The head of the International Accounting Standards Board (IASB) has set out plans for changes to financial reporting under IFRS to reflect the importance of intangibles reporting, create a stricter definition of operating profit and introduce management performance measures (MPM),
The IASB is currently focusing on two specific areas, primary financial statements and management commentary, to improve the quality of reporting for analysts and key stakeholders, with the objective of improving the structure and quality of financial statements and creating a better platform for broader developments in corporate reporting.
Speaking at the IASB annual conference in London, chairman Hans Hoogervorst said: ‘In the world of IFRS standards, change has been a constant pretty much since we started back in 2001. First, we had to knock the inherited standards into shape, in time for EU adoption in 2005. Then, we had to deal with our response to the financial crisis, while in parallel completing the major upgrades to the accounting for financial instruments [IFRS 9], revenue recognition [IFRS 15], lease accounting [IFRS 16] and most recently, insurance contracts [IFRS 17].
‘Just because the big reforms are done, it doesn’t mean that change is no longer required.
‘There is plenty going on around us. There is the changing nature of companies - the knowledge economy driving huge growth in intangibles, for example. There is also the proliferation of non-GAAP measures and greater interest in broader corporate reporting, particularly in the sustainability space. And there is the impact of technology; how it affects the preparation and consumption of financial information.’
The IASB is currently working on two key areas to ensure that IFRS remains relevant and reflects the current business market.
The primary financial statements project (PFS) focuses on improving the structure and the communication effectiveness of financial statements under International Financial Reporting Standards (IFRS)IFRS. The second is the management commentary project, which is the main vehicle for considering broader developments in reporting and how they relate to the financial statements.
Hoogervoorst said: The objective of the primary financial statements project is to provide better structure and content in IFRS financial statements, especially in the income statement. Currently, the IFRS income statement is relatively form-free. We define revenue, we define profit or loss, but not all that much in between.
‘In practice, both preparers and investors like to use subtotals to better explain and understand performance. Our lack of guidance in this respect has had the unintended consequence of stimulating the use of self-defined subtotals, also known as non-GAAP measures.
‘These measures can be useful to explain different aspects of the performance of a company and we do not intend to root them out. However, their use should come with a ‘health warning’ - or maybe a “wealth warning” is a better way to describe them.
‘Subtotals like operating profit and EBITDA are very commonly used, but in practice companies define these subtotals in very different ways. How many investors actually know about these differences? Some will, but I am sure that most investors are left profoundly confused.’
The IASB technical staff looked at 60 companies in different countries and industry sectors. About 70% of those companies used an operating profit subtotal, but there were nine different versions of that subtotal - even though each subtotal used the same name.
‘This is what financial reporting looks like in the absence of standards,’ he added. ‘Moreover, many non-GAAP measures tend to paint a very rosy picture of a company’s performance, almost always showing a result that is better than the official IFRS numbers.’
The main thrust of the financial reporting project is to set more rigid definitions of commonly used metrics, including operating profit and profit before financing and tax.
The IASB also plans to introduce greater transparency and discipline around the use of subtotals not defined in IFRS standards, grouping these numbers under the term management performance measures (MPM), which will be brought in line with the ‘fair presentation’ requirements set out in IAS 1 Presentation of Financial Statements, ‘to help weed out MPMs that are clearly unbalanced’.
Hoogervoorst explained: ‘We aim to improve transparency around management performance measures by requiring companies to locate MPMs and the information explaining these measures within a single note in the financial statements. This will make it much easier for investors to find the information. Currently, they often need to search around for this information both in and outside the annual report.
‘Some may worry that bringing MPMs into the financial statements enhances the status of non-GAAP. However, the presentation of the MPM’s will be subject to much of the discipline that many market regulators around the world already require. Management will need to explain how the MPM is calculated and why it is important. Consistent recognition and reporting will be required from one period to another, and if a company decides to change its performance measures, it will have to explain why.’
‘The proposals will create more structure in the income statement and will enhance comparability. The improved structure will make it much easier for users to find the components for the analysis that they prefer. It will also facilitate digital consumption of financial information,’ he added.
On management commentary, the IASB plans to revise the Management Commentary Practice Statement, non-mandatory guidance for annual report writers, which was first published in 2010 and needs to be revised to take into account the impact of intangibles on financial reporting.
‘The updated Practice Statement will remain primarily focused on the broader financial information needs of investors,’ he said. ‘We want companies to report on what is strategically important to them, including how remuneration policies align with their long-term objectives. There will be more focus on intangibles that underpin companies’ long-term success. And of course, companies would be expected to tell how sustainability issues, including climate change, may impact their business if that impact is material.'
The IASB has not set out a timetable for completion of the projects.