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Primary financial statements

Date recorded:

Classification of exchange differences and gains and losses on derivatives in the statement(s) of financial performance (AP 21A)

Background

The purpose of this paper is to clarify the classification in the statement(s) of financial performance (operating, investing and financing) of exchange differences included in profit or loss applying IAS 21; gains and losses on derivatives and losses on non-derivative financial instrument used for risk management, included in the profit or loss.

Staff analysis

The staff think that the Board should clarify its proposed requirement to have subtotals in the statement(s) of financial performance. Some stakeholders have raised concerns that it may be costly to track whether exchange differences relate to the entity’s main business activities, investing or financing activities and the cost may outweigh the benefits.

The staff recommend that the Board supplement its tentative decision with classification requirements for fair value gains and losses on derivatives because the application of the tentative decisions may lead to diversity in practice and fair value gains and losses on derivatives used for risk management are not necessarily classified in the section of the statement(s) of financial performance that is affected by the risk that the entity intends to manage.

The staff considered the pros and cons of two approaches, being reflecting risk management for designated derivatives or reflecting risk management for all derivatives, with classification in the investing section in all other cases. The staff opted for the latter option because they think it better reflects an entity’s risk management activities, regardless of whether the entity applies hedge accounting. The staff decided against allowing entities to develop an accounting policy for the classification of the gains and losses on derivatives because it would not achieve consistency across entities and the accounting policy may not be a faithful representation of its activities. The staff considered whether the Board should require entities to use the same approach for derivatives to classify gains and losses on all non-derivative financial instruments used for risk management. However, they recommended that entities be required to apply the Board’s definition for the sections to gains and losses on non-designated non-derivative financial instruments and classify gains and losses on designated non-derivative financial instruments using the approach for derivatives.

Staff recommendations

The staff recommended that the Board clarify that an entity is required to classify exchange differences included in profit or loss applying IAS 21 in the same sections as the income and expenses from the activities to which they relate, in accordance with the Board’s definitions for the sections. The proposals would require an entity to classify gains and losses included in the profit or loss on a financial instrument designated as hedging instrument in accordance with IAS 39 or IFRS 9 for both derivative and non-derivative financial instruments:

  • In the operating section, if the instrument is used to manage risks relating to the entity’s main business activities, except when it would require the grossing up of gains and losses;
  • In the financing section, if the instrument is used to manage risks relating to the entity’s financing activities, except when it would require the grossing up of gains and losses; and
  • In the investing section in all other cases, including when the above would require the grossing up of gains and losses.

Furthermore, the Board should clarify that an entity is required to classify gains and losses included in profit or loss on a non-designated non-derivative financial instrument in accordance with the Board’s definition for the section and require an entity to apply the above on a non-designated derivative financial instrument except when such classification would involve undue cost and effort. In such case, an entity may classify gains and losses on the derivative in the investing section.

Board discussion

The Board acknowledge that the cost of tracking the exchange differences and gains and losses on derivatives and non-derivatives may outweigh the benefits of classifying the items in the sections of the statement(s) of financial performance. Therefore, the Board will request feedback on this in the Exposure Draft (ED) and propose to discuss this in the Basis for Conclusion (BC).

The Board believe there should be no differences in treatment for gains or losses between non-designated and designated derivatives because hedge accounting is a choice made by management and entities that have not applied hedge accounting should not be prejudiced.  Furthermore, IAS 39 does not discuss risk management activities and therefore, classifying the gains or losses on what best reflects an entity’s risk management activities may not be appropriate. However, some members disagreed and said that the proposal will result in classification of gains or losses based on what fits naturally to the descriptions of the sections in the statement(s) of financial performance. The Board suggested that these concerns should be reflected in the ED to facilitate balanced feedback.

Board decision

The Board decided:

  • (a) To clarify that an entity is required to classify exchange differences included in profit or loss applying IAS 21 in the same sections as the income and expenses from the activities to which they relate, in accordance with the Board’s definitions for the sections. (Vote 14-0)
  • (b) That an entity is required to classify gains and losses included in the profit and loss on a financial instrument designated as hedging instrument in accordance with IAS 39 or IFRS 9 for both derivative and non-derivative financial instruments:
    • In the operating section, if the instrument is used to manage risks relating to the entity’s main business activities, except when it would require the grossing up of gains and losses;
    • In the financing section, if the instrument is used to manage risks relating to the entity’s financing activities, except when it would require the grossing up of gains and losses; and
    • In the investing section in all other cases, including when the above would require the grossing up of gains and losses. (Vote 13-1)
  • (c) To clarify that an entity is required to classify gains and losses included in profit or loss on a non-designated non-derivative financial instrument in accordance with the Board’s definition for the section and require an entity to apply the above on a non-designated derivative financial instrument except when such classification would involve undue cost and effort. In such case, an entity may classify gains and losses on the derivative in the investing section. (Vote 13-1)

Expenses from investments (AP 21B)

Background

The purpose of this paper is to discuss whether expenses related to the investments (i.e. investment management fees) should also be included in the investing section.

Staff analysis

The staff believes that the users would consider the expenses arising from activities relating to investments in considering the returns from the investments. Therefore, including expenses relating to investments in the investing section would provide better information about the performance of the investments. The staff considered requiring the inclusion of “directly related expenses” of an investment in the investing section but decided against it as the term was too broad. Instead, the staff recommends the inclusion of “incremental expenses” of an investment in the investing section.

Staff recommendations

The staff recommend that the Board include incremental expenses (those expenses that the entity would not have incurred if the investment had not been made) related to an investment in the investing section of the statement(s) of financial performance.  

Board discussion

Some Board members agree with the staff’s recommendation because this is consistent with the principle of classifying items to the section of statement(s) of financial performance. Furthermore, the members also agree that with the inclusion of expenses from investing activities in the investing section, a complete picture of investing activities could be formed which will result in more faithful representation. However, some Board members raised concerns that including these expenses could compromise the robustness of the model as they believe this is moving towards a rule-based approach by prescribing which expenses should be included in the sections. Another member said that one could argue that this should also extend to classifying incremental costs from financing activities to the financing section. Therefore, where would one draw the line on classifying expenses to the various sections in the statement(s) of financial performance. Most members agreed that only incremental expenses related to an investment should be included in the investing activity as it would be misleading to include this in operating activities because the costs would not have been incurred unless the entity had chosen to invest. The Board agree that clarification of incremental expense (i.e. expenses from investment vs. expenses on investment) should be provided in the ED and highlight that the principle of materiality should be applied.

Board decision

The Board decided to include incremental expenses related to an investment in the investing section of the statement(s) of financial performance. (Vote: 9-4)

Determining the income tax effect of management performance (AP 21C)

Background

This paper considered whether to provide guidance on how to determine the income tax effect of the difference between management performance measures (MPMs) and the most directly comparable IFRS subtotal, also known as MPM adjustments, and whether to require disclosure of the method used in to determine the income tax effect.

Staff analysis

Users have expressed concerns about the practicality of the proposed disclosure of income tax effect on MPM adjustments such as how the income tax effect should be determined and the cost and complexity of determining the income tax effect for each MPM adjustment. The staff believe that IAS 12 can be applied to MPM adjustments by applying the tax legislation to an individual transaction or on an aggregate basis. The staff considered two approaches which include applying the practical expedient in IAS 12:63 of allocating a pro rata share of current and deferred tax on a reasonable basis to all MPM adjustments or to provide specific guidance in applying the practical expedient. The staff decided on the latter as it provides users with a better indication of the likely income tax effect to the MPMs. Furthermore, the staff also believe that entities should disclose how the income tax effect of MPM adjustments have been determined in their particular circumstance as this provides useful information to the users of the financial statement.

Staff recommendations

The staff recommend that the Board specify that the income tax effect of MPM adjustments should be determined based on reasonable pro rata allocation of the current and deferred tax of the entity in the tax jurisdiction, or another method which achieves more appropriate allocation. Entities would be required to disclose how the income tax effect of MPM adjustments have been determined in their particular circumstances. The staff recommend to clarify that it should be tax jurisdiction with initial charge rather than the proposed wording in there. However, there is some concern around what is a more reasonable basis of allocation.

Board discussion

The Board members agreed that the proposal should clarify that, as a starting point, if an entity is able to calculate the tax effect of the MPM adjustments, the entity should do so. However, if an entity is unable to calculate the tax effect of the MPM adjustments, a reasonable basis for allocation should be made. The Board also agree that because MPM is not an IFRS-defined measure, an allocation of the tax effect would be sufficient in the event that the tax effect cannot be calculated.

Board decisions

The Board decided:

  • (a) To specify that the income tax effect of MPM adjustments should be determined based on reasonable pro rata allocation of the current and deferred tax of the entity in the tax jurisdiction, or another method which achieves more appropriate allocation. (Vote: 12-2)
  • (b) That entities would be required to disclose how the income tax effect of MPM adjustments have been determined in their particular circumstances. (Vote: 13-1)

Differences between management performance measures and segment measure of profit or loss (AP 21D)

Background

This paper discusses the disclosure requirements about the differences between management performance measure (MPMs) and the measures of profit and losses for the reportable segments.

Staff analysis

The staff think that the disclosure of the differences between the MPM(s) and the measures of profit or loss for the reportable segments would not provide useful information. If an entity has multiple MPMs and multiple segment measures of profit or losses, IFRS 8 would require an entity to disclose a reconciliation of the segment measures of profit or loss to the entity’s profit or loss. The Board is proposing to require a reconciliation between an entity’s MPM(s) and the most directly comparable IFRS-defined subtotal. The staff think these reconciliations should be sufficient to allow the users to understand the relationship between the measures of profit or loss for the reportable segments and the entity’s MPMs. Any additional disclosure is likely to be boilerplate.  

Staff recommendations

The staff recommend the Board does not require entities to disclose how and why the MPM differs from the total of the measure of profit or loss for the reportable segments, which would reverse a previous Board decision.

Board discussion

The Board agreed with the staff’s recommendations.

Board decision

The Board decided that entities should not be required to disclose how and why the MPM differs from the total of the measure of profit or loss for the reportable segments. (Vote 14:0)

Transition requirements and effective date (AP 21E)

Background

The purpose of this paper is to discuss the proposed transition requirements and effective date of any new IFRS requirements for the Primary Financial Statements project.

Staff analysis

The changes being proposed by the Primary Financial Statement project affect presentation and disclosure requirements rather than recognition and measurement. The staff believe that restatement of comparatives is important for the primary financial statements as the information included in the statement could be misleading if comparatives are not presented. The staff believe an implementation period of at least two years after the publication of any new requirements is considered reasonable as most entities should have the information available to apply the changes retrospectively.

Staff recommendations

The staff recommend that the Board require entities to apply the general requirements of IAS 8 for a change in accounting policy to any new requirements (which the staff describe as retrospective application) and provide an implementation period of at least two years after the publication of any new requirements.

Board discussion

The Board members agreed with the staff’s recommendations in principle but expressed concerns on the implications of retrospective applications for unusual items and MPMs. This is because some entities may not have MPMs in the prior years and hindsight could be applied to unusual items. However, some members said that the value in MPMs and unusual items was the comparability over time. The staff agreed to clarify that the starting point is to considering the MPMs and unusual items as defined in the current year and then to consider what would the amounts be in the comparative period. A Board member suggested to make it explicit in the ED that early adoption would be permitted. The Board proposed that the implementation period should be between 12 and 24 months.

Board decision

The Board decided any new requirements:

  • (a) Be applied retrospectively, but except for:
    • i. unusual items. (Vote: 12-2)
    • ii. MPMs. (Vote 8-6)
  • (b) Should have an implementation period between 12 and 24 months. (Vote: 11-3)

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