‘Tinubunomics’ meets IFRS 9: What it means for Nigeria’s financial future

The popular mantra within the political space is that “elections have consequences.” This saying has become more apparent with the current storm ‘Tinubunomics’ has brought forth on Nigeria and its citizenry. It is without a doubt that the impact of the policy pronouncements has been far-reaching, with economic macros loudly illustrating the “pains and hardships” Nigerians are experiencing. As we say within the finance profession, “numbers speak if we listen.” Whether the hardships are a sufficient condition for the greatness ahead for Nigerians remains the major theme of economic debates among analysts. What is most profound and interesting about financial reporting is that it also responds to external factors affecting reporting entities, and in this case, Tinubunomics!

“This implies that trade receivables have a higher susceptibility to credit loss, which may result in higher ECL estimates for the current year.”

The current economic situation has presented significant financial reporting challenges to corporate entities in Nigeria, with IFRS 9 being a key standard, particularly for businesses within the financial services space. IFRS 9 became effective on January 1, 2018 and has now become a household standard for reporting practitioners, as there is barely a financial statement prepared without financial instruments on its statement of financial position, otherwise known as the balance sheet.

IFRS 9 requires that financial instruments measured at “amortised costs” and “debt instruments” measured at Fair Value Through Other Comprehensive Income (FVTOCI) undergo Expected Credit Loss (ECL) assessment. This assessment essentially estimates a loss provision on the financial assets using forward-looking information. The significant disruptions caused by exchange rate unification and subsidy removal may give rise to liquidity concerns for some businesses, with attendant impacts on the quality of credits issued to these businesses. This implies that trade receivables have a higher susceptibility to credit loss, which may result in higher ECL estimates for the current year.

Looking at the ECL model, entities must also factor in the impact of macroeconomic variables that correlate with their historical loss rates. These rates (for instance, inflation rates, exchange rates, oil prices, unemployment rates, etc.) have shown downturns compared to prior years and would affect the ECL output, potentially differing from previous years’ numbers. Adjustments may also be required for collateral amounts due to valuation changes. Auditors may take interest in possible adjustments to the ECL model of reporting entities and whether these give rise to overlays.

Entities affected by the economic policies of the current administration may have experienced liquidity concerns stemming from significant increases in operating costs or decreases in revenue. This can prompt such entities to seek modifications to their current debt covenants with financial institutions, leading to discussions around IFRS modification of financial liabilities. In the same vein, this arrangement constitutes financial assets to financial institutions that have issued the loans, and these financial assets may have been modified. IFRS 9 requires that for financial liabilities, an entity derecognises the liability if the cash flows are extinguished (i.e., when the obligation specified in the contract is settled, cancelled, or expires) or if the terms of the instrument have substantially changed.

In cases of substantial modification of a financial liability, an entity compares the cash flows before and after the modification, discounted at the original effective interest rate (EIR), commonly referred to as the ’10 percent test.’ If the difference between these discounted cash flows exceeds 10 percent, the instrument is derecognized. The standard does not explicitly clarify the treatment of financial assets, but it allows entities the leeway to apply their accounting policies, which may include the application of the ’10 percent test.’

Furthermore, the volatility and uncertainty around exchange and interest rates may have led to changes in the business model for financial instruments, with businesses possibly selling instruments they would ordinarily hold and vice versa. Financial instrument classification fundamentally depends on the business model with which the instruments are held.

For accountants who may be tempted to “cook the books,” a sale due to an increase in credit risk could still align with the business model objective of ‘hold-to-collect,’ as the credit quality of financial assets is relevant to the entity’s ability to collect contractual cash flows. The sale of a financial asset because it no longer meets the credit criteria specified in the entity’s business model policy is an example of a sale consistent with the ‘hold to collect’ business model. Financial reporters should consider this assessment and present accordingly in the financial statements.

When uncertainties exist, businesses engage more in hedging transactions; more of these in Nigeria would be fair value hedges. This has reporting implications around the recognition, measurement, and disclosure of financial instruments.

The overarching responsibility for financial reporters is to assess the impact of the current economic outlook on their financial statements and consider implementing changes to governance, processes, and policies without compromising the objective of the financials to their respective users.

Side note: ECL is calculated as Exposure at Default x Probability of Default x Loss Given Default.

Sobur Olamilekan Bello, ACA, AAIA, aka Your IFRS Pal, Audit and Financial Reporting Expert.