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How to address Brexit in your financial reporting

Jake Green Jake Green

With 29 March 2019 fast approaching, there is still uncertainty around what our future relationship with the EU will be post-Brexit.

This has an impact on financial reporting, not least because management will need to disclose the uncertainties and risks to their business arising from Brexit and how their assumptions about these uncertainties have affected the numbers in the balance sheet.

These disclosures will be high on the Financial Reporting Council's (FRC) watchlist for the forthcoming reporting season and are likely to be scrutinised and challenged. Investors and other stakeholders increasingly expect to see an assessment of the impact of Brexit and a clear plan for readiness. This is particularly an issue for the preparation and publication of accounts between now and the end of March.

The areas most affected by Brexit uncertainty are those which rely on management’s ability to forecast. These are broadly, but not limited to:

  • going concern and, in the case of main market listed companies, viability statements
  • principal risk and uncertainty disclosures
  • impairment of non-financial assets and determination of recoverable amounts
  • impairment of financial assets
  • fair value determination of assets and liabilities where there are limited or no observable inputs (mainly level 3 and some level 2 fair values), including pension scheme assets and related net liability positions
  • tax and deferred tax assets and liabilities.

Below, we’ve explored some of the key points for management to consider when reporting on Brexit to meet their financial reporting responsibilities.

1 Measure exposure

All entities will need to assess their exposure in the areas that may be affected by Brexit. High-level exposure assessment will likely be driven by these eight factors:

  • the broader economic conditions arising from a Deal or No Deal Brexit
  • changes to the regulatory environment in which the entity operates resulting from a Deal or No Deal Brexit (including legal, data, product conformity, tax and customs)
  • reliance on European customers and markets (including the wider European Economic Area (EEA) and customs union with Turkey)
  • reliance on European suppliers and supply chain (including wider EEA and customs union with Turkey)
  • short and longer term changes to logistics and distribution
  • reliance on EU trade agreements for access to third country markets and other EU international agreements
  • reliance on European workforce
  • reliance of European financing, either commercial or grant funding.

2 Ensure No Deal is addressed

The key challenge for reporting in relation to Brexit is the uncertainty surrounding whether the withdrawal agreement will be ratified and what effect this will have on the regulatory and economic environment in the UK. For example, what will happen to UK companies with cross border operations in the EU should there be No Deal?

It is extremely important for boards of directors to give due consideration to the potential impact of a No Deal Brexit in order for them to meet their fiduciary duties. The level of analysis required will differ from entity to entity.

If at the reporting date 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.

A No Deal scenario analysis should include consideration of the potential impact of, among others:

  • the ability of the entity to continue to operate in the regulatory environment if the UK is no longer part of the single market, for example financial services providers
  • increased customs duties. This is likely to impact the entity’s margins to the extent the entity is unable to pass any increased cost on to the customer. It will depend on exposure to both imports from primary non-UK suppliers and to the exposure of UK based suppliers to custom duty to the extent this is passed on to the entity
  • non tariff barriers and costs, including additional customs administration and the cost of additional regulatory requirements
  • crystallisation of certain tax and deferred tax liabilities, and the entity’s ability to settle them
  • increased lead time in import and export of goods through European borders, and its potential effect on the manufacturing process for example
  • potential loss of a significant proportion of European workforce working in UK or increased cost of retaining them (eg visas)
  • recession or contraction in EU markets affecting demand on UK goods and services.

3 Consider the wider implications

There are two levels of uncertainty – one directly related to Brexit, for example, the impact of duties and tariffs and interaction with the EU such as through customers and suppliers, and another that arises due to the broader impact of Brexit on the general economy. More specifically in relation to Brexit directly, risks could arise from changes in regulation, access to capital, currency fluctuations and exchange rates, valuations, credit risk and the reduction in EU exports in the short term.

Other possible risks derived from the FRC's roundtable meetings with investors across a broad range of industries include:

  • cyber and data security
  • pensions – impact of actuarial valuations and future funding
  • climate change – obligations, non-compliance with laws and regulations and ethical misconduct
  • ability to attract key talent
  • impact of global political changes on asset values/impairment
  • impact on expected credit loss provisions made under IFRS 9 ‘Financial Instruments’
  • revenue recognition for long term contracts
  • impact on an entity’s supply chain
  • tax exposure/provisioning.

Conclusion

There is a significant amount of uncertainty, not only in relation to whether there is likely to be a withdrawal agreement, but also in relation to what the economic impacts of Brexit will be in the UK, Europe and the rest of the world. It is therefore vital that management plan for all scenarios and, from a financial reporting perspective, provide users of their financial statements with as much information regarding the impact of these uncertainties on the future prospects of the entity and the measurement of its assets and liabilities. This should cover what the uncertainties are and how sensitive management’s conclusions are to reasonably possible changes in the key assumptions made by them.

Our experts have examined all the possible impacts of Brexit on financial reporting and can help your business prepare. For more information, get in touch with Jake Green.

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