The Impact of the Economic Environment on Financial Statements

Allie Westwood Date published: Jul 12, 23

Rising inflation and interest rates not only impact the cost of living for you as an individual, but they will also impact how you recognize, measure, present and disclose items in financial statements. We have summarized some of the key areas to consider when presenting your financial statements and the impact that the economic environment can have on them.

The Customer’s ability to pay

The pressure on customer’s can impact businesses as you try to collect receivables and indeed sell your products or services. IFRS 15¹ needs particular consideration, as if it is unlikely the customer will be able to pay, then the sale is outside of the scope and revenue cannot be recognized.

You should also consider your disclosure as IFRS 15² requires disclosure on the nature, amount, timing and uncertainty of cash flows arising from revenue – as the current economic climate is bringing more uncertainty around revenue.

As the costs to fulfil sales increase, you may also find that additional costs due to rising prices may not be recovered, and you will increasingly be at risk from onerous contracts, relating to IAS 37.

Impact on discount rates

Rising interest rates and inflation will affect the discount rates used in future cash flow calculations. This could, in turn, impact the fair value of items reflected in your financial statements, as well as increasing impairment calculations.

The overall effect could be to reduce your asset values and increase your liabilities – which may impact on any loan covenants.

Impairment

Rising interest rates and inflation could be an indicator of impairment. The amount of any impairment involves calculating the value in use, which should reflect your adjusted discount rate as well as likely future cash flows, which could be greatly reduced due to a reduction in the number of customers.

Presentation of financial statements

It’s important to remember that IAS 1³ requires disclosure regarding assumptions about the future and any major sources of estimation uncertainty that have a significant risk of material adjustment to carrying amounts in financial statements.

With the future economic situation uncertain, along with the potential impact on your fair value calculations and the likelihood of further impairment, as mentioned above, you will need to carefully consider whether this is a significant risk to your carrying amounts. The aforementioned risks should also be reflected in your financial instrument sensitivity analysis and narrative disclosures on interest rate and inflation risk.

There is an increased risk of a fall in revenue, reduction in the fair value of assets, increased impairment and with all these factors to consider, you will need to carefully assess whether there are any material uncertainties around the going concern assumption which require disclosure under IAS 1⁴.

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¹ IFRS 15 para 5(e)

² IFRS 15 para 110

³ IAS 1 para 125

⁴ IAS 1 para 25