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Primary financial statements

Date recorded:

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:

  • Requirements for management performance measures (MPMs) (AP 21A)
  • Presentation of the share of profit or loss of ‘integral’ associates and joint ventures (AP 21B)

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) presentation of management-defined adjusted earnings per share; (c) classification of dividends received from associates and joint ventures in the statement of cash flows; (d) principles of aggregation and disaggregation, including considering thresholds and the need for additional minimum line items; and (e) developing illustrative examples/templates for the PFS for a few industries.

Requirements for management performance measures (MPM) – Agenda paper 21A

Background

This was a continuation of the December 2017 discussion. In this paper, the Staff discussed further issues around the disclosure of MPMs in the financial statements.

Staff analysis and recommendation

The Staff analysed the following areas:

1. Circumstances when an MPM should be required

Previously, the Board considered whether all MPMs communicated by management (e.g. through investor presentations, results announcements etc.) should be disclosed in the financial statements, or whether this should be limited to only those MPMs that are contained in an entity’s annual report.

The Staff believed that the scope should be limited to MPMs that are included in the annual report because this is a confined set of information that is publicly available and can be audited. This would adequately achieve the objective of enhancing investor confidence in a sufficiently wide range of MPMs used by management. Extending the scope to a wider population would be practically challenging from an access and enforcement perspective.

Nevertheless, the Staff acknowledged that management could still circumvent the requirement to disclose MPMs in the financial statements by disclosing them outside the annual report. However, in that case, management would presumably be under more pressure from users and regulators to explain why they are reporting different performance measures from the ones in the annual report/financial statements, thus helping to rein in abuse.

In light of the above, the Staff recommended that the Board require:

  • all entities to specify their key performance measure(s) in the financial statements;
  • an entity to identify such measures as MPMs if they are not IFRS-defined measures; and
  • the key performance measures identified in the financial statements to include, as a minimum, those that are communicated in the annual report.

2. Location of the reconciliation between the MPM and an IFRS-defined measure

In its December 2017 meeting, the Board tentatively decided that if an MPM does not meet the requirements to be presented as a subtotal in the statement of financial performance, the MPM should be provided in a separate reconciliation. However, the Board did not decide on the location of that reconciliation.

In this paper, the Staff further analysed the pros and cons of presenting the reconciliation either (a) as part of the primary financial statements immediately after the statement of financial performance, or (b) in the notes. On balance, the Staff believed that it is more advantageous to include the reconciliation in the notes because this would not affect the structure of the statement of financial performance or clutter it and would alleviate some Board members’ concern of inappropriately elevating the status of an MPM to an IFRS measure.

Accordingly, the Staff recommended that the Board require the reconciliation to be disclosed in the notes. Furthermore, they recommended that the Board require an entity to choose the most appropriate IFRS-defined measure to which the MPM should be reconciled, instead of mandating the starting point for the reconciliation.

3. Constraints on the MPM in a separate reconciliation

The Board had discussed this before. Views were mixed at previous meetings with some members observing that imposing constraints on an MPM would undermine the ability of management to tell its own story, while others observed that not imposing any constraints would allow management to present misleading information.

The Staff were of the view that an MPM should reflect management’s view as much as possible. They also noted that if the MPMs are presented on the face of the statement of financial performance, they would be subject to the stringent requirements of IAS 1.85A. Even if the MPM is presented in the notes, the general requirements of IAS 1 would require that such measures fairly present the financial performance of an entity and that they be consistently presented over time. These requirements would help reduce the risk of entities promoting misleading information through the use of MPMs.

Accordingly, the Staff recommended that the Board not impose any specific constraints on MPMs, but to require disclosures that would ensure transparency and discipline of such measures.

4. Additional disclosure requirements

This was another aspect that the Board had discussed before. The Staff continued to believe that the following disclosures should be required for each MPM, and recommended the same to the Board:

  • a description of why the MPM provides management’s view of performance, including an explanation of how the MPM has been calculated and why;
  • a five year historical summary showing the calculation of the MPM for each year; and
  • if there is a change in how the MPM is calculated during the year, sufficient explanation to help users understand the reasons for, and the financial effect of, the change.

5. Interaction with IFRS 8 segment profit or loss

Management use MPMs to assess the performance of an entity. Similarly, IFRS 8 requires an entity to report the profit or loss for each reportable segment, which management uses to assess the performance of the segment. As such, some Board members were of the view that these two measures are linked and that the MPM reconciliation could be included as part of the operating segments note.

The Staff disagreed. They believed that a typical MPM would not necessarily be the same as any or all of the reportable segments’ profit or loss. For example, the MPM might include amounts that are not allocated to segments such as share of profit of associates, headquarter expenses etc. Disclosing the MPM as part of the segment note would also obscure both sets of information.

Accordingly, the Staff recommended the following:

  • the reconciliation between the MPM and the IFRS-measure should not be combined into the operating segment information; and
  • an entity should explain how the MPM differs from the total profit or loss for the reportable segments.

6. Interaction with existing regulatory requirements for non-IFRS measures

As noted above, some Board members were concerned that including MPMs in the financial statements would elevate their status to an IFRS-measure. This has the potential of excluding the MPMs from the requirements of non-GAAP measures imposed by regulators.

The Staff acknowledged these concerns and recommended that the Board specify that MPMs are not an IFRS-defined measure and that existing regulatory requirements for non-GAAP measures would continue to apply to MPMs.

Discussions

1. Circumstances when an MPM should be required

The Board approved the Staff recommendations.

There was significant debate on this issue. Many Board members asked the Staff to clarify what is meant by an ‘IFRS-defined’ measure: does this include only subtotals specified in a Standard, or does it also include numbers derived from IFRS figures e.g. a subtotal that excludes restructuring costs or share-based payment expenses as calculated in terms of the relevant Standards?

The same question arose on ‘key performance measures’ – how is this term defined? This is critical because only MPMs that are identified as a key performance measure would need to be presented in the financial statements in terms of the Staff’s proposals.

The Staff agreed to provide more guidance on these two issues. Preliminarily, the Staff would not view operating profit as an IFRS-defined measure. They also reiterated that the MPMs under discussion are restricted to financial measures only and exclude ratios and growth rates (e.g. revenue growth rates or order books).

2. Location of the reconciliation between the MPM and an IFRS-defined measure

Eleven Board members agreed to include the reconciliation in the notes.

One of the Board members who disagreed observed that many investors would like to know the MPMs at the earliest opportunity which is usually on the results announcement date. However, notes to the financial statements usually do not form part of the results announcement package. To that point, another Board member observed that regulators often require only particular line items on the statement of financial performance (as opposed to the full statement) to be included in the results announcement. Consequently, including the reconciliation on the face of the statement of financial performance may not make the MPMs available earlier.

3. Constraints on the MPM in a separate reconciliation

Thirteen Board members agreed that no specific constraints should be imposed on the MPMs.

One Board member observed that there is actually information value in an unconstrained number because one can see how far management stretches the figures. From that, analysts can impute many things. Some members also believe that there are sufficient built-in constraints to rein in abuse, e.g. the existing requirements of IAS 1 about fair presentation. Furthermore, an entity may deliberately make an MPM fail the constraints so that it does not have to be included in the financial statements. This would go against the objective of the project.

4. Additional disclosure requirements

The Board agreed with the Staff recommendations except for the requirement to show a five year summary of the MPM. Some members believe that this would not be practicable when there are changes in Standards because different measurement and recognition bases (e.g. IFRS 16 versus IAS 17) would render the comparative figures meaningless. They believe that the normal requirement of two years is sufficient.

5. Interaction with IFRS 8 segment profit or loss

The Board modified the Staff’s suggestion to one where entities are not prohibited from including MPM information in the segment note if they wish to do so. However, if for structural of formatting reasons (e.g. there are multiple MPMs and/or the reconciliations are complicated) the MPM information does not fit within the segment note, then management should explain how it reconciles to segment information.

6. Interaction with existing regulatory requirements for non-IFRS measures

No member supported this recommendation.

This is linked to the points raised in issue 1. The Board generally thought that the proposed statement ‘a MPM is not an IFRS-defined measure’ was internally inconsistent given that the Board is proposing to mandate the inclusion of qualifying MPMs into the financial statements. The Vice-Chair observed that regulators may have to reassess the applicability of their requirements regarding non-GAAP measures to MPMs once the Board finishes this project.

 

Presentation of the share of the profit or loss of ‘integral’ associates and joint ventures – Agenda paper 21B

Background

This paper discusses whether an entity should distinguish between integral and non-integral associates and joint ventures for the purpose of presenting an entity’s share of profit or loss from these investments, as well as in which section of the statement of financial performance these shares of results should be presented.

Staff analysis

As previously discussed, some users incorporate the results of integral associates and/or joint ventures when assessing the performance of an entity. Notwithstanding this, many users exclude the results of investments from associates and joint ventures in their entirety when valuing a business because they regard the activities of these investees as peripheral and their results as being of a different quality from consolidated profit or loss. Be that as it may, the Staff believed that separately presenting the results of integral associates and joint ventures from those that are not integral would be useful because this would bring consistency to how preparers provide such information.

In order to apply this requirement consistently, the Staff suggested that the Board define an integral associate or joint venture as one ‘whose activities are integrated into an entity’s business activities and are thereby essential and fundamental in carrying out these activities’. This definition is based on the ordinary meaning of ‘integral’.

As to the location for presenting the results from integral associates and joint ventures (results from non-integral investees would be presented within the income/expense from investments category), the Staff proposed three alternatives:

  1. above the ‘income/expenses from investments’ category, as part of an entity’s business activities;
  2. above the ‘income/expenses from investments’ category, but placed immediately after the entity’s business activities by creating an additional subtotal; or
  3. within the ‘income/expenses from investments’ category but separately from the results from ‘non-integral’ associates and joint ventures.

The Staff analysed the pros and cons of each approach and preferred approach B. This was because it maintains a segregation between the returns on controlled assets and liabilities and the returns on non-controlled investments, while indicating the more integrated nature of particular associates and joint ventures. Given the varied views that stakeholders have on this issue, the Staff recommended that all three approaches be included in the next consultative document for comment.

Staff recommendation

The Staff recommended that the Board:

  • require entities to present the results of ‘integral’ associates and joint ventures separately from ‘non-integral’ associates and joint ventures;
  • with regard to the definition of ‘integral’:
    1. define an ‘integral associate or joint venture’ as described above;
    2. include a non-exhaustive list of indicators of an integral associate or joint venture; and
    3. prohibit entities from changing the way an associate or joint venture is classified, unless the relationship between the entity and the investee changes substantively (the Staff did not elaborate on what would constitute a substantive change); and
  • discuss all three approaches to presenting the share of profit or loss of integral associates and joint ventures, indicating approach B as the preferred approach.

Discussion

Twelve Board members agreed with separately presenting the results of integral associates and joint ventures from those that are non-integral. The Board rejected the Staff’s proposed definition of integral and suggested using the proposed definition of ‘income/expenses from investments’ to draw the distinction. The Board also preferred approach B with regard to presenting the share of profit or loss of integral associates and joint ventures and rejected the other two approaches.

The Board generally agreed that a distinction between integral and non-integral associates and joint ventures would provide useful information; however, they had mixed views regarding how that distinction should be made. Some Board members thought that the terms ‘essential and fundamental’ to an entity’s activities is a high hurdle for an integral associate or joint venture. This proposal would also introduce new terms into the Standards that are undefined which will cause further interpretation issues.

The Vice-Chair questioned why associates are different from other types of investments, i.e. why not split other investments between integral and non-integral? Some people may even argue that this could be extended to non-investor-investee relationships, e.g. sales to or purchases from integral customers and suppliers should be separately disclosed, especially if one of the indicators of an integral associate is its being a critical supplier or customer. Furthermore, IFRS 12 currently requires an entity to provide information about material associates. Separately disclosing integral associates would seem to duplicate efforts.

In light of the above, many Board members preferred using the proposed definition of ‘income/expenses from investments’ to distinguish between integral and non-integral associates and joint ventures. Under this approach, the results of associates and joint ventures that do not generate a return for the entity individually and largely independently from other resources held by the entity would be excluded from the investing category. More detailed application guidance have yet to be developed. This approach reduces the introduction of new concepts into the Standards and treats equity-accounted investments in the same way as other investments.

As for the location of presenting the results of integral associates and joint ventures, the Board rejected approach C because that would be inconsistent with the decision above. The Board also rejected approach A because it would exacerbate users’ concerns about mixing an entity’s share of post-tax results with other pre-tax consolidated results.

 

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