IAS 1 para 122, critical judgements, COVID – 19, sensitivities

Tesco PLC – Annual report – 29 February 2020

Industry: retail

Judgements and sources of estimation uncertainty (extract)
Critical accounting judgements (extract)
Impact of COVID-19
In light of the rapidly escalating COVID-19 pandemic, the Group has considered whether any adjustments are required to reported amounts in the financial statements.

As at the 29 February 2020 balance sheet date, no global pandemic had been declared, the UK was still in the ‘containment’ phase, large global share price falls had not yet occurred, and larger-scale outbreaks were only apparent in China, Republic of Korea, Iran and northern Italy where the Group does not have operations. The full ramifications of COVID-19, and the extent of Government interventions in response, were not apparent. To the extent that there were indicators of some level of disruption observable at the balance sheet date, these have been factored in to the Group’s financial statements as at 29 February 2020, in particular assessing the impact of incorporating an additional COVID-19 risk factor in to discount rates used in impairment testing of goodwill and noncurrent assets and incorporating an additional downside scenario in to ECL calculations in Tesco Bank.

Subsequent to the balance sheet date, the World Health Organization declared a pandemic on 11 March, the UK Government moved to a ‘delay’ phase on 12 March, announced social distancing measures on 16 March, and unprecedented ‘stay at home’ restrictions on 23 March. The first large falls in stock markets occurred in early March, and Tesco introduced a ‘3 items only’ limit on purchases on 19 March in response to customer demand. The Group has therefore concluded that the necessity for large-scale government interventions (both in the UK and the other countries in which the Group operates) in response to COVID-19 only became apparent after the balance sheet date and therefore that the consequences of such interventions represent non-adjusting post balance sheet events. However, given these events are of such significance, further disclosures, including additional sensitivities, are given in Note 36.

Note 36 Events after the reporting period (extract)
The Group’s operational response to COVID-19 is set out on page 3.

Refer to Note 1 for details of the Group’s judgement that the extent of Government interventions in response to the COVID-19 pandemic only became apparent after the balance sheet date and represent a non-adjusting post balance sheet event. Given these events are of such significance, further explanation of the impact of increased volatility of assumptions on sensitivities presented in the financial statements are given below.

Impairment of non-current assets
Refer to Notes 1 and 15 for details of the Group’s impairment methodology, impairment losses and reversals, net carrying value of non-current assets, and key assumptions and sensitivity analysis. As at 29 February 2020, indicators observable at the balance sheet date have been factored in to the Group’s impairment testing of goodwill and fixed assets, including a COVID-19 risk adjustment to discount rates to reflect the impact of increased volatility in forecast cash flows.
Subsequent to the balance sheet date, the Group has incurred significant additional costs in meeting customer demand and protecting the health and safety of customers and colleagues. In particular, payroll costs will be higher than normal as additional colleagues have been recruited both to meet demand and cover the work of those colleagues who are absent and being paid. The Group has also simplified ranges, and Booker’s wholesale business has seen a significant shift in balance from catering to retail sales. The Group’s businesses in Central Europe and Asia have incurred similar cost increases and also expect to generate a lower level of mall income as the vast majority of tenants in malls have not been able to remain open. The UK Government’s emergency policy changes (most notably the 12-month business rates holiday) will be an important offsetting benefit.

The Group has carried out further sensitivity analysis for its portfolio of store cash-generating units, in addition to the sensitivity analysis detailed in Note 15. While the full financial impact of the pandemic for 2020/21 is impossible to predict with a high degree of certainty, if customer behaviour were to return to normal by August it is likely that the additional cost headwinds incurred in our retail operations would be largely offset by the benefits of food volume increases, 12 months’ business rates relief in the UK and prudent operations management. The overall impact of the above changes to cash flows would not cause a material impact on the Group’s non-current asset impairment provision. An increase of 2.0% pts in post-tax discount rates for each geographic region, and a decrease in property fair values of 10% pts would increase the Group’s non-current asset impairment provision by £971m and £209m respectively. These additional sensitivities would not indicate impairment in any group of cash-generating units to which goodwill has been allocated.

Tesco Bank expected credit loss (ECL) calculations
Refer to Note 25 for details of the Group’s ECL calculations and sensitivity analysis. As at the balance sheet date, a five-scenario economic model is used, including a downside scenario representing a more severe recession incorporating the increased risk of an adverse impact on the economy given COVID-19 developments as at the balance sheet date. This scenario has been assigned a weighting of 5% and incorporates a higher unemployment rate and lower GDP than the base case.

Subsequent to the balance sheet date, the Group has sourced four updated economic forecasts reflecting current economic developments. The base scenario on which the Group has placed most reliance assumes a delayed ‘V’ shaped recovery in the third quarter of 2020 and is in line with Bank of England guidance that there will be significant economic disruption while social distancing measures are in place, followed by an expected sharp recovery when these are lifted. The ECL sensitivity to this base scenario is shown below, and excludes the estimated mitigating impact of any support the Group offers to customers who are experiencing financial difficulty as a result of the pandemic, and the effectiveness of this at reducing customer defaults.

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The sensitivity of ECLs to increases in unemployment between the balance sheet date and 31 December 2020 is approximately £60m for each 1% increase in unemployment.

Pension deficit
Review of the key financial assumptions relating to the Group’s pension schemes subsequent to the year end indicate movements that fall within the range of sensitivities described in Note 29. It is too early to assess the impact of COVID-19 upon the Group’s long-term life expectancy assumptions. The fair value of plan assets is expected to be volatile in the short term due to uncertain market conditions.

Financial risks
The interest rate, foreign exchange rate and inflation rate sensitivity assumptions in Note 25 have been reviewed in light of the latest market data. For all three assumptions, the sensitivities shown (1%, 10% and 25 basis points respectively) remain valid in the current economic environment. In reaching this conclusion, the Group has analysed both past- and forward-looking market data as well as movements in the relevant forward curves since the balance sheet date. Furthermore, interest rates are at an all-time low, the Group’s fixed/floating mix policy is unchanged, inflation rates are also already low, and material foreign exchange risk exposure is largely hedged.

Deferred tax asset recognition
Deferred tax assets can only be recognised to the extent it is probable there will be future taxable profits. Subsequent to the balance sheet date, the Group has reviewed the current impact of COVID-19 on those future taxable profits and concluded that deferred tax assets can continue to be recognised in full.