Impact of Covid-19 to Accounting: Financial Instruments

This fourth installment of the series will discuss the impact of Covid-19 to financial instruments. This article and other articles in the series summarize the impact based on several credible sources, i.e. the Big Four accounting firms, professional accountancy organization and IFAC (International Federation of Accountants). For further and detailed discussion, please refer to the original documents as cited in the sources at the end of this article for further reading, of which the links to access the full report are provided.

IFRS 9 is the standards that arranges financial instruments, it replaces the previous standard of IAS 39. One of the new features in IFRS 9 is the expected credit loss (ECL) for impairment, which makes financial reporting more forward-looking. ECL basically is the difference between contractual cash flows that an entity should receive and expects to receive. Entities must measure ECL through a loss allowance equal to the 12-month ECL or full lifetime ECL. This second option of measurement is required for certain conditions, or entities may choose to use it. ECL is based on probability-weighted amount determined by evaluating the range of possible outcomes and considering the time value of money. Past, present, and future economic conditions must also be considered by entities when measuring ECL.

ECL applies several instruments, such as loans, interest-bearing financial assets (for example bonds, debentures), trade receivables, contract assets, and lease receivables. In relation to current circumstances, entities face increased credit risk, in particular for banks and lenders, in which some of their borrowers are highly affected by Covid-19. Therefore, entities must re-assess their ECL to reflect current as well as future conditions. Additionally, banks and other relevant entities must also consider the impact of several incentives initiated by the government, such as payment holidays and decreased interest rate, to their financial statements. Entities must analyze this credit enhancement scheme and determine whether it will affect ECL measurement.

In addition to ECL, one recurring issue raised in the published documents listed below in the list of sources is regarding hedge accounting. IFRS 9 also prescribes the hedge effectiveness requirements that must be met for hedging relationship to qualify for hedge accounting:

“There is an economic relationship between the hedged item and the hedging instrument; the effect of credit risk does not dominate the value changes that result from that economic relationship; and the hedge ratio of the hedging relationship is the same as that actually used in the economic hedge”.

Based on the above criteria, hedging relationship is categorized effective to the extent of which fair value or cash flows changes of hedging instrument offsets the fair value or cash flows changes of the hedged item. Hedge ratio used by entities should reflect their risk management purposes. Covid-19 may cause hedging relationships no longer meet the hedge accounting qualifying criteria as stated in the standard. In that case, entities must discontinue hedge accounting prospectively.

Sources:

Deloitte 2020, IFRS in Focus: Accounting Considerations Related to the Coronavirus 2019 Disease, March

EY 2020, Applying IFRS: IFRS Accounting Considerations of the Coronavirus Outbreak, February

Gould, S. & Arnold, C. 2020, The Financial Reporting Implications of COVID- 19, 13 April, IFAC Knowledge Gateway

IFRS Foundation, IFRS 9 Financial Instruments

KPMG 2020, Quick Guide on COVID-19, https://home.kpmg/xx/en/home/insights/2020/03/covid-19-financial-reporting-resource-centre.html

PwC 2020, In Depth: A Look at Current Financial Reporting Issues – Accounting Implications of the Effects of Coronavirus, 17 March

(AL)