Where are we now
The UK has now left the EU, and we are currently in the ‘transition period’; ending on 31 December 2020. Brexit has therefore happened, but from an accounting and financial reporting perspective, the impact of the changes to be brought in for UK business as from 1 January 2021 need to be considered when preparing the forthcoming annual financial statements; whatever the company’s year-end reporting date.
There are no new accounting and financial reporting requirements that relate specifically to the UK, leaving the EU and the ongoing changes. There have however been changes made to company law although the fundamental objective of the Government is to ensure that the laws and rules that have always been in place (i.e. within the Companies Act 2006 and related regulations) continue to apply as far as possible.
Business activities and operational changes
The primary area of focus is, to identify the challenges and opportunities as a result of the UK leaving the EU and implement operational changes where necessary to address these. Many challenges and opportunities will expose the business to risks and uncertainties. The degree to which they are affected, however, will depend on the individual facts and circumstances surrounding activities and operations. For example, the geographical location of operations, the sector and industry in which a business operates and exposure to foreign exchange currency risk, will also influence how significantly a business is impacted.
Accounting and financial reporting matters
How a business assesses the ongoing implications of Brexit will subsequently inform how this must be dealt with in the financial statements. Various areas will need to be considered whether the reporting date is before or after the end of the transition period on 31 December 2020.
For non-listed businesses, currently reporting under FRS 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland (“FRS 102”), the principal accounting and financial reporting considerations are:
- applying judgments and estimates when determining and measuring assets and liabilities; and
- narrative reporting and disclosures within the strategic and/or directors’ reports and within the financial statements.
In this article, we consider the first topic - applying judgments and estimates when determining and measuring assets and liabilities.
Preparing financial statements - Applying judgments and estimates when determining and measuring assets and liabilities
Businesses should consider each of the Brexit-related changes, risks, and uncertainties that it faces taking these into account when determining and measuring the assets and liabilities within the financial statements. The principal accounting areas are those where management needs to apply judgments and estimates; we consider some of these key areas, as follows:
1. Applying judgement to assess for indicators of impairment of non-financial assets
An asset, or the cash-generating unit (“CGU”) to which an asset belongs, may be impaired. Indicators of impairment may arise from Brexit-related changes, risks and uncertainties, and may include:
- any significant changes taken, or expected to take place causing an adverse effect on the business’ financial performance and/or cash flows, and resulting in those being significantly lower than forecasted;
- any changes announced to restructure or significantly change the business’ operations that include the asset, or CGU being assessed;
- market value falls in an asset’s value declining significantly more than would be expected from normal use; or
- plans to dispose of an asset, or a CGU, before the previously expected date.
Where there is an indication of impairment, management must carry out an impairment review to determine the asset’s, or CGU’s, recoverable amount.
2. Applying estimates to carry out impairment reviews of non-financial assets
An impairment review requires management to determine the recoverable amount of an asset, or a CGU to which an asset belongs, as the higher of fair value costs less to sell and value in use. Determining the value in use of an asset, or CGU, requires management to use considerable estimates and assumptions.
Management should take account of all Brexit-related changes, risks and uncertainties when estimating the future cash flows that are expected to be derived from the asset, or CGU, and when considering expectations about possible variations in the amount or timing of those future cash flows. For example, changes in estimated future cash flows may arise from: increases in operational costs (from increases in tariffs and duties, or changing suppliers); falling revenues (from loss of customers or reductions in sales); foreign exchange currency fluctuations; and/or changes in selling prices (from changing suppliers or increases in operational costs).
3. Applying estimates to determine the carrying amount of stock
Stock is required to be held at the lower of cost or net realisable value (or estimated selling price less costs to complete or sell). Management are required to assess at each reporting date whether any stock is impaired by comparing each item of stock, or group of similar items of stock, with its net realisable value.
Brexit-related changes, risks and uncertainties will therefore impact on the estimates and assumptions applied by management when assessing stock provisioning, for example in relation to determining net realisable values due to any changes in estimated selling prices, increases in tariffs and duties and/or increases in costs passed on from suppliers.
4. Applying estimates to assess recoverability of debtors
Management are required to assess at the end of each reporting period whether there is any objective evidence that any debtors are impaired and where there is objective evidence of impairment, an impairment loss must be recognised.
The impact of Brexit-related changes, risks and uncertainties are likely to increase the possibility of debtors becoming impaired, for example as a result of increased financial and/or trading difficulties of customers who have been adversely affected by the challenges imposed from Brexit.
5. Applying estimates to measure property fair values
Investment property is required to be held at fair value, and other property is permitted to be held at revaluation, which involves determining the property’s fair value. Determining the fair value of a property asset does require significant estimates and assumptions to be applied by management as the fair value is usually measured using valuation techniques, which are often based on recent transactions for identical or similar properties.
Brexit-related changes, risks and uncertainties will likely affect the estimates and assumptions used within the valuation techniques and may impact the general market conditions for the property industry, which management should consider when determining fair values.
6. Applying estimates to other accounting areas
Other accounting areas require management to apply estimates and assumptions to determine the carrying amounts of assets or liabilities at the reporting date:
(i) deferred tax assets should only be recognised to the extent that it is probable that they will be recovered against future taxable profits or other deferred tax liabilities;
(ii) plan assets within defined benefit pension plans should be measured at fair value; and
(iii) provisions should be measured based on the best estimate of the amount required to settle the obligation.
Accordingly, each of these areas requires management to incorporate the Brexit-related changes, risks and uncertainties facing the business when assessing the expected future cash flows and other factors such as potential variations in timing and/or amount.
Summary and conclusions
Many different accounting areas require management to apply judgments and estimations when measuring and determining the carrying amounts of assets and liabilities to be reported in the financial statements. Hence, many areas may be affected by the implications of Brexit. Whether the extent and level of the impact is minimal or significant, depends upon the nature of a business’ activities and operations; each will be impacted differently.
The focus for most will, of course, be on the business activities and operational changes that need to be implemented, along with the consequential implications on stakeholders, such as employees, suppliers, customers and investors.
Accounting and financial reporting matters should not be overlooked. Businesses may wish to establish an operational working party, that includes a member of the finance team, ensuring accounting implications of operational changes are communicated on a timely basis, and any appropriate action is taken.
Next edition: Narrative reporting and disclosures
In our next article, we will consider the narrative reporting and disclosure requirements that companies will need to consider when reporting on the impact of Brexit within their forthcoming annual financial statements.
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