FINANCIAL REPORTING & IR

Over the past decade, investors and other financial statements users have increasingly expressed their concerns over the usefulness of financial statements. There are a variety of concerns expressed with the current IFRS® Standards, including the way that certain financial information is presented, which may not provide the best metrics to support decision making. As well, lack of consistency in using some financial statement captions also contributes to investor confusion.

In response to such concerns, in late 2019 the International Accounting Standards Board (IASB) proposed some significant changes to the way information on financial performance must be communicated in the financial statements. The proposals would require certain comparable information to be presented in the statement of profit or loss, and require a more disciplined and transparent approach to the reporting of management-defined (‘non-GAAP’) performance measures. If the proposals are adopted, a new IFRS Standard would be issued to replace IAS®1 Presentation of Financial Statements. An effective date for the proposed new standard has not been identified but the expectation is that it would be effective 18-24 months after being released in final form. The IASB notes that the standard would be applied retrospectively and early adoption would be permitted.

Shortly before the close of the comment period late last year, KPMG’s International Standards Group discussed the key points in the Board’s exposure draft (ED) with investors and analysts to better understand the views of its target audience. Here, we’ll outline the range of views expressed by the investors and analysts present at our discussion.

Defined Subtotals in the Income Statement

The Board’s proposals in this area aim to add consistency to income statement presentation. Currently, there is no consistent definition of any profit measures above the ‘profit before tax’ line. As a result, the structure and content of income statements varies from one company to another, which hinders comparison.

Consistent definitions: Investors generally welcomed the proposal to introduce consistent definitions to three profit measures between the ‘revenue’ and ‘profit before tax’ lines in the income statement – two of which are ‘operating profit’ and ‘profit before financing and income tax’.

The third new defined subtotal – ‘operating profit and income and expenses from integral associates and joint ventures (JVs)’ – was not as well received by attendees. As the subtotal caption suggests, it would require preparers of financial statements to analyze JVs and associates according to whether they were ‘integral’ or ‘non-integral’ from the preparer’s perspective. This would be a new judgment area which adds little value according to participants in our discussion, who noted its potential to generate further inconsistencies in financial disclosure.

Some participants noted that the proposed new categories used to classify items in the income statement (i.e. operating, investing and financing) are identical to those used in the cash flow statement; however, the categories themselves are not aligned. This may be confusing for financial statements users.

Analysis of Operating Expenses by Nature and Function

The Board is proposing new requirements for disaggregating income statement information: on the face of the income statement, companies would be required to present an analysis of operating expenses either by nature (e.g. ‘raw materials used’, ‘employee benefits’) or by function (e.g. ‘cost of goods sold’, ‘general and administrative expenses’), using whichever of these methods is thought to provide the most useful information to financial statement users. An analysis of operating expenses by nature would always be required, however, either in the income statement or in the notes.

Some participants expressed that they would benefit from always having income statement information analyzed both by function and nature: i.e. by function on the face of the income statement, and by nature in the notes.

Others noted concern that the proposals would impose a rigid structure that could prevent material items from being presented on the face of the income statement, reducing its usefulness. Participants also asked for clarification on treatment and disclosure of restructuring costs, which often straddle both by-nature and by-function disclosure.

Preparers in several jurisdictions use a multi-column income statement format to reconcile GAAP and non-GAAP financial measures. Under the proposals, this would no longer be permitted, yet several of our participants consider this format to be a useful presentation method that does not distort the underlying economic reality.

Management Performance Measures

The Board’s proposals introduce a new definition of management performance measures (MPMs), which are subtotals of income and expenses that:

• are used in public communications outside financial statements;
• complement totals or subtotals specified by IFRS Standards; and
• communicate management’s view of an aspect of an entity’s financial performance

The ED calls for disclosure of MPMs in the notes to the financial statements along with a requirement to reconcile to the most directly comparable total or subtotal specified by IFRS Standards. MPMs were acknowledged as an important means of presenting financial information but investors and analysts often bemoan a lack of transparency, which participants believed would be addressed by the ED.

Some participants questioned if the scope of the proposals is too narrow, indicating that many commonly-used performance measures would not be covered – particularly ratios and margins, or cash-flow performance measures.

Disclosure of Unusual Items

The proposals introduce a new definition of ‘unusual items’, intended to improve consistency and transparency in financial statement disclosures. Items of ‘limited predictive value’, defined as those for which it is ‘reasonable to expect that income or expenses that are similar in type or amount will not arise for several future annual reporting periods’, can be classified as unusual under the proposals.

Participants noted that although the new definition may be well-intentioned, a new label might not be necessary – consistent disclosure of lumpy or potentially unusual items could be more valuable than a new prescriptive definition of unusual, which introduces its own potential inconsistencies in application.

Next Steps

Overall, most users of financial statements consider the proposals to be a step in the right direction, but there are also several areas in which additional clarity and further consideration by the Board was encouraged. We look forward to seeing how this important project progresses in the coming year.

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