As the IASB consults on the presentation of primary financial statements, Muzaffar Nazirov FCCA gives his view of the problems and how to resolve them
This article was first published in the April 2018 International edition of Accounting and Business magazine.
Over the years, the requirements of IFRS Standards have been growing to meet the demands of users of financial statements (investors, regulators, media, etc). Financial statements that used to run to 15 or 20 pages in 2001 now typically contain over 50. Research from EY indicates that financial statements have grown in length by 25% in the last five years alone.
IFRS 7, Financial Instruments: Disclosures, was responsible for some of the greater volume of disclosures, but IFRS 9, Financial Instruments, and IFRS 15, Revenue from Contracts with Customers, which are applicable for periods from 1 January 2018, are going to add to the heft; and new standards IFRS 16, Leases, and IFRS 17, Insurance Contracts, are also in the queue.
Not only are financial statements getting bigger, they are also getting more complicated, with more detailed information. For example, if users of financial statements are to understand the extra disclosures required by IFRS 9, they will need to have above-average knowledge of financial topics.
While more disclosures are useful, it could be argued that:
- They may distract the reader of financial statements, causing them to lose focus and come to incorrect conclusions. For example, an investor with modest knowledge who concentrates only on the income statement may expect dividends; however, net income might be sourced mainly from estimates (such as fair values of investments) and therefore no dividends should be expected.
- With so many disclosures users won’t read them all.
- Some of the disclosures, such as those on estimates and sensitivities, are complex.
- Readers with modest knowledge may concentrate on primary statements only, and mainly on the income statement.
What is the solution? In my view, the income statement needs to be split to clearly separate actual transactions from management estimates and those subject to the interpretation or judgment of users. The statement would be presented with a columnar analysis of occurred transactions (such as dividends received and staff costs paid), accruals (contract-based transactions that have not yet occurred) and estimates (non-contractual transactions, such as fair value gain on investment properties), and a total. This would have significant benefits. For example:
- Realised values would be separated from disclosures that require judgments or interpretation, or which are estimates.
- Investors could assess corporate performance on the basis of cash profits (actual transactions).
- Investors could understand the main source of net profit.
- It would highlight the significance of estimates in the income statement, and prompt the reader to check the ‘critical judgments’ section of the financial statements.
- It would highlight estimates that are more susceptible to fraud and assumptions that may not be realistic in the reader’s judgment.
- Readers could apply their own estimates to recalculate the expected profits.
My proposal isn’t without its flaws. It would require the company to obtain more information, which could be costly and time-consuming. It could also be viewed as a replication of the cashflow statement (even though it is not). For example, where a construction company receives US$500,000 cash, consisting of US$300,000 as prepayment and US$200,000 as settlement for work performed to date:
- Cash basis accounting would record a revenue of US$500,000.
- My suggested presentation of income would include revenue of US$200,000 recorded as completed transactions, and the rest as deferred income.
These are just some things for the standard-setter to consider as it continues looking at improvements to the structure and content of primary financial statements.
Muzaffar Nazirov FCCA, manager, budgeting and MIS, financial control department, Qatar First Bank
"The income statement needs to be split to clearly separate actual transactions from all the others"