The IASB is developing new - and clarifying existing - guidance in response to concerns about disclosure in financial statements. Adam Deller explains
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This article was first published in the October 2017 international edition of Accounting and Business magazine.
The central theme for the International Accounting Standards Board’s (IASB) work over the next five years is better communication in financial reporting. It has identified three main concerns about disclosures in the financial statements:
- Not enough relevant information, leading to inappropriate investing or lending decisions.
- Irrelevant information, which can obscure relevant information and reduce the understandability of financial statements.
- Ineffective communication, which can also reduce the understandability of financial statements.
In response to this, the IASB has drawn up the disclosure initiative, which has two aims: to develop new principles of disclosure and guidance, and to clarify the existing principles.
The disclosure initiative covers a whole suite of projects, rather than being one piece of work. It is heavily linked in with the current materiality implementation projects and the work being undertaken on the Conceptual Framework and Primary Financial Statements project.
Alongside all of this, the IASB released a discussion paper in March 2017 looking specifically at the principles of disclosure. The ultimate result of the disclosure initiative is likely to be either the issue of a new general disclosure standard, or amendments to IAS 1, Presentation of Financial Statements, which currently covers general disclosure requirements.
Here’s a look at some of the key contents of the discussion paper and the questions raised by the IASB.
The IASB has identified seven principles of effective communication, stating that information contained within financial statements should be:
- clear and simple
- free from unnecessary duplication
- in an appropriate format
- linked to relevant information
- organised to highlight important matters.
It believes that information tailored to the individual entity should be more relevant than generic disclosures. This could potentially clash with the sixth principle of comparability, which is where judgment must be exercised by preparers to strike that balance.
The IASB also believes that information does not need to be duplicated across various parts of the financial statements and annual report. Instead, it could be linked to other parts of the annual report if they are disclosed there. And they believe that communication should be clear, stating that lists and tables may be more useful than ordinary narrative.
The discussion paper asks if these principles should be mandatory within an accounting standard or included within education material.
Role of financial statements
Currently IAS 1 states that a complete set of financial statements comprises the statement of financial position; the statement of profit or loss and other comprehensive income; the statement of changes in equity; and the statement of cashflows. It also comprises significant accounting policies and other explanatory information, in the notes.
Following feedback, entities perceive that the information contained in the complete set of financial statements used to be used more frequently and be subject to more scrutiny from users than the information in the notes.
To address this, the IASB proposes to specify that the statements covered in the financial statements are the ‘primary financial statements’. It has also included a suggested definition of the role of the primary financial statements, which is to provide a structured and comparable summary of the entity’s assets, liabilities, income, expenses and capital.
Clarifying the distinction between the primary financial statements and the notes seeks to emphasise the fact that users initially study the primary financial statements and use this for comparison with other entities. A key role of the notes is commonly accepted to be to provide further explanation of information contained within the primary financial statements.
In light of this, the IASB’s preliminary view of the notes is that their role is to provide further information to disaggregate or explain the items in the primary financial statements and to supplement the primary financial statements with other necessary information.
Location of information
The IASB is seeking to make the distinction between ‘IFRS information’, required for compliance with IFRS Standards and ‘non-IFRS information’, and has opened up the discussion as to where this information should be included.
Of course, IFRS information will generally be included within the financial statements, with non-IFRS information included in other parts of the annual report. The IASB notes that improvements can be made to provide further guidance and remove duplication.
It is looking to clarify that information necessary to comply with IFRS can be provided outside of the financial statements as long as it is provided in the annual report, its location makes the annual report more understandable, and is identified in the financial statements by means of a cross-reference made in the financial statements.
This is consistent with principles already established in more recent IFRS Standards, such as IFRS 7, Financial Instruments: Disclosures, which explicitly mentions that disclosures need not be duplicated in the financial statements if they are included in the annual report and cross-referenced.
In addition, the IASB is discussing whether non-IFRS information can be included within the financial statements. This could include items such as performance measures if they are clearly explained, stating why the information is useful and has been included.
Entities use a variety of performance measures in their financial statements, and most users support entities having some flexibility in presenting these. However, a number of users have expressed concerns over some performance measures. These concerns included that calculations are not explained by the entity; it is difficult to compare, as entities calculate items differently; and there is inconsistent classification of items as unusual or infrequently occurring.
Most of the concerns around performance measures relate to the use of measures in the statement(s) of financial performance, and the board is focusing on two areas:
a) when presentation of earnings before interest and taxes (EBIT) and/or earnings before interest, taxes, depreciation and amortisation (EBITDA) in the statement(s) of financial performance can be considered a fair presentation in accordance with IFRS Standards
b) whether to provide guidance on the presentation of unusual and infrequently occurring items.
Under (a), the IASB’s preliminary view is that showing EBITDA as a subtotal in the statement of profit or loss is fair presentation if the expenses are classified by nature – see table (right).
The IASB believes that fair presentation is unlikely if entities classify expenses by function, as this would potentially be confusing due to depreciation and amortisation being included within categories such as cost of sales or administrative expenses, rather than being shown separately.
Whether an entity analyses expenses by function or nature, the IASB deems that showing EBIT as a subtotal would result in fair presentation and so would be acceptable under either method.
As for (b), there has been much debate here. Many users feel separate presentation or disclosure of unusual or infrequently occurring items is helpful in decision-making. However, there are concerns that entities are applying unusual or infrequently occurring items inappropriately and/or inconsistently.
Based on a previous staff paper, the following definitions are to be taken forward as a starting point for developing requirements:
- Unusual: highly abnormal and only incidentally related to the entity’s ordinary and typical activities, given the environment in which it operates.
- Infrequently occurring: not reasonably expected to recur in the foreseeable future given the environment in which an entity operates.
These definitions could start a debate around terms such as ‘foreseeable future’. The IASB asks respondents to comment on whether people agree with the proposal to develop these definitions and identify requirements for presenting such events in the financial statements.
Some users feel that the accounting policies section of financial statements is often long and unhelpful, making it difficult for users to identify which policies are important and which less so.
The IASB has identified three categories of accounting policy:
- Category 1: accounting policies that are always necessary for understanding information in financial statements, and that relate to material items, transactions or event
- Category 2: policies not in category 1 but that relate to items in the financial statements that are material in size or nature
- Category 3: any other accounting policies applied by the entity.
The board’s view is that category 1 and 2 items must be disclosed in the notes, whereas it is unnecessary to disclose policies contained within category 3.
The disclosure initiative is wide-ranging, and attempts to bring clarity and consistency to disclosures. The IASB hopes to maintain the use of judgment from entities while not compromising comparability between entities.
The deadline for comments on the discussion paper is 2 October 2017.
Adam Deller is a financial reporting specialist and lecturer
Expenses classified by nature
|Expenses classified by nature|
|Change in inventories of finished goods and work in progress|
|Raw materials and consumables used||(X)|
Employee benefits expense
Depreciation and amortisation expense
Profit before tax
"he IASB is seeking to make the distinction between 'IFRS information' and 'non-IFRS information'"