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Conceptual framework — Presentation and disclosure; elements of financial statements; capital maintenance (IASB only)

Date recorded:

The IASB discussed an early draft of sections of a Discussion Paper (DP) on the revised Conceptual Framework, addressing:

  1. presentation and disclosure;
  2. certain elements of financial statements (distinguishing liabilities from equity particularly in the context of a written put option on own shares; and the definitions of income and expense and whether to define different types of income and expense); and
  3. a proposed approach to capital maintenance in the DP.

Presentation and disclosure

Presentation and disclosure

The IASB discussed presentation and disclosure issues. The existing Conceptual Framework does not have a section on presentation and disclosure, resulting, in the views of some, in disclosure requirements that are not always focused on the right/relevant disclosures and are too voluminous.

The staff prepared a draft section of the DP to discuss the conceptual principles that should underlie the IASB’s decision to provide guidance on presentation and disclosure.

The staff’s draft DP proposed that the objective of primary financial statements is to depict an entity’s financial position, financial performance and cash flows in a summary that is useful to a wide range of users for their assessment of the amount, timing and uncertainty of the entity’s future net cash inflows, and how efficiently and effectively the entity’s management and governing board have discharged their responsibilities to use the entity’s resources. Following from this primary purpose, the staff considered the conceptual principles underpinning:

  • Classification and aggregation;
  • Offsetting;
  • Cohesiveness;
  • Scope of information that should be included in the notes to the financial statements (i.e., disclosure).

Board members outlined many views on the staff’s proposed objective of primary financial statements. In particular, the IASB Chair believed the primary objective related to how efficiently and effectively the entity’s management and governing board have discharged their responsibilities to use the entity’s resources – an objective he viewed as synonymous with a stewardship role – as opposed to providing information to users to assess the amount, timing and uncertainty of an entity’s future net cash inflows. Several others, building on this view, noted that the revised Conceptual Framework should make clear that the objective of the primary financial statements should not be to allow users to forecast cash flows.

Beyond the objectives, Board members outlined several recommendations to discussion underpinning the objective. Examples of recommendations included requests to more clearly specify preparer responsibilities in presenting and disclosing risks and uncertainties in the business and further information related to the risks and pitfalls associated with aggregation.

On the topic of disclosure, Board members expressed varying levels of support for the direction of the staff paper – which noted that the notes should be inextricably linked to the primary financial statements and provide relevant information (capable of making a difference to the decisions made by users) that is faithfully represented (complete, neutral and free from error; clear, balanced and understandable; comprehensive; consistent over time; comparable amongst entities; and timely). The staff paper also proposed that notes to the financial statements should be limited to information arising from past and current conditions, transactions and events in order to provide relevant information to financial statement users.

Specific concerns/recommendations expressed by the Board to the staff paper included:

  • The revised Conceptual Framework should include discussion about the intent of notes (e.g., disaggregation of information, insight into the business, etc.).
  • A view that the revised Conceptual Framework should make clear that disclosures are intended to ‘communicate’ rather than result in a compliance exercise for preparers.
  • Concern that some of the principles underlying the concept of faithful representation, such as ‘comprehensive’ and ‘comparable’, are not appropriate as overall objectives.
  • Concern with the staff’s commentary that forward-looking information would be disclosed outside of financial statements, for example, in management commentary, so as to limit the financial statements to past and current conditions, transactions and events. The overriding concern with this statement was a discomfort as to what constitutes forward looking information. Therefore, it was requested that the staff more clearly specify what information should be captured in the financial statements (e.g., maturity analyses for items recognised in the primary financial statements are not considered forward looking information).

The staff acknowledged the comments from the Board and will consider such comments in further developing the Conceptual Framework DP.

Presentation in the statement of comprehensive income

The IASB discussed presentation in the statement of comprehensive income, including the purpose of the statement of comprehensive income, principles and concepts for presentation in profit or loss or other comprehensive income (OCI), how these principles and concepts apply to current and proposed OCI items and suggestions for changing the name of the statement of comprehensive income.

The staff, pre-empting the Board discussion, noted that there is no principle in IFRS to determine which items of income or expense should be presented in profit or loss and which should be reported in OCI, and when items initially recognised in OCI should be recycled into profit or loss. Therefore, the staff prepared a draft section of the DP to discuss the conceptual principles that should underlie the IASB’s future decision on these areas. On the basis of its analysis on these two topics, the staff recommended:

  • (Topic 1) The DP should include a set of principles for determining whether a recognised item of income or expense should be presented in profit or loss or in OCI. Those principles include:
    • Principle 1: Items presented in profit or loss communicate the primary picture of an entity’s financial performance for a reporting period.
    • Principle 2: All items of income and expense should be recognised in profit or loss unless presenting an item in OCI provides a better depiction of financial performance (i.e., OCI is an exception to presentation in profit or loss).
    • Principle 3: An item that has previously been presented in OCI should be reclassified to profit or loss if the reclassification results in relevant information about financial performance in that period.
  • (Topic 2) Two groups of items would be eligible for presentation in OCI applying the above principles: bridging items and mismatched remeasurements. A bridging item arises where the IASB determines that the statement of comprehensive income would communicate more relevant information about financial performance if profit or loss reflected a different measurement basis from that reflected in the statement of financial position (e.g., reflected changes in fair value in OCI for financial assets measured at fair value through OCI in the proposed limited scope amendments to IFRS 9), although the Board would need to determine circumstances that warrant different measurement bases being presented concurrently. A mismatched remeasurement arises where an item of income or expense represents an economic phenomenon so incompletely that, in the opinion of the IASB, presenting that item of income or expense in profit or loss would provide information that has little or no relevance for assessing the entity’s financial performance (e.g., reflecting the effective portion of changes in fair value for cash flow hedging instruments under IAS 39 Financial Instruments: Recognition and Measurement).
  • (Topic 3) The DP should include discussion of an alternative approach in which a single statement of comprehensive income (removing the distinction between profit and loss and OCI) is presented.

These recommendations elicited a long discussion by Board members.

(Topic 1)

Several Board members expressed significant reservations with the staff paper/early draft of the DP. While they acknowledged the discussion furthered the debate about what should be presented in OCI, they believed it ducked the core questions of defining OCI and financial performance, and instead, tried to optimise presentation and reverse engineer principles based on existing decisions by the Board regarding what should be presented in OCI. These Board members generally sought to provide constituents with a tool kit for identifying items to be reported in OCI. They also noted that as a first step, it was important that the Board decide more conceptually what financial performance is, with a subsequent step of how best to depict financial performance (i.e., through profit or loss or OCI).

Other Board members saw value in the information the staff had prepared. They believed the staff paper adequately portrayed the fact that all the primary financial statements provide relevant information, but acknowledged that profit or loss was generally seen to provide primacy of information (at least from the perspective of a starting point for commonality). They recognised that in its current form, the staff analysis failed to define financial performance, but they believed performance could not be analysed, understood or communicated in only one statistic. Instead, some suggested the Board could develop a ‘by exception’ definition, for example, financial performance is not necessarily driven by recurrence of earnings, controllability or volatility. They also supported the principles developed for determining whether a recognised item of income or expense should be presented in profit or loss or in OCI. While they acknowledged that OCI was being treated as a ‘parking lot’ for certain items/transactions, they were accepting of this solution where profit or loss was not an appropriate recognition measure for movements in equity.

From this general discussion, it become clear to many that the Board could not escape a more thorough discussion of financial performance.

(Topic 2)

Many Board members expressed concern that the proposed principles failed to capture practice considerations which would ultimately result in a large number of exceptions to the basic principles at a standards level. Some offered alternative suggestions. For example, one Board member believed that the bridging principle was just a construct of the mismatched remeasurements notion. He saw two categories – mismatched remeasurements and disaggregation – where disaggregation may be indicative of bridging and ultimately provide a recognised measurement basis.

Of particular concern to many Board members was the failure of the proposals to appropriate deal with pensions. Applying the staff proposed principles, it was unclear whether a remeasurement of a net defined benefit pension asset or liability would be presented in OCI.

Other Board members expressed support for the direction of the staff paper. One Board member noted that he could accept the bridging principle for many of the items where OCI is currently allowed on the basis that bridging responds to environments where a different valuation basis makes sense in the statement of financial position as compared to the profit or loss (e.g., value through usage may dictate a profit or loss valuation basis). He pointed to value realisation as the basis for recycling. When asked how he would explain the pensions quandary, he noted a belief that the correct profit and loss treatment would be the locked-in rate because that is the methodology the Board has chosen. He noted that if the Board chooses to make an exception for this, he believed an override should be included in the revised Framework which says if we make an exception that flows through, preparers must follow through with that exception.

Speaking specifically to the proposed value realisation basis for recycling, some were troubled by this basis, believing it contradicted some of the earlier Board discussions, and others were not convinced a mismatched remeasurement basis worked well in determining when items should be recycled.

Others outlined alternative views about applying a mixed measurement model, such as showing both a pure cost-based and pure fair valued-based model in the primary financial statements, but this proposal was swiftly refuted by others on the basis of relevance of information communicated.

Summarising the discussion, the IASB Chair noted a lot of concerns about the bridged items notion. He saw a general need for broad principles so as to avoid a significant number of model exceptions, but noted that the principles could not be so broad so as to introduce use of OCI for all remeasurements.

(Topic 3)

Most Board members were supportive of including in the DP discussion of an alternative approach in which a single statement of comprehensive income is presented. However, some individual concerns were expressed. The most significant of these concerns was a fear that a single statement was code for the elimination of profit or loss, which contradicted earlier discussions on the primacy of this measure. The Board member raising this issue believed much more work would be required to develop this approach, in particular, determining a sensible disaggregation of performance measures. He preferred that the DP merely ask whether the Board should look to redefine the statement of comprehensive income, but leave open the possible approaches. One approach he mentioned was the further disaggregation of the statement of comprehensive income by presenting the remeasurement of the net defined benefit pension asset or liability as a separate line item within profit or loss.

Other recommendations

Subsequent to this long discussion, the staff noted that it had one additional proposal in the staff paper. Citing confusion to use of the term ‘comprehensive income’ given that financial reporting is far from comprehensive, the staff recommended that the term ‘comprehensive income’ should be changed. Suggested replacement names included ‘Statement of income and expenses’ rather than ‘Statement of comprehensive income’, ‘Total income and expenses’ rather than ‘Total comprehensive income’ and ‘Remeasurements outside profit or loss’ rather than ‘Other comprehensive income’. The staff noted that it had received a number of offline comments from Board members at this recommendation, and thus, requested that any other Board comments be forwarded offline so as to determine the most appropriate path forward.

No formal votes were taken following any of the above discussions. Instead, the staff was directed to consider Board discussions in further developing the draft DP.

Elements of financial statements

Distinction between liabilities and equity instruments

At its February 2013 meeting, the Board began discussions of the boundary between liabilities and equity. At that meeting, it was noted that the existing Conceptual Framework defines equity as the residual interest in the assets of the entity after deducting all its liabilities. The existing definition of a liability focuses on whether the entity has an obligation to transfer economic benefits. However, some standards, such as IAS 32, use complex exceptions to these basic definitions when distinguishing between liabilities and equity instruments which many view as difficult to understand and apply.

Therefore, the IASB discussed a possible approach that retained the existing definition of a liability and remeasured equity claims through a statement of changes in equity to show wealth transfers between different classes of equity holders.

At this meeting, the staff presented illustrative examples of the approach discussed at the February 2013 meeting, including discussion of implications and corollary issues which would need to be considered in standards level decisions (e.g., how should an issuer measure written put options on its own shares, how should changes in the carrying amount of obligations arising under written put options on an entity’s own shares be treated, etc.).

In response to the staff analysis, many Board members were supportive of the outcome derived by the approach. Board members did seek clarification of certain aspects of the model (primarily in an attempt to understand how different transaction types, such as redeemable shares, would be treated) and communicated a number of recommendations and observations. Examples of some of the comments shared during the meeting include:

  • Concern with including the examples included in the staff paper within the DP out of fear that it may be perceived as an amendment to IAS 32. However, others were concerned with the absence of examples as they feared the approach/concepts were too abstract otherwise. It was suggested that the staff could include certain examples with a caveat to say that the examples indicate the possible consequences if this approach is taken as a standards level project.
  • Concern with the complexity of the approach. Board members noted many complexities in the model, including how to address binary situations and how to report/analyse wealth transfer (particularly from a dilution perspective).
  • Concern with the uncertainty introduced in the statement of financial position when applying the possible approach.

No vote was taken in support of the staff’s analysis or its inclusion in the DP, nor was it agreed whether certain issues underlying the possible approach would be considered in standards level decisions. Instead, the staff was left to consider Board discussions in further developing the draft DP.

Elements: income and expense

The Board discussed the elements of the statement of comprehensive income; namely, income and expense. The staff noted that very few problems have been identified with the existing definitions of income and expense. However, there have been requests for the revised Conceptual Framework to define different types of income and expense. In particular, definitions to differentiate revenue from gains and expenses from losses, and income and expense items that should be reported in profit or loss from items that should be reported in OCI, have been suggested. However, in analysing the issue, the staff ultimately suggested that the existing definitions of income and expense remain largely unchanged (although the staff did suggest that the revised Conceptual Framework should clarify whether an expense arises when an entity issues an equity instrument in exchange for services), with no definition differentiating types of income or expense.

Board members expressed very little feedback to the staff proposal. While no formal vote was taken on the proposals, Board members appeared generally agreeable to the staff recommendations.

Capital maintenance

The existing Conceptual Framework describes the concepts of financial and physical capital maintenance. However, the existing Conceptual Framework does not prescribe a particular model of capital maintenance – requiring the use of judgement in selecting the concept of financial maintenance that provides the most useful information to the users of financial statements.

As the concepts of capital maintenance are most relevant for entities operating in high inflation economies (with the concepts used in IAS 29 Financial Reporting in Hyperinflationary Economies), the staff recommended that the issues associated with capital maintenance are best dealt with at the same time as a possible standards level project on accounting for high inflation rather than as part of the Conceptual Framework project.

The staff also evaluated the current revaluation model in IAS 16 and IAS 38 Intangible Assets; noting that the current model is inconsistent with both the bridging concept described earlier today and a form of capital maintenance adjustment. Therefore, the staff suggested the IASB may wish to consider whether the revaluation model in IAS 16 and IAS 38 should be amended for consistency with either of those concepts, although the staff proposed not doing so as part of the Conceptual Framework DP.

Several Board members expressed support for not exploring further the capital maintenance concept at this stage. They noted that hyperinflation, in particular, is on the IASB’s research agenda, and therefore, further consideration of capital maintenance in relation to hyperinflation may be considered at a later date. With this view, however, there was a general discussion as to what information should be included in the revised Conceptual Framework about this concept. In particular, should existing content in the Conceptual Framework be carried forward (as some felt the existing discussion did little to help standard setting development) or eliminated, and if the latter, is it too integral to eliminate entirely? Very little feedback was provided on the revaluation model proposals, but Board members generally supported not evaluating further at this stage.

No formal vote was taken to confirm agreement with the staff discussion, but the Board generally appeared supportive with the staff’s direction.

Correction list for hyphenation

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