- As per our channel checks, IFRS-9 may be implemented for non-financial companies in the upcoming Jun’19 results. The standard entails a more prudent method of providing for potential losses on financial assets. We understand that certain energy companies have applied to the regulator SECP for exemption.
- We stress that, if implemented, IFRS-9 will negatively affect only earnings, not cash-flows. Within the Energy sector, we think the standard will be more negative for fuel suppliers than in case of IPPs.
- We highlight that our estimates and Jun’19 quarterly previews do not reflect any IFRS-9 related provisions, due to the subjectivity and accounting discretion that companies will likely exercise, if it is implemented.
How it works?
By IFRS standards, companies have to assess all financial assets for impairment, in terms of their probability of default and loss-given-default. This affects receivables from customers, investments, loans (to employees, for example) and other financial assets. While provision of value (say, for overdue receivables) was already practiced, IFRS-9 is different in that it requires companies to provide for any expected losses, on a more prudent basis than applied before.
Additionally, companies will also have to provide for losses on account of discounting of future payments of financial assets (including receivables). To illustrate, a PKR1,000mn payment due in 2 years’ time is worth PKR826mn today (discounted at 10% for example); the difference of PKR174mn will have to be charged in the financial statements. We understand that the charges related to prior years will reflect in the Equity balance, while current-year charges will route in the P&L statement.
What does it mean for Energy companies?
If IFRS-9 is implemented, there may be significant implications for the reported earnings of Energy companies; because an inefficient-payment system (sector-wide) has led to large receivable balances, which will be tested for the above conditions. A few important considerations are:
- All assets backed by sovereign guarantee would likely be excluded from impairment analyses.
- However, the effect of discounting to present-value will still apply to these assets (receivables and govt. securities)
- Those assets that bear mark-up on future payments may be less affected (will offset the discounting effect).
- Interest accrued on late payments will bear the most brunt (not compensated for compounding, thus fully exposed to provision due to discounting).
Subjectivity will arise in determining the expected timing of future cash recoveries. To address this, the standard allows making scenarios (for example, early, moderate and late payments) and to base the provision on weighted-average expected cash flows. We believe fuel suppliers (E&Ps, OMCs) will be affected more than power generation companies (IPPs) – because of the variety and size of assets that are affected by the standard (incl. outstanding late payment surcharges or LPS). The unpaid LPS balances are large in case of OMCs and E&Ps.