Brexit: IFRS considerations for US companies

From the IFRS Institute - May 2017

In March 2017, the UK activated Article 50 of the Lisbon Treaty, thereby commencing its exit from the European Union (EU). In April, the announcement of early elections in the UK showed the continued unpredictability related to the UK’s June 2016 referendum on Brexit. During periods of such heightened uncertainty and related market volatility, users will look for information in the financial statements and broader corporate reporting to better understand the effects these conditions could have on a company’s performance and to understand the actions taken by management to respond to the risks.

Measurement of assets and liabilities under IFRS

Uncertainty and volatility put particular pressure on the financial statement measures and related disclosures for items such as noncurrent nonfinancial asset and financial asset valuations, inventory values, potentially onerous contracts, deferred tax asset recognition, recoverability of receivables, hedge effectiveness, defined benefits obligations, and even the going concern assessment and covenant compliance.

Perhaps the greatest focus remains on asset impairment tests under IAS 36, Impairment of Assets, which require numerous factors to be considered.

• Brexit gives rise to many potential triggering events, including the British pound’s sharp fall against the US dollar, and decisions to relocate;
• cash flow projections with uncertainty about long-term implications, including inflation and growth rates; and
• risk premiums in discount rates and the effect of low interest rates in the UK.

Brexit monitoring activities

Management should conduct a robust evaluation of how the developments may affect their operations, including a comprehensive assessment of the risks and uncertainties they may be exposed to. This evaluation might comprise:

• continuously evaluating the company’s exposure to UK and EU markets;
• monitoring guidance provided by the SEC and other regulatory bodies related to Brexit;
• assessing the effect of decisions made by the UK government, EU and Central Banks on the entity’s operations and accounting; and
• reviewing and evaluating disclosures periodically to ensure these are up to date, consistent, company-specific and in accordance with the requirements of IFRS.

Because of the volatility in the British pound, preparers should monitor whether using an average exchange rate for translating foreign currencies as allowed by IAS 21, The Effects of Changes in Foreign Exchange Rates, remains appropriate.

Income tax impact

The UK currently operates under EU tax treaties for transactions with EU and non-EU countries. It is unclear which tax laws will apply after Brexit. Therefore, US companies with significant UK operations, which have benefited or are currently benefiting from various tax exemptions related to EU legislation because of the UK membership, may be affected.

Considering the unprecedented nature of the circumstances and the related uncertainty, the possible changes in the UK’s tax status should not be accounted for until the uncertainty is resolved. However, in the meantime, if material, a company should provide meaningful disclosures in its financial statements (or interim financial reporting) of the uncertainty about the effect of the UK leaving the EU.

Other Brexit-related disclosures

For companies that may be significantly affected by Brexit, the financial statements need to provide appropriate/enhanced disclosure so users are able to understand the effects of the events on the company’s financial position and cash flows – in particular, disclosure of risks, significant judgments and key assumptions in the financial statements.

As a reminder, IFRS requires disclosure of the following (not exhaustive).

• IAS 1, Presentation of Financial Statements. Estimation uncertainties, assumptions about the future and other judgments relevant to assets and liabilities in the financial statements and information about managing capital. Disclosure is required for any material uncertainties that may cast significant doubt on an entity's ability to continue as a going concern, and when management concludes that there are no material uncertainties but reaching that conclusion involves significant judgment (a ‘close call’ scenario).
• IAS 10, Events after the Reporting Period. Updates about conditions at the end of the reporting period and nonadjusting events after that date.
• IAS 36, Impairment of Assets. Assumptions and sensitivities related to the impairment testing of nonfinancial assets.
• IFRS 7, Financial Instruments: Disclosures. Risks arising from financial instruments during and at the end of the period and how the entity manages those risks, including credit, liquidity and market risks.
• IFRS 13, Fair Value Measurement. Assumptions underlying fair value measurements when there is no active market. 
  

The risk factors have led to increased risk disclosures with respect to forward-looking estimates and fair values. Furthermore, companies with significant UK operations have been providing more extensive risk disclosures in relation to the uncertainties and increased volatility as well as details about the potential effect of Brexit on their business models. Given the ongoing developments, this may require a company to update its disclosures to provide changes to its risk factors each quarter under IAS 34, Interim Financial Reporting.

The common risk factors expected in risk disclosures can be summarized as follows.

• Exchange rate. Effect of currency volatility on  business and operations.
• Economic environment. Risks to current business models due to economic slowdown in the UK and/or higher inflation.
• Legal and regulatory uncertainty. Specific disclosure of incremental risk from regulatory changes for heavily regulated industries (e.g. financial services, pharmaceutical and telecommunications) or companies relying on UK trademarks or patents.
• Political uncertainty. Besides the developments in the UK, (upcoming) elections in other Member States show calls for withdrawal or renegotiation with the EU.
• Other potential risks. Other (operational) risks may arise from limiting the freedom of movements of capital, people, labor and goods between the UK and the EU member states.

Specific considerations for foreign private issuers

FPIs are expected to include supplementary disclosures in their MD&A as part of their annual filings and interim information (when interim information is provided in the FPIs’ home countries). These supplementary disclosures focus on trends in operations and principal business risks and uncertainties, and their scope in the MD&A is generally broader and more forward-looking than information included in the financial statements. Determining which disclosures are appropriate requires consideration of what is important in the context of the company and its operations.

Sources:

— European common enforcement priorities for 2016 financial statements. Public  statement, ESMA; October 28, 2016

— Annual Review of Corporate Reporting 2015/2016. UK Financial Reporting Council (FRC); October 2016

— Brexit: Financial reporting implications. Audit Committee Institute, KPMG; July 2016