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With 31 October 2019, the date at which the UK will automatically leave the European Union (EU), fast approaching there is an increasing likelihood that the UK will not be able to negotiate a managed withdrawal agreement.
Therefore, the need to consider the implication of a ‘no deal’ outcome – one in which the UK would immediately begin trading with the EU on World Trade Organisation terms without any transition period – is becoming an ever more important one for management to consider. While there is a natural temptation to think of ‘Brexit’ (Britain’s exit from the EU) as a UK specific issue, the reality is that it needs to be considered by all entities that trade with, or have operations within, the UK.
Disclosures regarding uncertainties and risks arising from Brexit can be expected to be scrutinised by regulators in Europe and further afield. With this in mind, we consider below some of the potential financial reporting implications, focusing in particular on the possibility of a no deal scenario.
The no deal scenario
A no deal scenario is generally seen as the most disruptive one, as it will bring wide ranging and immediate changes. Under this scenario, there will be no transition period; no agreement in relation to the border between Northern Ireland (which is part of the UK) and the Republic of Ireland; no EU recognition of UK regulatory systems and no UK participation in EU international agreements. The UK would immediately begin trading on World Trade Organisation terms from 12pm Central European Time on 31 October 2019.
A no deal scenario analysis should include consideration of the potential impact of (among other things) the following:
- the ability of entities in the UK to continue to operate in the EU regulatory environment if the UK is no longer part of the single market
- increased customs duties between the UK and the EU. This is likely to impact entities’ margins to the extent they are unable to pass increased costs on to customers
- other non-tariff-based barriers and costs, including additional customs administration, and the cost of additional regulatory requirements
- crystallisation of certain tax and deferred tax liabilities at year-end and the entity’s ability to settle them
- increased lead time in import and export of goods through UK and European borders, and its potential effect on (for example) the manufacturing process
- potential loss of employees or increased cost of retaining them
- recession or contraction in UK or EU markets affecting demand for goods and services.
Corporate reporting implications
As we approach the 31 October 2019 deadline, the key challenges in relation to Brexit stem from the posibility of the UK leaving without a deal and the effect this will have on the regulatory and economic environment for entities that are affected.
For example, what will happen to UK companies with cross border operations in the EU (and vice-versa) should there be no deal? This is a very broad question that is not easily answered and will be dependent on individual facts and circumstances. However areas which can be expected to be most affected by this uncertainty are those which rely on management’s ability to forecast. These include (but are not limited to):
In assessing going concern, management should consider all available information about the future, which is at least, but is not limited to, twelve months from the reporting date. In making their judgements and assumptions about the future, management should consider all available information regarding Brexit up to the date the financial statements are authorised for issue, including the potential impact of a ‘no deal’ scenario.
If at the date the financial statements are authorised for issue, there is uncertainty regarding a ratified withdrawal agreement, management should prepare a scenario analysis that considers the impact of a no deal Brexit, where such a scenario could have a material impact on the entity.
|Impairment of non-financial assets and determination of recoverable amounts||
When considering impairment, the risk associated with Brexit uncertainty can be factored into
Where management concludes that a reasonably possible change in one or more of their assumptions used in the estimate of the recoverable amount would result in an impairment, or material change to the carrying amount of the asset, or cash generating unit, that impact should be disclosed in the financial statements.
Where an entity has a significant exposure to the risk arising out of a no deal Brexit, management should include in their scenario and sensitivity analysis their judgements and assumptions relating to such a potential outcome.
|Impairment of financial assets||
Management will need to consider the potential impact of Brexit on their IFRS 9 expected credit loss forecasts including any potential increase in credit risk associated with individual borrowers.Some consideration will also need to be given to the valuation of assets pledged as security.
IFRS 9 specifically requires expected credit losses to be measured with reference to probability weighted cash flows. If Brexit increases the likelihood of a credit loss, then this will impact the IFRS 9 provisions. Calculations should be based on management’s expectations at the reporting date and will not be amended for additional information arising after the reporting date.
|Fair value determination of assets and liabilities where there are limited or no observable inputs||
Both Level 3 and some Level 2 fair values under the hierarchy in IFRS 13 ‘Fair Value Measurement’ require the use of unobservable inputs. These unobservable inputs are subject to much of the same uncertainty associated with Brexit as described above in relation to the impairment of non-financial assets.
Fair value estimates must however reflect a market participant’s perspective in pricing an asset or liability, as opposed to internal management perspective applied to value in use forecasts for impairment assessments. Therefore, adjustments to reflect changes in a market participant’s views after the end of the reporting period are not permitted.
|Tax and deferred tax assets and liabilities||
There are currently a number of tax exemptions and reliefs resulting from EU tax directives, which apply to transactions involving companies resident in the EU. In the event of a no deal scenario, it seems likely that these tax exemptions and reliefs will cease to apply (affecting both UK and EU entities). If so, the effect may entail recognition of previously unrecognised deferred tax liabilities.
Our view is that this will only occur upon a change in tax status, so there will be no income tax accounting before Brexit actually takes place.
Given the uncertain nature of the future tax legislation, the most appropriate approach in the intervening period is disclosure in the financial statements of the uncertainties regarding possible future tax liabilities.
As part of their effective no deal Brexit scenario planning, management should quantify the potential tax liabilities which might arise to the extent they are able to. If material those potential tax liabilities should be disclosed along with the uncertainties underpinning the estimates.
Management should also consider the need to disclose contingent liabilities relating to tax.