With interest rates on the rise there are more considerations than ever when it comes to preparing your New Zealand International Financial Reporting Standards (NZ IFRS) financial statements. Here’s four key areas CFOs and Directors need to be aware of when preparing their statements this year.
1. Lower asset values
Rising interest rates create a higher weighted average cost of capital (WACC). This means lower fair values of assets that are measured using a discounted cash flow (DCF) approach. Similarly, the higher WACC could lead to a lower recoverable amount, for those assets that generate cash flows over a long period of time, such as goodwill, which in turn could trigger an impairment loss. Under NZ IFRS, your company is required to test goodwill for impairment annually or more regularly, whenever there is an indication of impairment. Impairment losses are recognised as an expense in the income statement. This reduces the company’s reported earnings and may impact its ability to pay dividends or meet debt covenants. Also, goodwill impairment losses may signal to investors that the company overpaid for the acquisition and did not achieve the expected benefits. This could reduce investor confidence in the company’s management and strategy, and may result in a decline in the company’s share price.
2. What about interest rate risk?
If your organisation – particularly if it’s publicly listed - has significant exposure to interest rate risk (e.g., through variable-rate debt or investments), you will need to disclose more information about the potential impact of rising interest rates on your financial position and performance. This would include sensitivity analyses or stress testing to assess the potential impact of different interest rate scenarios.
3. Covenant clauses
Higher interest rates could also trigger default or breach of covenant clauses especially interest cover covenants. Breaching these doesn’t just cause friction in your borrowing relationship, disclosure in your financial statements may also be required and in certain circumstances cause term debt to become current, which will negatively impact working capital ratios.
4. Lease liabilities
When it comes to interest rates, NZ IFRS 16 requires lessees to measure lease liabilities using a discount rate that reflects the interest rate implicit in the lease or their incremental borrowing rate (IBR), if the implicit rate cannot be readily determined. The OCR was 1.75% on 1 January 2019, when NZIFRS 16 became effective, with the OCR now at 5.25%, there are some considerations. If the lease term has changed the lease liability will need to be remeasured and a revised discount rate will need to be used. Also, if the practical expedient for portfolio application has been used in the past, when interest rates were consistently low, potentially a new rate will need to be explored more than once if the current rising trend continues.
