Currently, IAS 1 Presentation of Financial Statements imposes little structure on the content and format of the income statement. Instead, management is left to use significant judgement in deciding how best to present a company’s performance.
The International Accounting Standards Board (IASB) is concerned that this lack of structure may be impeding financial statement users from comparing the performance of companies. In response, the IASB is proposing to replace IAS 1 with a new standard that will govern the general structure and content of financial statements. It published its exposure draft (ED), General Presentation and Disclosures, in December 2019, with comments due by 30 September 2020.
The main proposals
Income statement structure
The ED proposes four new categories into which items of income and expense would be classified. These are:
- operating;
- integral associates and joint ventures;
- investing; and
- financing.
Categories 2, 3 and 4 are tightly defined but 1 is not. The operating category would be the default for items of income or expense not falling within another category and would contain income and expenses from the company’s ‘main business activities’. Management would determine what these are and would describe the nature of the company’s operations and its main business activities in the notes.
The integral associates and joint ventures category includes income and expenses from such investments. Integral is a new concept; intended to describe operations that are judged to be closely related to the company’s main business activities and generating a return “in conjunction with other assets of the company” (another new concept).
This might be through for example, having integrated lines of business, sharing a name or brand, or a supplier or customer relationship which would cause it significant business disruption to replace. To illustrate, in the mining and oil and gas sectors, associates and joint ventures are often used to share the risk in exploration and development activities, and these would probably qualify as integral. However, the integral associates and joint ventures category would be presented separately from the operating category, which is reserved for activities that the company controls.
Investing activities would be used to classify income and expenses, from investments, that are generated “individually and largely independently of other resources of the company”. However when these are generated as a main business activity they are operating activities, such as they would be for a bank or investment company. The judgements made in determining a company’s main business activities will be important for this category too
The last of the new categories, financing, is a measure of interest on net debt and includes:
- income and expenses from cash and cash equivalents;
- income and expenses on liabilities arising from financing activities; and
- interest income and
Financing activities are those involving the “receipt or use of a resource from a provider of finance with the expectation that (i) the resource will be returned to the provider of finance; and (ii) the provider of finance will be compensated through the payment of a finance charge that is dependent on both the amount of the credit and its duration”.
When a company’s main business activity is providing finance to customers, it could classify either all of (a) and (b) to the operating category, or only that part of them that relates to providing finance to customers, as a policy choice.
Item (c) includes interest expense on provisions, such as warranty and decommissioning provisions, and interest income or expense on a net defined benefit asset or liability. These could be all that is left for some companies, given the policy choice described above.
Aggregation and disaggregation
The IASB proposes guidance that should help companies aggregate items throughout the financial statements on the basis of ‘shared characteristics’; the characteristics that management judges should be informative to financial statement users.
Those characteristics could be the nature of the items, their function, their measurement basis, or some other characteristic. Unlike items should not be aggregated and useful information should not be obscured by excessive aggregation or disaggregation. The guidance on aggregation and disaggregation is closely related to the concept of materiality, and similar judgements will be needed.
Unusual income and expense items
Financial statement users claim that they need better information about a company’s income and expenses that have limited predictive value; users want to analyse these separately when predicting a company’s future cash flows.
The ED proposes that companies disclose, in a single note, each item of income or expense that is ‘unusual’. Unusual means it is “reasonable to expect that income or expenses that are similar in type and amount will not arise for several future annual reporting periods”.<
For each unusual item, a company would disclose the amount, describe the transaction or other event that gave rise to the item, explain why it is unusual and explain where the item is included in the income statement.
Management performance measures
The IASB has decided not to dictate what types of performance measures management may use to communicate a company’s performance. Instead, it proposes disclosure requirements for performance measures that meet its definition of a Management Performance Measure (MPM), which is one:
- used in public communications outside the financial statements;
- that complements totals or subtotals specified by IFRS; and
- that communicates to users management’s view of an aspect of a company’s performance.
An MPM is a subtotal of income and expense, only. Ratios, cash-flow measures or measures based on non-financial information are not MPMs. The disclosure requirement seems to include MPMs published anywhere. Presentations and publications made in support of the release of the annual financial statements, any subtotals published on websites or included in earlier and subsequent presentations to investors, customers, or suppliers would be captured.
Management would need to explain how the MPM communicates its view of performance, how it is calculated, why it is useful and, if it has changed, how and why. A reconciliation would be required for each MPM to the most directly comparable IFRS-defined total or subtotal, along with the tax effect and the effect on non-controlling interests of each reconciling item. The information would be presented in a single note to the financial statements and, consequently, be audited.
Preliminary observations
It is clear from reading the ED that the IASB has considered how users use financial statements, and has attempted to make financial statements more useful and user-friendly. The IASB has tried to balance the need for comparability with the flexibility required “to tell the company’s story”. Accordingly, important judgements would include identifying a company’s main business activities, whether the activities of some of its associates and joint ventures are closely related to those main business activities, and identifying which items of income and expense have limited predictive value for users, and are therefore unusual.
MPMs that managers choose to communicate the company’s performance would still be allowed, but with disclosure that would introduce some much-needed discipline. However, the proposal to capture all MPMs wherever published may cast the net too wide; and could lead to lengthy and, possibly, unhelpful disclosures. Perhaps restricting the requirement to those MPMs published in the annual reporting round; the annual report, results announcements and investor presentations, would bring a better cost/benefit balance.
The Financial Reporting Faculty is in the process of considering the proposals and preparing a response to the IASB. The final response will be publicly available in due course at icaew.com/representations.
About the author
Michael Stewart, Senior Financial Reporting Expert, Huawei Global Finance (UK) Limited
