United Kingdom
The Eurozone crisis - implications for financial reporting - Grant Robinson
Something from BDO to help companies with a period of uncertainty and change
The European monetary union is experiencing a period of unprecedented change. Contagion fears are very much on the agenda, with politicians warning that the crisis is far from over. Some warn that the Eurozone could be plunged further into crisis without measures such as recapitalisation of the banking system.
Risks associated with the Eurozone crisis should be high on the boardroom agenda particularly for companies operating in crisis-hit member states. The possible shocks to trading are far reaching caused by a fall in revenue generated by operations located in recession-hit economies. To assist clients and targets understand the possible effects on their businesses of developments in the Eurozone, BDO and CEBR have developed a tailored workshop that:
- explores the macro and micro impacts;
- considers risks and opportunities arising; and
- identifies actions to best position the company to deal with a developing situation.
A draft letter introducing this service is available here. For further information please contact Nigel Burbidge or Don Williams.
Specific financial reporting considerations for auditors and boards
Turning to one specific area: financial reporting. Investments in operations located in crisis-hit countries may need to be reviewed for impairment, and the recoverability of goodwill and other non-current assets assessed. Any impairment will be recognised in the income statement, with a potentially significant hit to profit. Management should consider whether this would impact covenants or other key performance metrics.
Impairments and valuation
Typically, the amount of any impairment is determined by DCF techniques. Thought should be given to assumptions used in these models, as the approach of previous years may not be appropriate. E.g. risk free rates may have been determined by reference to the bonds of governments or financial institutions that are now considered far from risk free. In such circumstances, it would be necessary to look to other instruments in calculating discount rates. Growth assumptions may also need to be more conservative, perhaps reflecting declining revenues, due to increased uncertainty arising from the economic conditions. Of course, it is not only accounting for impairments that uses DCF techniques, but also liability measurement like provisions and defined benefit pension schemes.
Recoverability
Companies with exposure to government debt will need to assess recoverability of these receivables. Although most companies are unlikely to have direct exposure these instruments, management should consider the domino effect of any indirect exposure to such instruments.
Going concern
Management should consider the appropriateness of the going concern basis if significant trade is conducted with affected countries. This encompasses not only the effects of reduced demand from customers, but also the consequences of key suppliers coming under financial strain. If there are significant doubts about the appropriateness of the going concern basis, the financial statements should include appropriate disclosures. Further guidance from the FRC is available here.
Currency and inflation
A break-up of the Eurozone could see further complications as companies grapple with legal uncertainties concerning which currency to re-denominate Euro contracts, not to mention the spectre of hyperinflation in affected jurisdictions. Boards should ensure they understand financial reporting risks by modelling best and worst case scenarios of further developments. This should help identify risk mitigation processes to manage a worsening of the crisis.
There are clearly several financial reporting considerations arising from the Eurozone crisis. For any specific queries please contact Grant Robinson or James Nayler.
8 May 2012
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