This article
provides guidance on the presentation and disclosure of exceptional items in
the financial statements arising due to Covid-19. Firstly, it is important to
look at the requirements of various authoritative guidances which are given
below:
(1) Schedule III to the Companies Act, 2013
specifically requires a line item for ‘exceptional items’ on the face of the
statement of Profit and Loss (P&L).
(2) The Securities and Exchange Board of India
Circular dated 5th July, 2016 requires that listed entities shall
follow the Schedule III to the Companies Act, 2013 format for purposes of
presenting the financial results.
(3) The term ‘exceptional items’ is neither
defined in Schedule III nor in any Ind AS.
(4) Paragraphs 9, 85, 86, 97 and 98 of Ind AS 1 Presentation
of Financial Statements are set out below:
9 ‘The objective of financial statements is to
provide information about the financial position, financial performance and
cash flows of an entity that is useful to a wide range of users in making economic
decisions… This information, along with other information in the notes,
assists users of financial statements in predicting the entity’s future
cash flows and, in particular, their timing and certainty.’
85 An entity shall present additional line items
(including by disaggregating the line items listed in paragraph 82), headings
and subtotals in the statement of profit and loss, when such presentation is
relevant to an understanding of the entity’s financial performance.
86 Because the effects of an entity’s various
activities, transactions and other events differ in frequency, potential for
gain or loss and predictability, disclosing the components of financial
performance assists users in understanding the financial performance achieved
and in making projections of future financial performance. An entity includes
additional line items in the statement of profit and loss, and it amends the
descriptions used and the ordering of items when this is necessary to explain
the elements of financial performance. An entity considers factors including
materiality and the nature and function of the items of income and expense. For
example, a financial institution may amend the descriptions to provide
information that is relevant to the operations of a financial institution. An
entity does not offset income and expense items unless the criteria in
paragraph 32 are met.
97 When items of income or expense are material,
an entity shall disclose their nature and amount separately.
98 Circumstances that would give rise to the
separate disclosure of items of income and expense include:
(a) write-downs of inventories to net realisable
value or of property, plant and equipment to recoverable amount, as well as
reversals of such write-downs;
(b) restructurings of the activities of an entity
and reversals of any provisions for the costs of restructuring;
(c) disposals of items of property, plant and
equipment;
(d) disposals of investments;
(e) discontinued operations;
(f) litigation settlements; and
(g) other reversals of provisions.
(5) In December, 2019 IASB issued
an Exposure Draft General Presentation and Disclosures (ED) that, once
finalised, would replace IAS 1 and eventually Ind AS 1. The deadline for
submitting comments is 30th September, 2020. The ED proposes
introducing a definition of ‘unusual income and expenses’ and requiring all
entities to disclose unusual income and expenses in a single note.
(6) As per the ED: ‘Unusual income and expenses
are income and expenses with limited predictive value. Income and
expenses have limited predictive value when it is reasonable to expect that
income or expenses that are similar in type and amount will not arise for
several future annual reporting periods.’
(7) Paragraph B67-B75 of the application guidance
to the ED provides further explanation of the nature of ‘unusual’ items. In
particular, the following extracts may be noted:
‘In
determining whether income or expenses are unusual, an entity shall consider
both the type of the income or expense and its amount. For example, an
impairment loss resulting from a fire at an entity’s factory is normally an
unusual type of expense and hence would be classified as an unusual expense
because in the absence of other indicators of impairment, another similar
expense would not reasonably be expected to recur for several future annual
reporting periods.
Income and expenses that are not unusual by type may be unusual in
amount. Whether an item of income or expense is unusual in amount is determined
by the range of outcomes reasonably expected to arise for that income or
expense in several future annual reporting periods. For example, an entity that
incurs regular litigation costs that are all of a similar amount would not
generally classify those litigation expenses as unusual. However, if in one
reporting period that entity incurred higher litigation costs than reasonably
expected because of a particular action, it would classify the costs from that
action as unusual if litigation costs in several future annual reporting
periods were not expected to be of a similar amount. The higher litigation
costs are outside the range of reasonably expected outcomes and not predictive
of future litigation costs.’
(8) The ED also supports the conceptual concerns
raised by certain stakeholders about the presentation of exceptional items as a
separate line item in the P&L statement rather than in the notes. The
following may be particularly noted:
The Board
proposes that information about unusual income and expenses should be disclosed
in the notes rather than presented in the statement(s) of financial
performance. The Board concluded that disclosure in the notes would enable
entities to provide a more complete description and analysis of such income and
expenses. Disclosure in the notes also provides users of financial statements
with a single location to find information about such income and expenses and
addresses some stakeholders’ concerns that unusual income and expenses may be
given more prominence than other information in the statement(s) of financial
performance.
Some
stakeholders suggested that, given the importance some users of financial
statements attach to the disclosure of unusual income and expenses, operating
profit before unusual income and expenses should be added to the list of
subtotals specified by IFRS Standards and the requirements relating to analysis
of operating expenses by function or by nature adjusted accordingly. In their
view, no longer being able to present an operating profit subtotal before
unusual items would be a significant step back from current practice. The Board
has not proposed adding this subtotal because, in some cases, presentation of
an operating profit before unusual income and expenses subtotal could result in
a presentation that mixes natural and functional line items. Users have told
the Board that they do not find mixed presentation useful and want to see all
operating expenses analysed by one characteristic (nature or function).
AUTHOR’S ANALYSIS AND CONCLUSIONS
The two
fundamental questions that need to be answered are as follows:
(i) What items are included as exceptional items?
(ii) Whether an exceptional item is presented as a
separate line item in the P&L or only described in the notes?
Before we start
addressing the above questions, the following points may be kept in mind:
(a) Exceptional items may arise from Covid or
non-Covid factors or a combination of both. For example, the fall in oil prices
may be due to Covid as well as trade wars between oil-producing countries.
(b) The separate presentation of exceptional item
in the P&L is required by both SEBI and Schedule III.
(c) The two factors / tests that dominate whether
an item is exceptional are the size of the item (‘materiality test’) and the
predictive value (‘predictability test’). For example, by presenting a non-recurring
item as exceptional, investors can exclude those exceptional items in making
future projections of the performance. This aspect is also clear in the IASB’s
ED. At this point in time, the pandemic should be considered to be unusual and
non-recurring and will meet the test in the ED.
(d) Whilst Schedule III and SEBI require separate
presentation of exceptional items, there are a few anomalies which are listed
below:
(i) The presentation of exceptional item as a
separate line item results in a mixed presentation. For example, presentation
of losses on inventory due to marking them down to net realisable value as
exceptional item results in cost of sales division into two separate line
items.
(ii) An item of expense or loss may be caused by
both exceptional and non-exceptional factors. Segregating between what is
exceptional and what is not exceptional may be challenging. For example,
consider that the value of investment in an equity mutual fund at December-end
was Rs. 100. Prior to the outbreak / lockdown the value had gone up to Rs. 110.
On 31st March, 2020 the value
had fallen to Rs. 85. Consequently, a net loss of Rs. 15 is included in the
P&L for the last quarter. This theoretically may be represented in two
ways, (a) Rs. 15 is an exceptional item, or (b) Rs. 25 is an exceptional item
and Rs. 10 is income from normal gains. Putting it simply, determining what is
exceptional can be very arbitrary in this case, because it involves determining
an arbitrary cut-off date. It also results in a mixed presentation when one
item is segregated into two different components. In this given case, the
author believes that Rs. 15 should be considered as an exceptional item and the
segregation was done to merely illustrate the point.
(e) Given the specific
requirement of SEBI and Schedule III, it may not be incorrect to disclose a
material and non-recurring item as exceptional on the face of the P&L.
However, a better option would be not to present an exceptional item in the
P&L because it results in a mixed presentation and arbitrariness in
segregating an item as exceptional and not exceptional. Rather, exceptional
items may be more elaborately described in the notes to accounts.
Table
1
|
Expenditure
|
Author’s evaluation of exceptional and
non-exceptional
|
|
Impairment
|
For many enterprises, impairment is
non-recurring. Therefore, the same may be presented as exceptional items if
those are material, irrespective of whether they are caused due to Covid or
non-Covid factors
|
|
Incremental costs
due to Covid
|
If the costs are incremental to costs incurred
prior to the Covid outbreak and not expected to recur once the crisis has
subsided and operations return to normal, and clearly separable from normal
operations, they may be presented as an exceptional item. Temporary premium
payments to compensate employees for performing their normal duties at
increased personal risk, charges for cleaning and disinfecting facilities
more thoroughly and / or more frequently, termination fees or penalties for
terminated contracts or compliance with contractual provisions invoked
directly due to the events of the pandemic, may be both incrementally
incurred as a result of the coronavirus outbreak and separable from normal
operations. On the other hand, payments to employees for idle time, rent and
other recurring expense (e.g., security, utilities insurance and maintenance)
related to temporarily idle facilities, excess capacity costs expensed in the
period due to lower production, paying employees for increased hours required
to perform their normal duties and paying more for routine inventory costs
(e.g., shipping costs) will generally not be incremental and separable and
should not be presented as exceptional items
|
|
Provision for
doubtful debts
|
Provisions for doubtful debts are determined using
the expected credit loss method (ECL). The forward-looking projections in the
ECL model may be adjusted to reflect the post-Covid economic situation.
Generally, it will be difficult to segregate the overall ECL between those
that are Covid-caused and others. Besides, a higher ECL may be expected, on a
go forward basis, because Ind AS 109 specifically requires the ECL model to
be adjusted for forward-looking information. Consequently, it is difficult to
argue that a higher ECL provision will be a non-recurring feature. Therefore,
the provisions should not be identified as an exceptional item
|
|
Suspension of capitalisation of borrowing cost
due to Covid lockdown
|
There can be two views on this matter. Due to
suspension, the borrowing costs incurred during construction of an asset may
be expensed rather than capitalised. Consequently, the expense will impact
the P&L all at once. Had the interest expenditure been capitalised, had
there been no Covid, the expense would have been reflected by way of future
depreciation charge. As a result, since the expenditure is in any case
incurred, there is no exceptional item. The alternative view is that because
of the lockdown the interest expenditure is impacting the P&L all at
once. Since such expenditure is non-recurring the same may be presented as an
exceptional item
|
|
Litigation costs
|
Is the litigation caused due to Covid? For
example, there is clear evidence that the contract delay was due to Covid and
the customer is litigating on the same? Legal costs incurred to defend the
entity’s position may be presented as an exceptional item. Similarly, advice
from counsel on force majeure clauses in contracts may be considered
to be exceptional. These items may be presented as an exceptional item
|
|
Write-off / write-down
of inventories
|
If this meets the materiality test and the
predictability test, it may be presented as an exceptional item
|
|
Losses due to fall in NAV of investments made in
mutual
funds (MF)
|
If this meets the materiality test and the
predictability test, it may be presented as an exceptional item
|
|
Restructuring costs
|
Costs incurred on downscaling of operations if
caused due to Covid may be presented as an exceptional item
|
|
Onerous contracts
|
If this meets the materiality test and the
predictability test, it may be presented as an exceptional item
|
|
Severance pay for premature termination of
employment
|
Normal salary cost paid for lockdown period will
generally not pass the tests because salary is a recurring cost. However,
severance pay may be non-recurring in nature, whether caused due to Covid or
otherwise, and hence may be presented as an exceptional item
|
For the
purposes of providing additional guidance, the following indicative list of
expenditures is evaluated from the perspective of whether those are
exceptional, from the prism of the principles described above. The assumption
is that the items discussed in Table 1 (on the previous page) are
material to the specific entity.
The fundamental challenge in
identifying an exceptional item is that it results in arbitrariness due to
segregating an item into two separate components and a mixed presentation. Therefore,
it is suggested that the items discussed above which are identified as
exceptional items may be presented as such with an elaborate description in the
notes to the accounts.
It is not uncommon for
entities to supplement the EPS figures required by Ind AS 33 by voluntarily
presenting additional amounts per share, for example, profits before and after
exceptional items. For additional earnings per share amounts, the standard
requires:
(I) that the denominator used should be that
required by Ind AS 33;
(II) that basic and diluted amounts be disclosed
with equal prominence and presented in the notes;
(III) an indication of the basis on which the
numerator is determined, including whether amounts per share are before or
after tax; and
(IV) if the numerator is not reported as a line item
in the statement of comprehensive income or separate statement of P&L, a
reconciliation to be provided between it and a line item that is reported in
the statement of comprehensive income [Ind AS 33.74].
Alternative EPS figures may
be presented on the face of the P&L as well as in the notes.
