The Ukraine conflict and financial reporting

The Russian invasion of Ukraine has given rise to potentially complex financial reporting considerations for Irish companies with a presence in one or both territories.

The ongoing conflict in Ukraine, and resulting sanctions and counter sanctions imposed globally on and by Russia, have impacted certain companies. Although the conflict is first and foremost an immense human tragedy for those involved, companies whose operations have been affected will need to consider the financial reporting implications. Here, we consider two potential issues—the first being whether control of subsidiaries located in Russia has been lost, and the second being whether impairment tests of nonfinancial assets in the affected territories should be carried out.

Do you continue to control your subsidiary?

Under IFRS 10 Consolidated Financial Statements, a company (investor) controls a subsidiary (investee) when it has power over the subsidiary, is exposed to variable returns from its involvement with the subsidiary, and can also affect those returns by exercising its power. Control requires power, exposure to the variability of returns, and a linkage between the two.

Continuous control assessment

Suppose the facts and circumstances indicate that there are changes to one or more of the elements of the control model. In this scenario, an investor must reassess whether it continues to have control over the investee. Here, companies will need to consider whether the consequences of the ongoing conflict lead to changes in investors’ relationships with investees in Russia. As a result of the effects of the ongoing conflict, for example, foreign investors may:

• face difficulties in repatriating funds from investees;
• exit or cease operations in these markets, either by choice or by being forced to do so because of sanctions imposed; or
• be impacted by potential new restrictions imposed on foreign owners – e.g. nationalisation of local operations.

The hurdle for losing control of an existing subsidiary is generally high, but the loss of control of subsidiaries in the conflict-affected countries or regions should not be immediately presumed. There is, for example, no exclusion from consolidation due to difficulties alone in repatriating funds from the subsidiary to the parent or the lack of exchangeability of currencies. In considering the impact of these ongoing conflicts, management must consider these two critical elements of control: power and returns.

Power

When assessing power over the investee, an investor considers only substantive rights relating to an investee – i.e. rights that it has the practical ability to exercise. Determining whether rights are substantive requires judgement. Whether there are any barriers due to the consequences of the ongoing conflict preventing the holder from exercising these rights should be considered (e.g. due to current sanctions a company may no longer be able to exercise rights previously available to it.)

Returns

When assessing returns, an investor evaluates if they are exposed to variable returns from involvement with an investee. The sources of these returns may be very broad and may include both positive and negative returns.

Sources might include dividend or other economic benefits, for example, remuneration for services provided to the investee, tax benefits or certain residual interests.

Management should consider whether the company’s exposure to the variability of returns has been impacted and needs to be reassessed. IFRS 10 does not establish a minimum level of exposure to returns to have control.

Where there has not been a loss of control, there may be other impacts to consider. These might include:

• possible impairment of the investment in the subsidiary;
• presentation of the subsidiary as held-for-sale or as a discontinued operation; or
• possible impairment of the assets held by the subsidiary.
• possible impairment of the investment in the subsidiary;

Do I need to test my non-financial assets for impairment?

Control in relation to other assets

Before considering impairment for companies with assets on the ground in Russia or Ukraine, it is necessary to assess whether they have, in substance, lost control of those assets.

Control in the context of assets generally means the practical ability to control the use of the underlying asset. If control has been lost, the asset is derecognised in its entirety, and no impairment is carried out.

Sources might include dividend or other economic benefits, for example, remuneration for services provided to the investee, tax benefits or certain residual interests.

Where there has not been a loss of control, there may be other impacts to consider. These might include:

• presentation of the subsidiary as held-for-sale or as a discontinued operation; or

IAS 36 Impairment of assets

The standard requires management to assess whether there is any indication of impairment at the end of each reporting period. Irrespective of any indicator of impairment, the standard requires goodwill, and intangible assets with indefinite useful lives (and those not yet available for use) to be tested for impairment at least annually. An annual test is required alongside any impairment tests performed as a result of a triggering event.

Indicators of impairment may come from internal or external sources, but the likelihood of some impairment indicators existing has increased for companies impacted by the Russia- Ukraine war. Some indicators that may arise include:

Control in the context of assets generally means the practical ability to control the use of the underlying asset. If control has been lost, the asset is derecognised in its entirety, and no impairment is carried out.

• significant adverse effects in the technological, market, economic or legal environment, including the impact of sanctions on the entity’s ability to operate in a market;
• are significantly affected by the sanctions imposed and/or Russia’s counter-measures;

The likelihood that a triggering event has occurred for noncurrent assets has increased significantly for companies that:

Before considering impairment for companies with assets on the ground in Russia or Ukraine, it is necessary to assess whether they have, in substance, lost control of those assets.

• significant changes in the extent or manner in which an asset is (or is expected to be) used which has (or will have) an adverse effect on the entity.
• the carrying amount of the net assets of an entity exceeding its market capitalisation. Falling stock prices may result in an entity’s net assets being greater than its market capitalisation.

Triggering events

The likelihood that a triggering event has occurred for noncurrent assets has increased significantly for companies that:

• have significant assets or operations in Russia or Ukraine;
• are significantly affected by the sanctions imposed and/or Russia’s counter-measures;
• are adversely affected by increases in the price of commodities; and/or • are significantly affected by supply chain disruption.

Impairment indicators

Indicators of impairment may come from internal or external sources, but the likelihood of some impairment indicators existing has increased for companies impacted by the Russia- Ukraine war. Some indicators that may arise include:

• the obsolescence or physical damage of an asset. For example, plants and operations in Ukraine may be subject to physical damage;
• significant changes in the extent or manner in which an asset is (or is expected to be) used which has (or will have) an adverse effect on the entity.
• a significant and unexpected decline in market value;
• significant adverse effects in the technological, market, economic or legal environment, including the impact of sanctions on the entity’s ability to operate in a market;
• a rise in market interest rates, which will increase the discount rate used to determine an asset’s value in use; and
• the carrying amount of the net assets of an entity exceeding its market capitalisation. Falling stock prices may result in an entity’s net assets being greater than its market capitalisation.

Abandonment or idle assets

Companies may have abandoned—or have considered a plan to abandon—certain operations or properties in Russia or Ukraine. Some companies may have been forced to abandon owned or leased facilities in Ukraine as a result of the war, for example. In such cases, the company needs to accelerate or impair the depreciation of the property based on the revised anticipated usage or residual value. Assets lefts temporarily idle are not regarded as abandoned—for example, when a company temporarily shuts a manufacturing facility but intends to resume operations after military activities in the area abate. Although temporarily idling a facility may trigger an impairment of that item (or the CGU to which it belongs), a company does not stop depreciating the item while it is idle— unless it is fully depreciated or is classified as held-for-sale. Companies should, however, consider the most appropriate depreciation method in this situation.

Disclosures

When reporting in uncertain times, it is essential to provide the users of financial statements with appropriate insight into the key assumptions and judgements made by the company when preparing financial information. Depending on an entity’s specific circumstances, each area above may be a source of material judgement and uncertainty requiring disclosure.

This article first appeared in Accountancy Ireland and is reproduced here with their kind permission.