Elaborate reporting required during extreme uncertaintyMonday April 25 2022
Recently, the World Bank revised its forecast for global economic growth in 2022 downwards, citing factors described by its president as “…severe overlapping crisis...”. Notable among this crisis is the Russian invasion of Ukraine, Covid and inflation impacting the global economy.
Many nations are experiencing rising commodity prices and rising interest rates that impact consumer spending habits, lead to an increase in poverty and inequality and affect the performance of businesses.
Forecasting is an area many organisations have grappled with during conventional times. However, when we combine the current crisis facing the globe, it becomes more difficult to make forecasts and predictions.
These forecasts could include cash flow projections regarding a sales forecast or the price of an asset or liability of an organisation. Today, financial reports contain different values on the balance sheet. These include historical costs, net realisable value and fair value.
Investors typically prefer fair value as it reflects the current situation. However, measurements of fair value not based on a quoted market price rely on some element of forecasts and projections to derive those values.
Organisations face two distinct challenges using fair value measurements. These include deriving the best estimate possible about the future and providing ample disclosures on those estimates.
When provided together, these disclosures can provide the needed context for stakeholders.
While organisations need to apply a rigorous and comprehensive process in determining their forecasts and predictions, they need to appreciate that in an environment with extreme uncertainty, the disclosures accompanying those estimates are equally as important.
Inherently, estimates are usually unable to capture every permutation that could occur in real life and, therefore, are subject to some inaccuracy in their predictions.
It implies that in addition to providing stakeholders information on estimates about the future and how they impact the organisations, it is vital to include sufficient disclosures on the valuation methodology applied, the inputs used, including the level of sensitivity of results and values to changes in the inputs.
This approach will ensure that organisations conduct corporate reporting having considered the perspective of their stakeholders.
It will make reporting relevant to stakeholders by providing information that enables them to understand the key inputs that impact the estimates made by the organisation about the future.
While no organisation can predict the future with precise accuracy, they can ensure estimates include comprehensive disclosure to enable users to understand how changes in the environment affect the organisation.
Some noteworthy aspects that organisations should consider for robust disclosures in their financial statements include valuation methods for asset and liability at fair value, impairment testing of goodwill in subsidiary companies, plants, machinery and buildings, measurement of credit losses on financial assets and receivables to name a few.
These areas will require organisations to exercise judgment in deriving the underlying cash flows that underpin the values assigned to these assets in the financial statement.
The disclosures that accompany the values assigned to these assets are as important as the values included in the financial statements.
Therefore, the key to reporting during extreme uncertainty is to ensure that the appropriate disclosures accompany estimates made by the organisation about the future.
By providing the related disclosures on these estimates, stakeholders have access to relevant information for their decision-making.
It encourages transparency which helps the organisation to build trust with its stakeholders.
Though predictions might not be perfect, the ability to accompany them with relevant disclosures will go a long way to help stakeholders build confidence in the organisation’s reporting and better navigate an environment with extreme uncertainty.
Awodumila, Associate Director at PwC Kenya. He writes and speaks on corporate reporting topics