I came across an interesting article by Gediminas Ziemelis: New IFRS for airlines with provisions for virus impact?

The article sets out the heavy impact of the ongoing pandemic on the airline industry, one in which – as has been quite widely commented upon – “some airlines announced dividends to shareholders from last year’s profit and asked for states aids several weeks after.” It sets out the importance of ensuring that the industry better anticipates and plans for such events, leading to the following commentary on financial reporting:

• In order to guarantee stability and be fully prepared, all airlines and airline-supporting businesses must evaluate the provision amounts and reserve them for possible unpredicted events referring to the International Accounting Standard 37: Provisions, Contingent Liabilities and Contingent Assets (IAS 37). The amount of the provision must be of the size required to settle the present obligation of the entity arising from past events. The funds to cover the expenditure for the future events are generated by the appointed sums set to reserve on a regular basis considering the projected frequency of the possible events, may it be outbreaks, repairs, debts, etc.
• Taking the last decade, details of the properties of coronavirus were first announced in 1968; although the most compelling ones do not recur very often, the average numbers show that detrimental ones do so approximately every 5-7 years. After this last, COVID-19, event is over, the damage to companies will be known, and it will be clear what exactly needs to be settled. Therefore, if coronavirus has a tendency to recur every 5-7 years, the loss amount shall be divided into parts for this period of time, and set aside every year, which would ensure the preparation for the next cycle and act immediately without waiting for decisions from governments to be made. However, the subsequent measurement must be calculated and divided carefully – it should not be based only on the losses, caused by COVID-19.
• When the reserve for possible losses are formed, company’s annual profit is reduced, thus shareholders are not able to pay off more dividends yet when confronted with the crisis, the company has funds to help it overcome the suspension of operation. To substantiate the funds, which are kept in the reserve, the company must refer to the requirements of IAS 37.
• Such method, supported by IAS 37, is highly beneficial as it allows the airlines and airline-supporting businesses to avoid sudden fallouts, vast losses that are often lead to bankruptcies and extents, where third parties are often involved and victimized.

It seems quite debatable whether this is an appropriate analysis of IAS 37. Even if one knew with some certainty (which of course isn’t the case) that another pandemic would occur five years into the future, this doesn’t make it a “past event” in the sense of the IAS 37 definition. The implementation examples of IAS 37 set out an illustration of an airline that’s required by law to overhaul its aircraft once every three years. In this example, the future expenditure is certain and the amount presumably capable of being fairly reasonably estimated, but a provision isn’t recognized “because no obligation exists to overhaul the aircraft independently of the entity’s future actions – the entity could avoid the future expenditure by its future actions, for example by selling the aircraft.” It seems unlikely then that a provision should be recognized for the even less forseeably obligating event of a future pandemic. For many, such an argument will evoke memories of past undesirable practices, as summarized for example in a speech by past SEC Chair Arthur Levitt:

• It’s difficult to hold the line on good practices when competitors operate in the gray area between legitimacy and outright fraud.
• A gray area where sound accounting practices are perverted; where managers cut corners; and, where earnings reports reflect the desires of management rather than the underlying financial performance of the company.
• While the problem of earnings management is not new, it has risen in a market unforgiving of companies that miss Wall Street’s consensus estimates. For many, this pressure has become all too hard to resist.
• (among other things)…Companies stash accruals in “cookie jar” reserves during the good economic times and reach into them when needed in the bad times.

But it’s also true that if airlines did account for the costs of future pandemics along the lines that Ziemelis advocates, it might not currently look like such a big scandal, compared to our current situation where (in addition to the problem cited) the amount of support demanded by some airlines broadly corresponds to the cash they’d accumulated and then poured into share buybacks in recent years. Maybe airlines (and others) should be reporting two sets of numbers – the ones required by IFRS, and others (if only for supplemental perspective) which attempt to grapple with the issues that Ziemelis raises. Or maybe, less disruptively to the accounting model, they should be establishing additional non-distributable reserves within equity, and preserving corresponding amounts of restricted cash, based on such expectations. We’re in a time when any idea motivated by concern for the future deserves a hearing, however disruptive it may be to established practices…

The opinions expressed are solely those of the author