Accounting Matters: Investing in better communication
The message from the International Accounting Standards Board (IASB) is that better communication starts with the income statement. Prompting this revelation is the demand from some respondents to the IFRS Foundation’s 2015 agenda consultation for the IASB to investigate how companies communicate financial performance in their financial statements.
The starting point for the board’s latest foray are the four primary financial statements: the income statement; the statement of cash flows; the balance sheet; and the statement of changes in equity. But away from the focus in the agenda consultation responses to the statement of financial performance, there was less of a push from constituents for the board to examine either the cash flow statement or the balance sheet.
During a meeting of the IFRS Advisory Council in October, IASB staff added that there are no plans to take a fresh look at the statement of changes in equity. The news is perhaps unsurprising, given that the board has already launched a project to look at financial instruments with the characteristics of equity.
The staff team also signalled that they plan to establish whether there is any pressing need to look at the cash flow statement and the balance sheet. It is pretty safe to say that the board’s thinking on the primary financial statements (PFS) project is at an early stage.
So, with the income statement taking centre stage for the time being, staff are concentrating their early thoughts on two main areas:
• The structure of the income statement;
• Alternative performance measures.
Indeed, as project manager Koichiro Kuramochi told the October IFRS IC meeting: “We hear very different views – almost opposing views. Some people focus on comparability and believe it should be enhanced, [while] others focus on flexibility.… to enable preparers to tell a story.”
The staff’s efforts to tease out the tension within the project between these two polar opposites has involved a number of preliminary steps. First, they have met with users of financial statements in a bid to assess what, if any, challenges they face in this area and how significant those challenges might be. Additionally, staff have also reviewed a number of financial statements to assess the extent to which they enable comparability across entities. Finally, they are scouring third-party literature to assess the scale of the problem.
So what are the concerns that users of financial statements have about the income statement? In broad terms, companies that operate as competitors in the same sector can produce income statements that have a varied structure. For example, one company might present a cost such as marketing as a single-line item such as operating expense, while a competitor might present no operating expenses at all but, instead, make a footnote disclosure. This leaves the board to assess whether these differences are down to a lack of comparability, or whether it is merely a case of preparers telling their own story.
Alongside the concerns about geography, there are also worries about content. Perhaps the most glaring example of this is the operating profit sub-total, the IASB suspects. Although many companies present this sub-total, the calculation is not necessarily the same across entities.
The project is still at an early stage and the staff have not yet produced a strategy or scope. Accordingly, there are a number of possible ways forward for the board. It could:
• Allow companies to present financial statements as they choose, or
• Develop a detailed chart of accounts and compel companies present line items along the same prescriptive lines.
Within the framework of these two extremes, one possible compromise might be to develop templates and encourage preparers to use them. Another option could be for the board to define comparable sub-totals such as operating profit.
One additional focus of the project is the use of Alternative Performance Measures (APM) or non-GAAP (Generally Accepted Accounting Principles) information. The board’s current thinking runs along the lines that although non-GAAP measures can provide additional insights for investors, they might equally undermine the integrity of financial information if they are inconsistently presented or defined too loosely.
The issue has attracted the interested of numerous players. The IFRS Foundation Trustees, for example, noted the issue in their recent strategy review and identified it as both a risk and an opportunity. Some say that if certain APMs were incorporated within the financial statements, they could provide more transparent, comparable and, most importantly, audited information.
The International Organisation of Securities Commissioners (IOSCO), with which the IFRS Foundation has pledged to co-operate on areas of common interest, shares these views. Indeed, the similarities between the IASB staff presentation to the October IFRS IC meeting and a June IOSCO statement on of non-GAAP performance measures are striking. Of particular interest in the IOSCO statement are the 12 indicators that IOSCO argues could ensure that non-GAAP provide non-misleading information.
In parallel with this statement, the US FASB has published an agenda consultation document in which it explores a number of possible ways to improve the income statement. It is worth recalling that in 2008, the FASB, together with the IASB, issued a joint discussion paper on financial statement presentation. This was followed in 2010 by a draft Exposure Draft on Financial Statement Presentation.
Both documents set out proposals to classify information consistently in the cash flow statement and on the face of the balance sheet across four categories – operating, investing, financing and other. The boards also proposed a number of ways to disaggregate the income statement. The rush to complete priority convergence projects forced the boards to abandon the proposals.
In addition, the FASB has a project on financial performance reporting on its research agenda. This project is tasked with examining improvements to the structure and display of revenues, expenses, gains, and losses in the income statement. Not to be left out, the UK Financial Reporting Council recently launched a consultation on possible improvements to the cash flow statement.
Meanwhile, in a speech in November in Peru, the IASB chairman, Hans Hoogervorst, gave some insight into the future direction of the project. He said: “We will be looking at possibilities of defining commonly used sub-totals in the income statement, such as operating income and earnings before interest and tax.
“We might look at creating more disciplined ways for companies to adjust their earnings for infrequently occurring components of income. We also need to do more work on electronic reporting, as financial information is increasingly being consumed electronically.”
Neither the promise of more comparability nor the characteristically exotic location have impressed Tim Bush, head of governance and financial analysis at the Pensions Investment Research Council.
“Nothing the IASB says or does surprises me anymore,” he says. “IFRS was pushed onto Europe on the basis it would create ‘comparability’ between companies. Yet the IASB chairman has admitted the profit-and-loss account has not been comparable but ‘make-it-up-to-suit’ instead.
“It’s impossible to be too critical when the IASB persistently fails to deliver what has been promised. Let’s be honest, the IFRS project has been a false prospectus and a gravy train for the standard setters themselves. I challenge Mr Hoogervorst to drop the set-piece speeches and debate the issue publicly.”