| Message from the CEO – Don’t discount your discount rates |
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We know all too well the impact the increase in inflation and interest rates has had on our household purses. Inflation was 5.9% in March 2022 and 7.1% in March 2023. The prime lending rate for the same period was 7.75% and 11.25% respectively. So, what do these changes mean for the financial statements?
Inflation and interest rates are used frequently in the financial statements to value assets and liabilities, both throughout the year and at the reporting date. Examples where interest rates are used to value assets and liabilities include the: - Replacement cost of assets where the revaluation model is applied.
- Value-in-use of assets for impairment purposes.
- Fair value of financial assets at year end.
- Present value of provisions for rehabilitation of assets, e.g. landfill sites.
- Fair value of assets held to fund defined benefit plans.
- Present value of liabilities to pay retirement benefits under defined benefit plans and other employee benefits.
Changes in price indices, like CPI, can impact what discount rate is used and/or how cash flows are determined for certain valuations. Entities should be sure when they perform their valuations whether they are using price adjusted cash flows (or not), and real or nominal interest rates.
Given the changes in interest rates over the last year entities should consider: - Whether past valuations need to be updated (if they are not required at every reporting date).
- Whether the effect of discounting an asset or liability is material in the current year (where this was not assessed as immaterial and not accounted for in the past).
- What information users will need in the financial statements to assess the impact of the changes in interest rates (and potentially price indices) on the financial statements. Providing boilerplate wording from the Standards about rates used are unlikely to meet users’ needs. Where changes in interest rates have a material impact on the financial statements, information that could be provided about the changes in rates include how the rates were determined; how changes in rates have or will affect the valuation of assets and liabilities; and the judgement applied in determining the rates so that users can assess how changes in rates could affect the financial statements.
While the Standards often provide guidance on the type of information to disclose, it is important to remember that preparers should disclose any additional information if it will be relevant to users’ information needs.
Wishing you all the best for your financial statement preparation! |
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