FINANCIAL REPORTING AND IR

With first quarter reporting out the door, companies now have first-hand experience with how the new revenue and financial instruments standards have changed their financial statement disclosures. The rigorous requirements of the new standards mandate more detailed disclosures than ever before. Even if a company’s reported revenues or financial asset balances were not greatly affected by the new standards, it still had to make detailed new disclosures.    

Whereas disclosures in the full annual financial statements are generally longer and more detailed, finding the right level of disclosure for interim financial statements can be more subjective. Preparers had to apply their own judgment for first quarter reporting, without the benefit of seeing what others were doing. While there are certain minimum requirements, some companies chose to include full annual disclosures related to revenue and financial instruments, others went with the minimum concise quarterly disclosures, and most were somewhere in between. 

As the implementation projects for the new standards reach completion, many IROs have already spent time understanding the impact of the standards on their company’s KPIs in order to educate investors and analysts. While that task is mostly complete, there may be one final step IROs want to consider. 

Are you an outlier?

Given the judgment required, no one is completely certain about what is the right amount of detailed information to be disclosed. We suggest IROs do a ‘sideways look’ to see if their company significantly deviates from others within their industry. Benchmarking can be done by analyzing the amount of detail disclosed on items such as impairment models, the level of disaggregation of revenue, or initially even simply by looking at the number of pages dedicated to each of the new standards. The key is to ascertain whether your company is an outlier relative to its peers.

Impacts of being an outlier

First, investors and analysts want information that allows comparisons across companies. If too little detail is provided, IROs will inevitably receive questions from analysts looking to better understand the impact on the company’s KPIs and trends. Additionally, providing less disclosure than one’s peers may result in analysts relying on their own significant assumptions rather than accurate data provided by the company.

Secondly, regulators are watching. Public statements to date from Canadian securities regulators show the emphasis they have placed on ensuring investors are provided with decision-useful information regarding these new standards^[1]. In the first year of implementation, you can expect that regulators will scour the new disclosures and make their own judgments on adequacy of disclosures, in part informed by comparisons with similar companies. Providing less information than your peers may be an invitation for securities regulators to challenge your company.    

Disclosures to Seek

Revenue – Historically, companies were not required to provide much detail on the breakdown of revenue, even though it is one of the main KPIs that investors consider. Providing limited information has long been supported by the justification that such disclosure is ‘commercially sensitive’. With the new standard that is, unfortunately, no longer an acceptable rationale. Disaggregating your revenue streams involves linking them to your segment disclosures, providing information on payment terms, being explicit about the amount and expected timing of the receipt of revenue from open contracts – and disclosure of these items will not come naturally. But that is what the new standard requires companies to do. This may indeed provide others – unfortunately including competitors – with greater insight into how you run your business, just as you may gain insights into their business.

The new revenue standard represents a fundamental shift in the disclosures required. Disclosures could now run across several pages and will need to be consistent with other disclosures inside and outside the financial statements. There will be many qualitative statements to make with judgments and estimates involved, particularly where contracts have built in variability. Applying these new requirements will undoubtedly create disparity between companies, and will evolve over time, as management exercises considerable judgment in determining how granular the disclosures should be.

Financial Instruments – The new financial instruments standard also introduces new disclosure requirements, including effects of credit risk on the amount, timing and uncertainty of future cash flows and an explanation of the entity’s risk management practices as they relate to hedge accounting. The standard will affect industries in varying degrees. We can expect the biggest impact of additional disclosures on financial institutions, but most companies will be affected to some extent. When companies have significant financial assets that are required to be tested for impairment, the new forward-looking impairment model introduces significant new judgments, which will also need to be explained in detail to financial statement users.

Refining over Time

First quarter reports are now in the hands of analysts and investors. A company’s disclosure documents are ever evolving and it is unlikely that companies will be completely satisfied with their disclosure on the first try. There is an expectation that companies will compare, reconsider and refine their disclosures as time passes. Understanding how your disclosures compare with competitors is important information for IROs to have in order to engage in a meaningful discussion about future refinements to the company’s disclosure strategy.

Charmaine Mak, CPA, CA is a Senior Manager, and Rob Brouwer, FCPA, CPA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.