Accounting implications of the war in Ukraine
The effects on the balance sheet and P&L as well as ...
The first question to be considered is whether or not the effects of the war in Ukraine have to be reported already in the annual financial statements that have to be prepared, in accordance with German commercial law, for the financial year ending 31.12.2021. According to German GAAP, the invasion by Russian forces of the sovereign state of Ukraine, on 24.2.2022, has to be regarded as a significant development and thus a non-adjusting event.
As a result of the principle of the cut-off date, the accounting consequences thus generally only have to be included in the balance sheet and P&L of the annual financial statements for financial years that end after 23.2.2022. This would not apply solely in those cases where, due to the impact of the war, it is no longer possible to maintain the going concern assumption. An indication of such a situation could be a massive deterioration in the financial position, cash flows and results of operations after the reporting date.
Please note: Technical Guidance recently issued by the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer in Deutschland e.V., IDW), on 8.3.2022, should also be considered in addition to our guidelines. Moreover, it should be noted that the guidelines apply analogously for group accounting and accounting under IFRS.
... on the notes to the financial statements
The notes form part of the annual financial statements and fulfil a variety of functions. These include, for example, adjustments to the balance sheet and P&L. The adjustment function – in accordance with Section 285 no. 33 of the German Commercial Code (Handelsgesetzbuch, HGB) – is performed through so-called supplementary reporting of: “events of particular significance that occurred after the end of the financial year and that have not been taken into account either in the profit and loss statement or the balance sheet, indicating their nature and financial effects.”
Within the scope of supplementary reporting, the nature and financial effects of an event should generally be explained. In doing so, the war in Ukraine and its significance for the business should be described in the individual case. If it is not yet possible to specifically quantify the financial effects then it would be sufficient to provide a qualitative description of the impact on the company’s overall business situation.
Cross-referencing between the notes and the management report
In principle, in view of the similar nature of the contents, it is possible that a reporting requirement will arise for both the notes and the management report. To avoid duplication and to increase the transparency of forward-looking information it is possible to present the effects in a prominent place. The IDW, in its Technical Guidance, clarified that in the supplementary report it would be permissible to refer to the descriptions in the management report if identical information would otherwise have had to be included in both reports. This would be on condition that the references in the supplementary report to the management report and/or those in the management report to the supplementary report would have to be unambiguous and clearly identifiable.
The comments on the impact on the business situation would have to be adequately presented. In this case, the time period for which the effects have to be presented should cover the start of the subsequent financial year (normally 1.1.2022) up to the date of the completion of the preparation of the annual financial statements.
Please note: In view of the explicit legal exemption regulations with respect to supplementary reporting and the management report, small and micro enterprises as well as companies that prepare their annual financial statements in accordance with the requirements that apply to all businesses under German commercial law are, accordingly, not required to prepare such reports. Those who prepare accounts only have to report on risks to the company as a going-concern and they are required to provide information on this fact as well as on how they plan to deal with these risks.
Specific implications for the management report
In the case of medium-sized companies and large companies, the management report complements the backward-looking information in the annual financial statements. According to Section 289(1) clause 4 HGB “the management report has to provide an evaluation and explanation of the developments that are expected as well as their main opportunities and risks”. A distinction has to be made here between the reporting requirements in the risk report, on the one hand, and in the report on expected developments, on the other hand.
In the risk report, the following risk categories, in particular, are reportable:
- possible further developments that could lead to negative deviations from the company’s forecasts or targets,
- the occurrence of a material individual risk,
- no accurate picture of the company’s risk situation is conveyed,
- the existence of risks to the company as a going-concern, such as e.g., imminent illiquidity or impending over-indebtedness, as well as
- risks that could materially affect the company’s financial position, cash flows and results of operations.
The documentation of the liquidity risk or the risk of illiquidity is especially important. This can be done, e.g., in liquidity and financial plans extending at least to the end of the new financial year.
Report on expected developments
In the report on expected developments, the management has to make statements about the anticipated (i.e. the planned) development of sales and earnings for at least the first year after the balance sheet date. If current events and the effects of sanctions have already resulted in a change in management’s expectations with regard to the forecast performance indicators then this would have to be appropriately reflected in the report on expected developments.
Generally, the only types of forecasts that may be introduced are the following:
- point forecasts (e.g. EBIT €1m),
- interval forecasts (e.g. EBIT €1 – €2m),
- qualified comparative forecasts (e.g. considerably higher EBIT when compared with the previous year).
Companies may deviate from this if with respect to the effects of the war in Ukraine all of the following preconditions have been met:
- exceptionally high level of uncertainty as regards the future outlook due to the macroeconomic conditions and
- the company’s forecasting ability is significantly impaired.
In this case, a comparative forecast would be sufficient, such as, e.g., “... for the financial year 2022, in view of the war in Ukraine, we expect lower revenues … strongly negative EBIT…“.
Please note: In the opinion of the IDW, a general reference to the war in Ukraine and its consequences would not be sufficient. Totally dispensing with reporting on expected developments would likewise not be permissible.
Conclusion: There is neither a requirement nor a possibility to take into account the war in Ukraine in the balance sheet and P&L as at 31.12.2021. Nevertheless, you will have to give an account of the effects in the notes to the financial statements, in the so-called supplementary report as well as in the management report. The greater challenge is likely to be the preparation of the risk report where statements will have to be made as to whether or not, if all the risks are aggregated, the risk-bearing capacity can be ensured and the extent to which there are developments that could jeopardize the company as a going-concern.