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Primary financial statements

Date recorded:

Primary Financial Statements – Cover note – Agenda paper 21

Background

The IASB continued its discussion on the Primary Financial Statements (PFS) project. The topics for this meeting were as follows:

  • Objective of and suitable locations for the management performance measure (MPM) (AP 21A)
  • Classification of interest and dividends in the statement of cash flows (AP 21C)
  • Initial thoughts on other targeted improvements to the statement of cash flows (AP 21D)

AP 21B provides background information about improvements to the statement of cash flows and provides an overview of APs 21C and 21D.

The Staff plan to discuss the following topics at future Board meetings: (a) further development of the proposed structure of the statement of financial performance to cater for more complex scenarios; (b) other outstanding MPM related issues; (c) principles of aggregation and disaggregation, including the need for additional minimum line items; (d) developing illustrative examples/templates for the PFS for a few industries; and (e) further targeted improvements to the statement of cash flows.

Objective of and suitable locations for the management performance measure (MPM) – Agenda paper 21A

Background

In this paper, the Staff set out the primary objective of introducing a MPM subtotal into the statement of financial performance and consider various locations for the presentation of that measure.

Staff analysis

Objective of a MPM subtotal

The reason for introducing a MPM subtotal is to respond to concerns from stakeholders that some entities only communicate their key performance measures outside the financial statements, resulting in their being unaudited and difficult to reconcile to the financial statements. Consequently, the Staff think that the primary objective of disclosing a MPM subtotal is to encourage preparers to present their key performance measures inside the financial statements where they would be subject to greater transparency and audit.

The Staff will supplement this primary objective with guidance on the presentation of infrequently occurring items so that users can assess the sustainability of an entity’s financial performance. The Staff will consider the feedback received on the Principles of Disclosures discussion paper (PoD DP) when developing their ideas.

A high-level analysis of the feedback received on the DP indicated that respondents were generally supportive of the Board providing principles-based guidance on how to present infrequent/unusual items fairly, but they foresee that this would be a difficult undertaking for the Board. Many respondents also questioned how infrequently occurring items differ from extraordinary items. Furthermore, many respondents disagreed with the Board’s suggestion to prohibit the use of other terms to describe unusual and infrequently occurring items because entities would resort to other means to disclose such items, which is what happened when the Board banned the presentation of extraordinary items. Furthermore, this requirement would be difficult to implement and enforce from a translation perspective.

Another general comment on the DP was that the discussion of performance measures should be developed within the PFS project and not in the Principles of Disclosures project. With regard to the presentation of EBIT/EBITDA, respondents had mixed views about whether the Board should mandate their disclosure because they are not relevant to all entities.

Location of the MPM subtotal

The Board has discussed this topic before. Based on the Board members’ comments, the Staff have identified the following ways of presenting the MPM subtotal (these are illustrated in appendix D to the paper):

  1. as a subtotal in the statement of financial performance, above the proposed investing section;
  2. as a separate column in the statement of financial performance;
  3. in a separate reconciliation accompanying the statement of financial performance; or
  4. in the notes.

Having analysed the advantages and disadvantages of each approach, including an assessment of the implications of electronic reporting, the Staff believed that approach 1 is the most appropriate. However, if the MPM does not fit in with the proposed structure of the statement of financial performance, e.g. the MPM includes investing or finance income/expenses, then it should be provided in a separate reconciliation directly after the statement of financial performance.

The Staff believed that this dual approach recognises the importance of presenting the MPM prominently in the statement of financial performance where possible, so long as it does not undermine the information presented in that statement. The ability to present the MPM in a separate reconciliation also allows flexibility to cater for a wide range of MPMs to forestall entities reverting to disclosing MPMs outside the financial statements.

Staff recommendation

The Staff recommended that:

  • (a) they explore how to present unusual or infrequently occurring items separately at a future Board meeting;
  • (b) the MPM be presented as a subtotal in the statement of financial performance unless it does not fit in with the proposed structure of the statement. If that is the case, the MPM should be provided in a separate reconciliation directly following the statement of financial performance.

Discussion

The Board was generally supportive of having a reconciliation between the MPM and an IFRS-defined performance subtotal in the financial statements, albeit not on the face of the statement of financial performance. However, the Board believe that no reconciliation is necessary if the MPM fits naturally within the statement of financial performance, e.g. if the MPM is profit before tax, or if the entity does not use alternative performance measures in its communications (the Board will discuss the boundaries of such communications at a future meeting). There was no detailed discussion as to what constitutes ‘fitting naturally within the statement of financial performance’.

The Board did not vote on any other questions on grounds that they need further discussion.

There was significant debate on this paper. The Board had mixed views on what the primary objective of disclosing a MPM subtotal was. The discussion also revealed that Board members had different ideas on what a non-GAAP/IFRS subtotal is and what kind of subtotal is allowed by IAS 1.85 – e.g., is a subtotal drawn before share-based payment expense (presuming a presentation of expenses by nature) allowed? Board members also had mixed views on whether they should pursue trying to describe infrequently occurring items.

The Board agreed on the reconciliation because they believe that it would provide valuable information to users for them to make their own adjustments. Some Board members emphasised that the reconciliation must clearly indicate the MPM as a non-IFRS subtotal to ensure that it is not accorded with IFRS status and that the non-GAAP measures guidance of regulators would continue to apply to those subtotals. Most Board members felt that no constraints should be imposed on how the MPM is calculated to make it a truly management-defined number but disciplines should be put around it to ensure no opportunistic usage of the measure, e.g. to require robust explanations of each of the adjustments and consistency of application over time.

Classification of interest and dividends in the statement of cash flows – Agenda paper 21C

Background

This paper explored the removal of options for the classification of interest and dividends paid/received in the statement of cash flows by prescribing a single classification for each of these items. The Staff have focused their analysis on non-financial institutions.

Staff analysis

The Staff suggested that interest and dividends paid/received be classified based on their underlying nature and not whether they are included in profit or loss (which is reason currently given in IAS 7 for classifying these items as operating cash flows). In its November 2017 meeting, the Board tentatively decided to clarify the definition of financing activities as follows:

  • (a) the receipt or use of a resource from a provider of finance (or provision of credit);
  • (b) the expectation that the resource will be returned to the provider of finance; and
  • (c) the expectation that the provider of finance will be appropriately compensated through the payment of a finance charge.

The Staff noted that interest paid on financing activities would meet point c) above and should be classified as a financing cash flow. The same applies to interest paid that has been capitalised because the underlying nature of the cash flows is to obtain finance for the acquisition/construction of the related asset. The Staff believe that this outcome is more appropriate than the tentative decision previously made by the IFRS Interpretations Committee that capitalised interest should be classified in the same category as the related asset. That would lead to an arbitrary allocation of interest paid between operating and investing activities which is not optimal.

Similarly, the Staff believed that dividends paid should be classified as a financing cash flow because it is a direct cost of financing the entity with equity.

As regards interest and dividends received, the Staff believed that they should be classified as investing cash flows because by nature they are returns from an entity’s investments.

Staff recommendation

The Staff recommended that the Board remove the options for classifying interests and dividends cash flows and prescribe that:

  • interest paid on financing activities, regardless of whether they are capitalised, be classified as financing cash flows;
  • dividends paid be classified as financing cash flows;
  • interest and dividends received be classified as investing cash flows (subject to further discussion on dividends received from associates and joint ventures that are integral to an entity), and amend the definition of investing activities in IAS 7 to this effect.

Discussion

The Board approved all of the Staff recommendations.

The Staff reiterated that the classification of interest and dividends received as investing cash flows was proposed as a simplification and admitted that it is rules-based. They also acknowledged that they have yet to analyse the classification of broader financing or borrowing costs other than interest paid.

Initial thoughts on other targeted improvements to the statement of cash flows – Agenda paper 21D

Background

This paper provided the Staff’s initial thoughts on identifying a consistent starting point for the indirect reconciliation of cash flows and the potential alignment of the operating sections of the statements of cash flows and financial performance.

Staff analysis and recommendation

Starting point for reconciliation of cash flows from operations

IAS 7.20 requires the use of the ‘profit or loss’ total as the starting point for the indirect reconciliation of cash flows from operating activities. Practices vary as to the actual starting point used due to the lack of specification.

The Staff recommended that the Board mandate a consistent starting point for this reconciliation and suggest using the new subtotal ‘profit before investing, financing and income tax’ as the starting point. This is considered a convenient subtotal because it would remove the need to adjust for income and expenses of a financing or investing nature.

Aligning the operating sections of the statements of cash flows and financial performance

Stakeholders have always sought linkage between an entity’s operating profit and cash flows from operating activities because this helps them understand the entity’s cash conversion cycle. The Staff acknowledge their concerns but realise that such an alignment would require a bigger project and that the Board would face significant challenges just trying to define operating profit.

Given that the statements of cash flows and financial performance serve different purposes and alignment would never be entirely possible, any attempt at this would add little value. Accordingly, Staff recommend that the Board not seek to align the operating sections of the two statements.

Discussion

The Board approved the Staff’s recommendations without much discussion.

Furthermore, the Board rejected a suggestion to explore further improvements to the statement of cash flows as there are no widespread calls to address those other issues.

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