of plan implementation.
Financial Implications Arising from Geopolitical Uncertainties
The surge in geopolitical uncertainties, exemplified by events like the Russian-Ukraine war and the Israel-Hamas conflict, significantly impacted companies globally in FY2023. Beyond war zones, businesses worldwide are grappling with disruptions due to these developments. Companies with ties to affected regions may encounter delays in their operational cycles, affecting supply chains and collection processes.
The imposition of international sanctions on Russia, particularly by the United States and the European Union, is far-reaching, impacting various sectors. Recent U.S. sanctions on China, specifically targeting the semiconductor, microelectronics, and information technology industries, further complicate the landscape.
Entities affected by these geopolitical shifts must carefully consider the resulting accounting implications. Given the evolving nature of global geopolitical dynamics, these considerations will play a crucial role in preparing financial statements.
Provisions:
- Recognize provisions for onerous contracts if expected losses outweigh the economic benefits from a revenue contract.
- Record provisions for obligations arising from delayed/cancelled deliveries or breaches in contractual terms when applicable.
Expected Credit Loss (ECL):
- Assess the impact of trade restrictions and major Russian banks’ exclusion from the SWIFT payment system on previous ECL evaluations.
- Consider the recoverability of amounts owed by debtors with operations, significant customers, or inventory in affected areas.
Going Concern:
- Evaluate the likelihood of disruptions to production in the going concern assessment, including potential business failures of critical suppliers, temporary closures of own operations, and workforce availability issues.
- Consider any significant deterioration in the company’s net working capital due to suppliers demanding earlier repayment or customers delaying payments beyond agreed credit terms.
Impairment:
- Assess the recoverability of asset or CGU carrying amounts, considering increased costs, potential supply chain disruptions, and changes in cash flow expectations.
- Examine intangible assets, like software under development in affected regions, for potential impairment due to disruptions.
- Evaluate physical assets in affected regions for impairment, especially those damaged or left idle.
- Write down slow-moving inventories due to imposed trade sanctions or physical damage from war to lower costs and net realizable values.
- If disposing of assets or subsidiaries to comply with government sanctions, measure non-current assets held for sale and discontinued operations at the lower of carrying amount and fair value less cost of disposal. Present them separately in the statement of financial position. The sale must be highly probable and expected to be completed within one year from the classification date, with assets available for immediate sale in their current condition.
Below is the table of treatment of various financial items in Financial Statements under Macroeconomic, climate change movement and geopolitical uncertainties:
Criteria | Impairment | Debt Covenants | Going Concern | Green Financing | Provisions | Expected Credit Loss |
---|---|---|---|---|---|---|
Macroeconomic Uncertainties | Assess impact on top and cost lines; recession risks; consider sensitivity disclosure for recoverable amounts of CGUs; monitor higher interest rates’ effect on discount rates; evaluate potential write-downs for slow-moving inventories. | Monitor rising interest rates affecting discount rates and asset values; assess risk of breaching debt-to-equity or asset-to-liability ratios. | Perform robust assessment of highly leveraged companies; analyze impact of higher interest rates, disruptions to production, and changes in net working capital; update cash flow projections. | Address implications of sustainability bonds; ensure proceeds are used for designated purposes; consider complexities in accounting for sustainability-linked bonds based on ESG targets. | Recognize provisions for potential loss of revenue, increased costs, or contract terminations; evaluate need for provisions related to restructuring plans. | Changes in credit risk due to macroeconomic uncertainties; assess if a 12-month probability of default remains supportable; disaggregate homogeneous groupings based on climate-related risks. |
Climate Change | Evaluate impact on revenues, length of forecast period, and discount rates; consider increased costs due to greener initiatives; reassess useful lives and residual values of fixed assets; potential write-downs for damaged inventories. | Evaluate potential impact on asset values and ratios due to higher interest rates; monitor terms of debt arrangements for possible breaches and obtain waivers if necessary. | Assess likelihood of disruptions to production, temporary closures, and workforce availability; consider potential impacts on net working capital due to delayed payments and supplier demands. | Examine impact on financial performance and cash flows; assess potential changes in expected cash flows if ESG targets are not met. | Consider provisions for potential revenue loss, increased costs, and contract terminations; recognize provisions for restructuring based on detailed plans. | Assess impact on periods beyond 12 months; evaluate if there is a significant increase in credit risk requiring lifetime ECL estimation; disaggregate homogeneous groupings impacted by climate-related risks. |
Geopolitical Uncertainties | Examine recoverability of assets in affected regions; assess impact on carrying amounts due to increased costs, supply chain disruptions, and changes in cash flow expectations; consider impairment of damaged or idle physical assets. | Consider disruptions to production and net working capital due to geopolitical events; assess potential impacts on debt covenants, repayment expectations, and refinancing plans. | Evaluate likelihood of disruptions to production, business failures, and significant changes in net working capital; consider impact on debt covenants and repayment expectations. | Consider implications of sustainability bonds; assess alignment with climate-related projects and potential impacts on debt repayment. | Assess need for provisions related to potential revenue loss, increased costs, and contract terminations; recognize provisions for restructuring based on operational changes. | Consider trade restrictions and exclusion from payment systems; assess recoverability of amounts owed by debtors with operations and significant customers in affected areas; evaluate changes in credit risk due to geopolitical uncertainties. |
Enhanced Quality Control Reviews by ACRA
Effective July 1, 2023, amendments to the Accountants Act empower ACRA with expanded inspection authority, now encompassing Quality Control (QC) reviews for accounting entities.
These reviews evaluate entities’ adherence to the Singapore Standards on Quality Management, ensuring robust quality controls for consistent, high-quality audits.
Audit Committees (ACs) are advised to consider these QC review findings when assessing the suitability of external auditors.
Understanding Audit Inspection Outcomes
Changes in the Accountants Act now require public accountants with a “Not Satisfactory” inspection outcome to disclose these findings to the audit client, specifically if the client is a public interest entity.
Audit Committees (ACs) are strongly encouraged to collaborate with auditors to identify the root causes and create practical improvement plans.
ACs should use this opportunity to evaluate the following:
- Auditor’s Commitment: Assess the auditor’s dedication to delivering quality audits.
- Financial Reporting Quality: Examine if the company’s financial reporting contributed to the findings and explore ways to enhance the overall quality of financial reporting.
Conclusion
In conclusion, successfully navigating the complexities of financial reporting in FY2023 requires a multifaceted approach. The convergence of macroeconomic uncertainties, the increasing impact of climate change, and geopolitical complexities necessitate careful consideration. As financial stewards, directors must scrutinize impairment scenarios, assess evolving debt covenant landscapes, and analyze the company’s going concern robustly. Aligning green financing strategies with sustainability goals and judiciously addressing provisions for potential losses is crucial. ACRA’s guidance, particularly in audit quality and Pillar Two tax reforms, serves as a guiding force for fiscal integrity. Beyond observation, our consultancy actively aids clients in adapting to challenges, offering expertise in proactive strategies for macroeconomic uncertainties, resilient debt management, and sustainable practices. Through collaborative efforts, we empower clients to weather financial storms and thrive in an ever-evolving landscape.
FAQs on Financial Statement Critical Areas
- Obtain an understanding from management about discerning events, if any, occurring from the reporting date to the authorization of the financial statements (FS). This includes events up to the date of authorizing the FS.
- It is advisable to rely on more than historical trends. ACs should re-assess the validity and supportability of inputs and assumptions in cash flow projections.
- Engage the external auditor early to ensure that management’s going concern assessment is adequate and appropriate.
- Directors are advised to gain insight into the influence of climate-related risks on FS. Valuable educational resources, such as those from the Institute of Singapore Chartered Accountants (ISCA) and the International Financial Reporting Standards (IFRS) Foundation, offer in-depth information for further exploration.
- ACs should exercise vigilance, mainly when commitments are made to ambitious goals like achieving carbon neutrality or zero emissions in a short timeframe. This involves being cautious of exaggerated claims and ensuring the credibility of environmental pledges.
- In the face of growing demands for climate reporting, ACs play a crucial role in maintaining coherence between financial and non-financial reporting. This involves ensuring alignment in key climate-related assumptions, risks, and opportunities disclosed in financial and non-financial reports.
- Companies are temporarily exempted from applying deferred tax accounting for Pillar Two tax reforms. However, those with annual reporting periods beginning on or after 1 January 2023 must disclose in their financial statements (FS) that they have applied the exception.
- Companies must disclose their current income tax expense related to Pillar Two income taxes separately. Additionally, they should provide qualitative and quantitative information about the exposure in countries that have enacted or substantially enacted Pillar Two tax reforms.
- Directors are encouraged to proactively review and understand the new requirements associated with BEPS Pillar Two. To ensure compliance with accounting standards, making meaningful disclosures on the impact of adopting these standards, even if they still need to be effective, in the FY2023 FS is advisable. This early consideration helps in better understanding and preparation for the implications of the new regulations.
- The 2023 Audit Regulatory Report can be accessed on ACRA’s official website at https://www.acra.gov.sg/training-and-resources/publications/reports/practice-monitoring-programme-public-reports.
- To access the updated guide on Audit Quality Indicators, please refer to https://www.acra.gov.sg/accountancy/public-accountants/audit-quality-indicators-and-industry-average#Disclosure.
- Inspection results of the firm’s quality management system serve as an evaluation of the firm’s measures towards ensuring quality audits (input-based measures).
- Inspection results of audit engagements directly measure audit quality, providing insights into the effectiveness of the audit process.
- ACs are encouraged to stay informed about ACRA’s audit regulatory activities, including Quality Control (QC) reviews and audit inspections, by regularly checking the public reports accessible at https://www.acra.gov.sg/training-and-resources/publications/reports/practice-monitoring-programme-public-reports.
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