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Goodwill – Sustainable in Current Environment?

Financial Reporting Brief July 2020

This month’s article ‘Goodwill – Sustainable in Current Environment?' considers the broad perspective of corporate reporting in presenting a response to the question of whether business value can be sustained during and after Covid-19, and whether entities can avoid erosion of goodwill.

Has goodwill been eroded?

We are in the midst of a global health crisis unlike any in living memory. It is much more than a health crisis, it is a human, economic and social crisis. Never has there been a greater need for sustainable investment and development and at a social level we must promote inclusion, reduce inequalities and eradicate poverty. In the words of the UN Secretary General “We must come to the aid of the ultra-vulnerable – millions upon millions of people who are least able to protect themselves. This is a matter of basic human solidarity.” This is the moment to step up for the vulnerable. It is crucial for combating the virus.

Corporate reporting is very much challenged by the Global pandemic. It has revealed just how impactful Economic, Social and Governance (ESG) issues can be on the financial performance of a business and the robustness of its financial position going forward. The fundamental question is how do these challenging times impact on how organisations create and preserve value over the long term. A core element of an organisation’s business model is its value proposition, and how can it be achieved within the constraints of the ESG factors involved.

Covid-19 has changed the market place and economic conditions for many industries and organisations within. It will be a challenge at an extreme level for organisations and getting it right as to how far people, companies and institutions will go back to ‘business – as – usual’ and how much will change will call on them to renew or adapt their business models and ultimately determine their success or failure.

In this context, a recent oft-quoted example is the decision of one of the world’s leading investors, Warren Buffett, to withdraw his company’s investments out of United Airlines. The reason for his decision was his commonly held belief that in the years immediately following the pandemic people will not go back to flying as much as they used to. A primary reason for this will be peoples’ fears and concerns but a strong secondary reason is that during the pandemic people have become more and more aware of the power and reach of advanced technology and communications.

In serving the investment community and other stakeholders, organisations must focus even more intensely not only on financial reporting but also on delivering the appropriate messages on sustainability of their business model. There is a growing momentum in calling for a global solution to interconnected standard-setting that can meet the need for reliable, consistent information in non-financial reporting that is interconnected with financial reporting.

The Immediate Challenges
A recent publication by the UK Financial Reporting Council (FRC) Lab drew attention succinctly to ‘live’ matters that companies need to focus on and that investors and other stakeholders need to be made aware of if there are significant issues. These include:

  • Timing of resumption of operations.
  • Further restrictions that limit the return to normal operations.
  • Restrictions placed on government (or other) capital.
  • Timing and continuation of government schemes and support packages.
  • The outcome of capital raising actions, discussions with banks, and landlords.
  • Short-term impacts of pricing changes to revenue and expenses.
  • Impacts on human capital, the supply chain and customers.

Accompanying this narrative are two reports with specific focus on current conditions, as follows:

Covid-19 – Resources, Action, The Future – Reporting in Times of Uncertainty

Practical advice to companies setting out the disclosures investors expect to see from companies during this time of uncertainty. The report focuses on five key questions investors seek information on, particularly during these troubled times, to include:

  • How much cash does the company have?
  • What cash and liquidity could the company obtain in the short-term?
  • What can the company do to manage expenditure in the short-term?
  • What other action can the company take to ensure its viability in the short-term?
  • How is the company protecting its key assets and value drivers?

Covid 19 – Going Concern, Risk and Viability

The report provides specific guidance with regard to those areas, and emphasises that in challenging times investors seek clarity on the key factors and events that impact the level of uncertainty and prospects for companies over the short, medium and longer term. Investors expect and understand disclosure in these areas in the current environment, and want to see the full range of anticipated possible outcomes and the market reaction to them being disclosed.

The report makes reference to recently published similar guidance in these areas from the FRC and from the Institute of Chartered Accountants in England and Wales.

Managing the Capitals
Much of what is in the FRC Lab’s reports addresses the risks and challenges in the shorter term. Longer-term survival will depend on the future viability of a company’s business. Integrated entity-wide thinking is more important than ever, with reflection commencing with assessment by reference to each of the capitals and whether their value is being maintained during the pandemic and going forward. In considering how a company may respond to the challenges raised by Covid-19, the following are some questions which may help the thought process.

  • Human Capital: In how far do your products and technologies serve to address or add to the healthcare problem (e.g. products enhancing obesity, respiratory diseases and other chronic conditions)?
  • Social and Relationship Capital: In how far does your company offer solutions for the mental health of people of different age groups and in different working contexts?
  • Natural Capital: In how far do the operations and solutions of your company support the conservation and sustainable use of natural resources?
  • Manufactured Capital: In how far does your company offer solutions for the digital economy, one that includes virtual collaboration, alternative concepts of mobility, data processing, as well as online commerce, education and entertainment?
  • Financial Capital: In how far is your company offering solutions that facilitate reliable and accountable transfer of financial resources to families, entrepreneurs and small businesses to support activity?
  • Intellectual Capital: In how far is your company contributing to enhanced trust in science, integration in risk management, enabling the re-skilling of employees, shaping attractive working environments and providing online solutions to build the capacity of future talent?

Sustainability for the Future
Somewhere in between the short-term emergency need for solutions and the longer-term prospects and growth of a company is its sustainability. Covid-19 has increased attention on risk factors, including public health threats, supply chain problems, environmental disruptions and operational flexibility. Companies must have in place a strategy and business model which will enable them to sustain their activities, and to adapt to changing conditions. They must report on these to investors and other stakeholders in a manner which allays concerns regarding dependability and future viability.

The Covid-19 pandemic illustrates that non-financial risks extend to a wide range of social and sustainability issues. There is a plethora of guidance available from different sources, including the Global Reporting Initiative and the Sustainability Accounting Standards Board, on how companies can report on sustainability. In recent years there has been a major focus on climate change and its impact. In response to that there has been significant development in reporting on the topic, with the Task Force on Climate-related Disclosure (TFCD) being to the forefront.

The TFCD reporting recommendations could provide some inspiration on how to report on other sustainability challenges. The TCFD framework and recommendations are based on four reporting pillars – governance, strategy, risk, metrics and targets. Scenario analysis could be used to consider a range of possible future outcomes.

Ability to Report
The Covid-19 pandemic has challenged the ability of companies, like never before, to provide meaningful and reliable financial information to investors and other stakeholders. Effective forecasting in the midst of the pandemic is nigh-on impossible, with the level of uncertainty inherent in business conditions and the question of assets being impaired, including goodwill. Companies must make best efforts with regard to assumptions and estimates, and perhaps most importantly the inclusion of transparent disclosures in their financial reports.

Entities will be expected to monitor assets, including goodwill, for indicators of impairment, to reach well-reasoned judgements based on their particular facts and circumstances, and to disclose their significant judgements and estimates.

With interim reporting imminent for many companies, entities may be required to carry out asset value tests at the interim date if the changing conditions and circumstances of Covid-19 provide an indication of impairment.

Returning to the question of whether goodwill has been eroded, it is a complex question with one clinging on to faith in humanity to address the social issues.

With regard to asset valuation and financial reporting, they are in many ways linked to the environmental, social and governance (ESG) issues that permeate all. Those that manage their various capitals in a protective and productive manner and maintain a strategy and business model to sustain profitability and growth will benefit from continuing engagement by investors and other stakeholders. Failure to do so will inevitably lead to goodwill erosion.

Deloitte has continued its series of IFRS in Focus — Accounting considerations related to the Coronavirus 2019 Disease with the latest publication, the fourth, published in June. At a higher level, aimed at finance directors and audit committees, Deloitte has also published a summary document IFRS in Focus — COVID-19 and financial reporting under IFRS Standards.

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