COVID – 19 effects, IAS 1 paras 125, 97, key sources of estimation uncertainty, impairment of PPE, RoU assets, inventory and receivables

Burberry Group plc – Annual report – 28 March 2020
Industry: retail

1. BASIS OF PREPARATION (extract)
Key sources of estimation uncertainty (extract)
Preparation of the consolidated financial statements in conformity with IFRS requires that management make certain estimates and assumptions that affect the measurement of reported revenues, expenses, assets and liabilities and the disclosure of contingent liabilities.

If in the future such estimates and assumptions, which are based on management’s best estimates at the date of the financial statements, deviate from actual circumstances, the original estimates and assumptions will be updated as appropriate in the period in which the circumstances change.

Estimates are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

The COVID-19 pandemic (COVID-19) has had a major impact on the global economy and is expected to have a significant impact on the operations and financial performance of the Group for at least the next 12 months. At the date of signing these financial statements many of the Group’s retail stores are closed due to government restrictions relating to COVID-19 and the ultimate impact of COVID-19 is uncertain.

As a result, management have assessed the assets held by the Group at 28 March 2020 to identify any indicators of impairment. Where a potential impairment may have arisen as a result of COVID-19, an estimate of the expected recoverable value of the asset has been made and compared to the current carrying value of the asset, to estimate any impairment to be recorded. These estimates, where applicable, have been derived from management’s planning assumption of the likely trading performance over the next two years, taking into account their assumption of the impact of COVID-19 and reflecting a protracted impact of lockdown, the resultant store closures, footfall decline across key regions and gradual improvement in the following year. Longer term growth rates of mid-single digits have been applied thereafter. Where material, these significant estimates have been disclosed below and in the relevant notes to the financial statements.

Due to the significant uncertainty regarding the ultimate impact of COVID-19, the assumptions used in these estimates include an increased level of inherent uncertainty. As a result, management have also considered, where applicable, a potential range of outcomes applying revenue estimates of 15% higher or lower than those included in the central planning assumption. A range of sensitivities for the material estimates are also included in the notes, to indicate the potential range of outcomes considered by management in forming these estimates.

The key areas where the estimates and assumptions applied have a significant risk of causing a material adjustment to the carrying value of assets and liabilities within the next financial year are discussed below. Further details of the Group’s accounting policies in relation to these areas are provided in note 2.

Impairment of property, plant and equipment and right-of-use assets
Property, plant and equipment and right-of-use assets are reviewed for impairment if events or changes in circumstances indicate that the carrying amount may not be recoverable. When a review for impairment is conducted, the recoverable amount of an asset or a cash generating unit is determined based on value-in-use calculations prepared using management’s best estimates and assumptions at the time. Refer to notes 13 and 14 for further details of property, plant and equipment, right-of-use assets
and impairment reviews carried out in the period.

Inventory provisioning
The Group manufactures and sells luxury goods and is subject to changing consumer demands and fashion trends. The recoverability of the cost of inventories is assessed every reporting period, by considering the expected net realisable value of inventory compared to its carrying value. Where the net realisable value is lower than the carrying value, a provision is recorded. When calculating inventory provisions, management considers the nature and condition of the inventory, as well as applying assumptions in respect of anticipated saleability of finished goods and future usage of raw materials. Refer to note 17 for further details of the carrying value of inventory.

6. ADJUSTING ITEMS (extract)
Impact of COVID-19
COVID-19 has impacted both business operations and financial markets worldwide. The ultimate impact of this pandemic is unclear and hence the measurement of its impacts requires a significant degree of estimation. The financial statements for the 52 weeks to 28 March 2020 include costs relating to the impairment of the carrying value of assets as a result of the expected impact of COVID-19 on the Group’s activities and future trading as adjusting items.

Impairment of retail cash generating units
COVID-19 is expected to have a significant impact on the Group’s retail operations in the next 12 months and beyond, with many of its retail outlets currently closed as a result of government restrictions in a number of countries worldwide. As a result management have carried out a review for potential impairment across the whole retail portfolio. The impairment review compared the value-in-use of the retail cash generating units, based on managements’ assumptions regarding the likely future trading performance (taking into account the effect of COVID-19) to the carrying values at 28 March 2020. Following this review, a charge of £156.5 million was recorded within net operating expenses for impairment of retail store assets due to the impact of COVID-19. A charge of £28.4 million was recorded against property, plant and equipment and a charge of £128.1 million was recorded against right-of-use assets. A related tax credit of £28.7 million has also been recognised in the year. This charge has been recognised as an adjusting item arsing as a result of COVID-19, in accordance with the Group’s accounting policy, as it is considered to be material and one-off in nature. Refer to note 13 for details of impairment of retail cash generating units.

Impairment of inventory
Management assesses the recoverability of the carrying value of inventories at every reporting period and, where the expected recoverable amount is lower than the carrying value, a provision is recorded. Typically, inventory provisions are recorded against aged inventory or specific products which have been identified as having a low expectation of future sale. Due to the impact of COVID-19, the closure of many of the Group’s retail stores worldwide and the associated build-up of inventory, management have reassessed their plans for the usage of inventory over the next 12 months, taking into account the expected length of the shutdown, products ordered for future seasons and the Group’s projected future sales. As a result of this reassessment, management have identified additional inventory which is no longer expected to realise its carrying value. Provisions of £68.3 million have been recorded against this additional inventory, which relates to current and recent seasons that under more normal circumstances would be expected to sell through with limited loss. This additional charge for inventory provisions has been presented as an adjusting item arising as a result of COVID-19, in accordance with the Group’s accounting policy, as it is considered material and one-off in nature. A related tax credit of £12.5 million has also been recognised in the year. Refer to note 17 for details of inventory provisions.

Impairment of intangible assets
Following changes to management investment plans, due to the impact of COVID-19, an impairment charge of £10.0 million has been recorded in relation to computer software assets under construction. Due to resulting delays in the development of this software, management no longer expect to fully utilise the expenditure incurred to date. This impairment charge has been presented as an adjusting item arising as a result of COVID-19, in accordance with the Group’s accounting policy, as it is considered one-off in nature. A related tax credit of £1.9 million has also been recognised in the year. Refer to note 12 for details of impairment of intangible assets.
Impairment of receivables
Due to the global financial uncertainty arising from COVID-19, management have reassessed and increased the expected loss rates for trade and other receivables at 28 March 2020. This increase reflects the greater likelihood of credit default by the Group’s debtors in the next 12 months due to the impact of COVID-19. The increase in expected loss rates has resulted in a charge of £11.1 million for impairment of receivables in the year. The Group has not incurred significant costs for impairment of receivables in previous years. This charge of £11.1 million has been presented as an adjusting item arising as a result of COVID-19, in accordance with the Group’s accounting policy, as it is considered to be one-off in nature. A related tax credit of £2.1 million has also been recognised in the year. Refer to note 28 for details of impairment of receivables.

Other impacts of COVID-19
A credit of £5.0 million, principally related to the reversal of accrued costs for share-based payments no longer expected to vest, as a result of the impact of COVID-19 on the expected performance of the Group, has been presented as an adjusting item. A related tax charge of £1.0 million has also been recognised in the year.

12. INTANGIBLE ASSETS

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During the 52 weeks to 28 March 2020 an impairment charge of £11.6 million was recognised in relation to computer software assets under construction (last year: £nil). £10.0 million of this charge related to rescheduling of the development of a software project following changes to management investment plans due to the impact of COVID-19. As a result of this delay, management no longer expect to fully utilise the expenditure incurred to date. The recoverable value of the asset at the balance sheet date is £25.8 million. £10.0 million of the impairment charge has been presented as an adjusting item relating to COVID-19 (refer to note 6).

Impairment testing of goodwill
The carrying value of the goodwill allocated to cash generating units:

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  1. Goodwill which arose on acquisition of Burberry Manifattura S.R.L. has been allocated to the group of cash generating units which make up the Group’s retail and wholesale operating segment cash generating unit. This reflects the level at which the goodwill is being monitored by management.

The Group tests goodwill for impairment annually or where there is an indication that goodwill might be impaired. The recoverable amount of all cash generating units has been determined on a value-in-use basis. Value-in-use calculations for each cash generating unit are based on projected pre-tax discounted cash flows together with a discounted terminal value. The cash flows have been discounted at pre-tax rates reflecting the Group’s weighted average cost of capital adjusted for country-specific tax rates and risks. Where the cash generating unit has a non-controlling interest which was recognised at a value equal to its proportionate interest in the net identifiable assets of the acquired subsidiary at the acquisition date, the carrying amount of the goodwill has been grossed up, to include the goodwill attributable to the non-controlling interest, for the purpose of impairment testing the goodwill attributable to the cash generating unit. The key assumptions contained in the value-in-use calculations include the future revenues, the margins achieved, the assumed life of the business and the discount rates applied.

The value-in-use calculations have been prepared using management’s cost and revenue projections for the next two years combined with a longer term growth rate for the following three years to 29 March 2025. A terminal value has been included in the value-in-use calculation based on the cash flows for the year ending 29 March 2025 incorporating the assumption that growth beyond 29 March 2025 is equivalent to long term inflation expectations. These projections are based on management’s assumptions regarding the likely trading performance over the next two years, taking into account the effect of COVID-19, and growth for the following three years reflecting its expected impact on the global economic environment in the longer term (refer to note 1).

The value-in-use estimates indicated that the recoverable amount of goodwill exceeded the carrying value for each of the cash generating units. As a result, no impairment has been recognised in respect of the carrying value of goodwill in the year.

For the material goodwill balances of China, Korea and the retail and wholesale segment, sensitivity analyses have been performed by management. The sensitivities include applying a 15% reduction in revenue and gross margin from management’s base cash flow projections, considering the potential outcome from a more extended duration of COVID-19. Under this more severe but plausible scenario, the estimated recoverable amount of goodwill in China, Korea and the retail and wholesale segment still exceeded the carrying value.

The pre-tax discount rates for China, Korea and the retail and wholesale segment were 15.0%, 13.4% and 11.1% respectively (last year: China 16.0%, Korea 14.0%, and the retail and wholesale segment 11.1%).

The other goodwill balance of £14.1 million (last year: £13.3 million) consists of amounts relating to seven cash generating units none of which have goodwill balances individually exceeding £7.0 million as at 28 March 2020.

13. PROPERTY, PLANT AND EQUIPMENT (extract)
COVID-19 is expected to have a significant impact on the Group’s retail operations in the 52 weeks to 27 March 2021 and beyond, with many of its retail stores currently closed as a result of government restrictions in a number of countries worldwide. As a result management have carried out a review for potential impairment across the whole retail portfolio. The impairment review compared the value-in-use of the retail cash generating units to the carrying values at 28 March 2020 including the value of any right-of-use assets. The pre-tax cash flow projections were based on management’s assumptions regarding the expected trading performance over the next two years, taking into account the impact of COVID-19, and growth thereafter reflecting the global economic environment in the longer term, using growth rates and inflation rates appropriate to each store’s location.

The pre-tax discount rates used in these calculations were between 9.2% and 21.1% (last year: between 10.4% and 25.3%), based on the Group’s weighted average cost of capital adjusted for country-specific tax rates and risks. Where the value-in-use was less than the carrying value of the cash generating unit, an impairment of property, plant and equipment and right-of-use asset was recorded. Potential alternative uses for property, such as subletting of leasehold or sale of freehold, were considered in estimating the value for calculating impairment charges.

During the 52 weeks to 28 March 2020, a charge of £156.5 million was recorded within net operating expenses as a result of the review of impairment of retail store assets for the impact of COVID-19. A charge of £28.4 million was recorded against property, plant and equipment and a charge of £128.1 million was recorded against right-of-use assets. Refer to note 14 for further details of right-of-use assets.

Management has considered the potential impact of changes in assumptions on the impairment recorded against the Group’s retail assets. Given the significant uncertainty regarding the impact of COVID-19 on the Group’s retail operations and on the global economy, management have considered sensitivities to the impairment charge as a result of changes to the estimate of future revenues achieved by the retail stores. The sensitivities applied are an increase or decrease in revenue of 15% from the estimate used to determine the impairment charge. It is estimated that a 15% decrease/increase in revenue assumptions for the 52 weeks to 27 March 2021, with no change to subsequent forecast revenue growth rate assumptions, would result in a £41.3 million increase / £31.5 million decrease in the impairment charge of retail store assets in the 52 weeks to 28 March 2020.

The charge relating to COVID-19 has been presented as an adjusting item (refer to note 6).

During the 52 weeks to 28 March 2020, a net charge of £11.2 million (last year: £11.2 million) was recorded within net operating expenses as a result of the annual review of impairment of retail store assets. This review was carried out during the year, and did not include any impacts relating to COVID-19. A credit of £2.0 million (last year: charge of £7.5 million) was recorded against property, plant and equipment and a charge of £13.2 million (last year: £nil) was recorded against right-of-use assets. In the prior year, £3.7 million was charged in relation to onerous lease provisions. Refer to note 22 for further details of onerous lease provisions.

In the 52 weeks to 30 March 2019, an impairment charge of £0.4 million was recorded relating to stores being closed as part of the non-strategic store closure programme.

As a result, the total impairment charge recorded in property, plant and equipment was £26.4 million (last year: £7.9 million) relating to 140 retail cash generating units (last year: 26 retail cash generating units) for which the total recoverable amount at the balance sheet date is £59.9 million (last year: £18.1 million).

14. RIGHT-OF-USE ASSETS (extract)
On adoption of IFRS 16, all impairment and onerous leases across existing leased properties were remeasured to take account of the impact of the change in accounting for leases on the measurement of impairments. No changes in underlying assumptions were made during this remeasurement. As a result of the remeasurement, an impairment of right-of-use assets of £121.9 million was recorded, with a corresponding charge to equity of £57.5 million, net of a reversal of existing onerous lease provisions of £48.0 million and an increase in deferred tax assets of £16.4 million. The impairment charge recorded of £121.9 million related to 63 retail cash generating units and two other properties, for which the total recoverable amount at the date of adoption was £200.1 million.

As a result of the assessment of retail cash generating units for impairment, a charge of £141.3 million was recorded for impairment of right-of-use assets. Refer to note 13 for further details. The impairment charge consists of £128.1 million relating to the impact of COVID-19 on the value-in-use of retail cash generating units and a charge of £13.2 million relating to other trading impacts during the year. The charge relating to COVID-19 has been presented as an adjusting item (refer to note 6).

The impairment charge recorded in right-of-use assets relates to 140 retail cash generating units for which the total recoverable amount at the balance sheet date is £344.7 million.

An impairment reversal of £1.0 million relating to other properties was recorded in the year.

17. INVENTORIES (extract)
Inventory provisions of £169.5 million (last year: £92.2 million) are recorded, representing 27.3% (last year: 16.5%) of the gross value of inventory. The provisions reflect management’s best estimate of the net realisable value of inventory, where this is considered to be lower than the cost of the inventory.

The cost of inventories recognised as an expense and included in cost of sales amounted to £893.1 million (last year: £822.0 million). Of this charge, £68.3 million has arisen as a result of the estimated reduction in net realisable value of inventory due to COVID-19 and has been presented as an adjusting item.

Taking into account the significant uncertainty regarding the outcome of COVID-19 and its impact on retail operations and the global economy, as well as other factors impacting the net realisable value of inventory, management consider that a reasonable potential range of outcomes could result in an increase or decrease in inventory provisions of £20.0 million in the next 12 months. This would result in a potential range of inventory provisions of 24.1% to 30.6% as a percentage of the gross value of inventory as at 28 March 2020.

The net movement in inventory provisions included in cost of sales for the 52 weeks to 28 March 2020 was a cost of £88.9 million (last year: £15.7 million). The reversal of inventory provisions as at 30 March 2019 during the current year was £16.2 million (last year: reversal of £30.0 million).

The cost of finished goods physically destroyed in the year was £0.1 million (last year: £2.2 million).

28. FINANCIAL RISK MANAGEMENT (extract)
Credit risk
Trade receivables
The Group has no significant concentrations of credit risk. The trade receivables balance is spread across a large number of different customers with no single debtor representing more than 4% of the total balance due (last year: 5%). The Group has policies in place to ensure that wholesale sales are made to customers with an appropriate credit history. Sales to retail customers are made in cash or via major credit cards. In some retail locations, where the Group’s store is contained within a department store or mall, for example a concession, the sales proceeds may be initially held by the operator of the wider location, giving rise to retail debtors. In addition, receivables balances are monitored on an ongoing basis with the result that the Group’s exposure to bad debts is not significant and default rates have historically been very low.

The Group applies the simplified approach when measuring the trade receivable expected credit losses. The approach uses a lifetime expected loss allowance. To measure the expected credit losses trade receivables have been grouped based on segment, geographical region and the days past due. The expected loss rates are reviewed annually, or when there is a significant change in external factors potentially impacting credit risk, and are updated where management’s expectations of credit losses change.

At 28 March 2020, management have assessed the expected credit losses for trade receivables. Due to the global financial uncertainty arising from COVID-19, management have increased the expected loss rates for trade receivables based on their judgement as to the impact of COVID-19 on the trade receivables portfolio. In addition, certain individual customers (where there is objective evidence of credit impairment) have been identified as having a significantly elevated credit risk and have been provided for on a specific basis. This has resulted in a charge of £12.3 million for impairment provisions recognised in profit and loss in the year, of which £9.1 million is considered to relate to the impact of COVID-19.

Receivables excluding trade receivables
The counterparty credit risk of other receivables is reviewed on a regular basis and the impairment is assessed as follows: At inception the receivable is recorded net of expected 12 month credit losses. If a significant change in the credit risk occurs during the life time of the receivable, credit losses are recorded in the profit and loss account and the effective interest is calculated using the gross carrying amount of the asset. If a loss event occurs, the effective interest is calculated using the amortised cost of the asset net of any credit losses.

As at 30 March 2019, the expected 12 month credit losses of receivables, other than trade receivables, were negligible and hence there were no impairments of these receivables. At 28 March 2020, management assessed that there was an increased credit risk relating to store rent deposits, as a result of COVID-19, and hence recorded a provision of £2.0 million.

During the year ended 31 March 2013 the Group entered into a retail leasing arrangement in the Republic of Korea. As part of this arrangement, a KRW 27 billion (£19.3 million) 15-year interest-free loan was provided to the landlord. The Group holds a registered mortgage over the leased property for the equivalent value of the loan which acts as collateral. At 28 March 2020, the discounted fair value of the loan is £15.5 million (last year: £15.2 million). The book value of the loan, recorded at amortised cost, is £13.4 million (last year: £13.3 million). Other than this arrangement, the Group does not hold any other collateral as security. Management consider that the security provided by the mortgage is sufficient risk mitigation and hence the credit loss relating to this receivable is not significant.

The expected credit loss allowance for receivables was determined as follows:

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The closing loss allowances for receivables reconcile as follows:

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In aggregate, as at 28 March 2020, the movement in the impairment provision on receivables and other financial assets recorded in the income statement was a charge of £14.3 million, of which £12.3 million relates to contracts with customers and £2.0 million relates to other receivables (last year: credit of £4.1 million all of which related to contracts with customers). £11.1 million of this charge is presented as an adjusted item relating to COVID-19.

The maximum exposure to credit risk at the reporting date with respect to trade and other receivables is approximated by the carrying amount on the Balance Sheet.

The expected loss allowance for trade receivables at 28 March 2020 of £16.5 million is 13.4% of the amounts receivable. Due to the significant uncertainty regarding the outcome of COVID-19 and its impact on the global economy, management consider that this expected loss allowance, while representing managements’ best estimate of the future outcome, may be required to be updated in future periods depending on actual circumstances. However any updates are not anticipated to result in a material change in the next 12 months.