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IASB Chairman speaks on how high-quality accounting standards can help resist the incentives for short-termism

  • IFRS - IASB Image

Dec 19, 2019

On December 19, 2019, the International Accounting Standards Board (IASB) released a speech by IASB Chairman Hans Hoogervorst given at the 9th Symposium on Accounting Research hosted by the French standard-setter ANC. In his speech, he talked about the importance of high-quality accounting standards in supporting long-term investment.

Mr. Hoogervorst's speech followed two tracks. First he showed how the IASB's projets on primary financial statements and on wider corporate reporting will help companies to better explain their long-term performance to investors. He then turned to the accounting treatment of equity investments.

In the exposure draft of a new standard on general presentation and disclosures in financial statements the IASB published earlier this week, the IAS proposes defining operating profit, which will enhance comparability and become a powerful instrument for companies to explain their long-term performance to investors. The exposure draft also proposes a note in which companies will have to identify elements of income and expense which are ‘unusual’ in the sense they have limited predictive value. The IASB believes that the proposals will help investors gain insight into the persistence of earnings and will also help companies better explain their long-term strategy.

The IASB also believes that the work around updating the Management Commentary Practice Statement is important in helping companies tell their long-term story to investors. Elements that may be essential to a company’s long-term strategy often escape the financial statements, such as its business model, its intangible resources, the business environment it operates in, and more forward-looking information. Especially on information on intangibles and sustainability, which are becoming critical a company’s long-term viability, the current practice statement says little.

Mr. Hoogervorst then turned to short-term volatility vs. the long-term perspective. He explained that looking at the long term does not imply that that short-term economic phenomena can be ignored:

If short-term volatility in the financial statements reflects real economic volatility, it should not be discarded or ironed out in an artificial way. [...] Companies or investors that take a long-term view, must be able to withstand the inevitable short-term fickleness of the marketplace. 

Mr. Hoogervorst noted that in IFRS 9 the IASB abolished the available-for-sale (AFS) category for equity investments and fair value through profit or loss became the default requirement for equity investments. He stated that ever since, some stakeholders have suggested this accounting treatment is a disincentive for long-term investment in equity instruments as it could lead to more short-term volatility in the income statement. And he noted that he could perfectly well understand these comments as "the AFS category for equity investments in IAS 39 [...] provided a perfect instrument for companies to smooth their income statement over time".

Mr. Hoogervorst actually provided an example of an actual company that tended to release larger quantities of AFS reserves when its net earnings before AFS were under pressure. This form accounting was perfectly in accordance with the requirements of IAS 39, yet it did not fully reflect the performance of the company: The deteriorating performance of the company was less clearly visible to investors. Therefore, Mr Hoogervorst stated, he strongly believed in accounting standards that minimise the scope for earnings management. Nevertheless, stated the belief that AFS will probably be one of the hot topics in the post-implementation review of IFRS 9, which will be able to draw on the experience of companies around the world that have already adopted IFRS 9.

Mr. Hoogervorst concluded his speech by stating that: "Long-term goals should also be subject to the scrutiny of shorter-term performance measures. Otherwise, how would you know that you are on track?"

Review the full speech on the IASB's website.

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