The April meeting of the International Accounting Standards Board set the scene for yet another rushed consideration of draft chapters for inclusion in the conceptual framework discussion paper. The document is to be published in July.
The starting point is the notion that the board will retain the concept of profit or loss and disaggregate items of profit or loss between net income and other comprehensive income (OCI). In order to ascribe a principled basis to this cut, staff have proposed three principles.
These principles give primacy to items of income and expense that communicate the key elements of an entity’s financial performance – net income. They also note a preference for net income unless an OCI presentation results in a more realistic picture of an entity’s performance.
Finally, entities must recycle all items of profit or loss. Staff believe that OCI items fall into two neat categories: mismatch remeasurements and bridging items. The draft discussion paper chapter, at least as it stood in April, is available in meeting paper 10H(a).
But the concern that emerged from one quarter during the meeting is that staff have presented the board with a fait accompli that fails to deliver information that is useful for decision-making. Taking foreign exchange as his starting point, Stephen Cooper asked what the proposed model would mean where a business chooses to close a foreign subsidiary.
“Foreign exchange translation is identified as a mismatched remeasurement,” he began. “What does that recycled amount mean? What information content is there for a user of financial statements in that recycled amount?” Noteworthy, as he indeed pointed out, is the assumption: you must recycle.
The response from project manager Kristy Robinson might strike you as unconvincing. “I think it is very akin to a sale. It evidences the fact that you’ve got out of that business; that exposure is no longer continuing.” And, she said, reflecting that in profit or loss would provide relevant information about the change.
Cooper’s starting point is that there is no economic relevance in the recycled amount. And although his example relates to a discontinued foreign subsidiary, the point about informational relevance is one that should pervade the responses from everyone with a DB plan.
He continued: “Entities seek to avoid running down a business so much that it triggers a recycling because it produces volatility in the profit or loss account that has no economic meaning.” By implication, the board risks baking a presumption of recycling into IFRS where, as Cooper puts it, “it makes no economic sense, it doesn’t relate to any economic event”.
Turning to the so-called bridging items, Cooper, somewhat more positively, said: “I think for the different measurement basis, the bridging items, there is some logic that if you believe one measurement basis is appropriate in the income statement [and] a different one on the balance sheet, then that’s fine. I don’t believe it’s actually recycling in that case. You’re just using two different measurement bases that meet the definitions of income and expense.”
One of the ironies of the new thinking around OCI is that it appears to work flawlessly for cashflow hedging. But hedge accounting is itself an exception and who needs a conceptual basis for hedge accounting? It just is what it is.
Part of the solution, as Cooper sees it, is to explore a third category of OCI items in the discussion paper to accommodate large, one-off remeasurements.
As for the dangers of where the board is heading? According to him, it is likely that OCI will persist for both pensions and other items long after the dust has settled on the conceptual framework project. But what could emerge is a proposal for a conceptual framework completely at odds with much of today’s use of OCI.
As Cooper put it: “I think [it] would be a real backward step if we were to start to find a way to recycle pensions, find a way to squash pensions into the two categories that have been identified…. That would be just meaningless, to start reclassifying pensions on some arbitrary basis.”