Primary Financial Statements – Agenda Paper 21

Background

The Board is exploring potential changes to the structure and content of the primary financial statements, with a focus on the statement(s) of financial performance. A DP or ED is expected in 2019.

At this meeting the Board discussed clarifying the requirements for management performance measures (MPMs) and requirements for management-defined adjusted earnings per share (adjusted EPS) in the financial statements.

Clarifying requirements for management performance measures (MPMs) – AP21A

Staff analysis

This Agenda Paper seeks the Board’s views on clarifying the requirements for management performance measures (MPMs).

At the February 2018 Board meeting, the Board asked the staff to develop a simplified approach for MPMs for a future meeting. Board were concerned that:

Because additional subtotals presented by entities in accordance with paragraphs 85-85A of IAS 1 are required by IFRS, rather than refer to ‘subtotals or totals required in IFRS Standards for the statement(s) of financial performance’ for the purposes of the MPM requirements it would be better to specify exact subtotals or totals (for example, by making reference to a list of specific subtotals that are required in IFRS Standards).

The Board could appear to be ‘elevating’ MPMs (ie requiring more MPMs to be presented as subtotals compared to today) if specific requirements for MPMs to be presented as subtotals were introduced. Some Board members wondered whether paragraphs 85-85A of IAS 1 are well understood, are being applied well in practice or might benefit from clarification/improvement.

The focus should be on requiring the reconciliation described in paragraph 8(c), rather than including more MPM subtotals in the statement(s) of financial performance and that the MPM reconciliation should be presented in the notes.

They need to address a scenario when an entity identifies more than one MPM.

The requirements appear to mandate that all entities identify a MPM, even if they don’t currently communicate any to users. An entity might communicate only subtotals or totals specifically listed in IFRS Standards, for example profit.

The requirements should clarify that entities should use their own labels for their MPM(s), for example ‘recurring profit’, rather than using the label ‘MPM’.

Staff recommendations

The staff are recommending that the Board modify the tentative decisions reached in December 2017 and January 2018 and propose that:

(a) All entities be required to identify a measure (or measures) of profit or comprehensive income that is (are) relevant to an understanding of the entity’s financial performance and, in the view of management, best communicate(s) to users the financial performance of the entity.

(b) If the identified measure is a subtotal or total required by paragraph 81A of IAS 1 the entity should identify this measure and explain why it best communicates management’s view of the entity’s financial performance.

(c) If the identified measure is not a subtotal or total required by paragraph 81A of IAS 1 the entity must:

(i) Provide a reconciliation in the notes between that measure and the most directly comparable subtotal or total required by paragraph 81A of IAS 1;

(ii) Ensure that the measure is labelled in a clear and understandable way so it is not misleading;

(iii) Explain how the measure provides relevant information about an entity’s financial performance; and

(iv) Make a statement that the measure provides management’s view of the entity’s financial performance and is not necessarily comparable with other entities.

Although there are no specific constraints on how management determines the measure, it must relevant to an understanding of the entity’s financial performance.

Paragraph 81A of IAS 1 would include the existing subtotals in that paragraph and the proposed new subtotals developed as part of this project.

The staff recommendation is that the MPM reconciliation be disclosed in the notes, rather than below the statement(s) of financial performance (consistent with the Board’s tentative decision at its January 2018 meeting). At the March 2018 CMAC meeting, some CMAC members said that it is important for the MPM reconciliation to be easy to locate. Some CMAC members said that it would be easier for users to locate the MPM reconciliation if it is provided below the statement(s) of financial performance, rather than in the notes.

The staff are therefore asking a follow-up question as to whether, in light of the feedback received by CMAC members and also the evolution of the proposals, the Board wishes to revisit its tentative decision to require the MPM reconciliation to be disclosed in the notes to the financial statements rather than be provided below the statement(s) of financial performance.

Board discussion

Several Board members raised concerns that in their current form the proposals would require entities to create and disclose MPMs if they are not already doing so. Further concerns were raised in relation to ensuring that the MPMs are not presented as being equivalent, or superior, to IFRS measures. Most Board considered that these concerns could be addressed through redrafting.

It was suggested by one Board member that the proposal could include an upfront expectation that the MPM will ordinarily be an IFRS measure rather than a non-IFRS measure. In this context the Chairman commented that the phrase ‘best communicates’ in terms of selecting an MPM would encourage entities to use non-IFRS measures.

One Board member commented that the Appendix which appears to state that MPMs should only be changed if IFRS standards change. Staff clarified that this is no longer a proposal and whilst MPMs are expected to be consistent year on year they should be updated if they are not aligned to the perspective of management. The Board agreed with this.

The columnar format, which has previously been rejected by the Board, was discussed as the proposals suggest that this could be used. Staff were asked to clarify the use of this format and a Board member commented that its use is in decline but still being used for a change in year end.

In relation to IAS1.85, one Board member asked if the staff had considered deleting this paragraph given that it allows MPMs to be on the face of the financial statements which may give them undue prominence compared to those that are only disclosed in the notes. The member suggested that IAS1.85A could be strengthened to produce an enriched note on MPMs. Staff noted that they have not considered this but may look at it separately. The Vice Chair added later in the meeting that nothing in the proposals was expected to change paragraph 85 but in parallel to consultations for this project staff could seek feedback on the effectiveness of paragraph 85.

A Board member suggested that the information relating to MPMs should be presented in a consistent location across all financial statements and suggested a specific note e.g. “Note 2”. Whilst some MPMs will be on the face, as they fall within paragraph 85 and within the structure of Statement of Profit and Loss, all MPMs could be required to be included within this note with equal prominence.

One Board member suggested that the MPMs could be flagged on the face of the financial statements. Another member strongly disagreed with this suggestion but asked if IAS1.81 could be updated to include additional subtotals such as EBITDA or PBT.

A Board member questioned whether the word ‘relevant’ was required in section 1.1 and it was agreed by some Board members that this was not required given that the measure must be such that it best communicates the financial performance of the entity. Furthermore, paragraph 85 already acts as a constraint and the removal of the word ‘relevant’ could prevent unnecessary discussions in practice.

Board decisions

In relation to the main recommendation, the Board unanimously supported the staff recommendation, subject to comments on wording updates from the Board.

In relation to the follow up question, 13 members voted to not reconsider the location of MPM disclosures.

Management-defined adjusted earnings per share (adjusted EPS) – AP21B

Staff analysis

The staff say that users have told them that MPMs can provide useful information about how management views and drives the entity’s financial performance, and about the persistence or sustainability of an entity’s financial performance. For the same reasons, some users find management’s adjusted EPS useful for their analysis. But some users say that many entities currently present adjusted EPS outside the financial statements with little or no explanation and they would prefer that they be required to be presented in the financial statements and subject to appropriate IFRS requirements/disclosures.

Other users expressed concern about giving adjusted EPS (and other ‘non-IFRS’ information) undue prominence by including these measures in the financial statements. Some users say it is difficult to see whether an entity’s MPM and adjusted EPS are calculated consistently.

The staff states that many users want to make further adjustments to make that measure suitable for their analysis and for comparison with other entities. Some users have said that they need information about the effect of tax and NCI on each of the adjustments made in determining adjusted EPS. If users are given information about the effect of tax and NCI on the share-based payment expenses, they can calculate their own EPS measure.

Staff recommendations

The staff are recommending that:

(a) If an entity identifies a management performance measure (MPM), it is required to:

(i) disclose an adjusted EPS that is calculated consistently with that MPM. To calculate the numerator of adjusted EPS an entity must make only the following adjustments to the MPM:

1. Add/deduct all income/expenses between:

a. the most directly comparable subtotal/total required by paragraph 81A of IAS 1 under our proposals in Agenda Paper 21A; and

b. profit or loss attributable to ordinary equity holders of the parent entity (ie the numerator of EPS).

2. If the MPM is a pre-tax and/or pre-NCI measure, make further adjustments for tax and/or NCI effects for the differences between the MPM and the most directly comparable subtotal/total required by paragraph 81A of IAS 1.

(ii) disclose the effect of tax and NCI separately for each of the differences between the numerator of adjusted EPS and the numerator of EPS.

(b) If an entity identifies more than one MPM, this requirement would apply to each MPM.

(c) An entity be prohibited from presenting adjusted EPS in the statement(s) of financial performance.

(d) An entity be prohibited from disclosing any other adjusted EPS.

Board discussion

One Board member did not agree with the staff recommendation to require EPS to be calculated for MPMs. They considered it unreasonable to require entities to calculate an EPS figure when management were not using the MPMs in that way and the cost of doing so would outweigh the benefits. Another Board member agreed with the recommendation given that the MPM would otherwise hang in isolation rather than carrying through to EPS in a way that would be useful for users. They noted that as a sell-side user one is ordinarily guided by the management defined EPS number, however, as a buy-side user you would want the ability to disagree with management’s adjustments and to understand the affect they have on EPS.

It was noted that in practice a large number of entities do not disclose their MPMs through to EPS due to the significant cost in doing so and it would be for the Board to demonstrate that requiring this would be of significant benefit to users.

One Board member suggested that using MPMs should be an alternative way of looking at a business and in doing so management should be able to quantify the EPS impact even though this would require a more disciplined approach.

One Board member suggested that there were areas that would need to be clarified in the illustrative disclosures, such as when shares only vest if a profit is made and a profit is made only on an adjusted basis, should an entity assume these had vested in their adjusted EPS calculation?

The Board agreed that multiple EPS measures should not be required and are not sought by users as it is too confusing.

One Board member was concerned that the discussion was centred on adjustments that exclude transactions but did not include issues around tailor-made accounting policies such as accelerated revenue which could cause difficulties in calculating the tax impact in particular.

A Board member suggested, as an alternative, that the numerator of adjusted EPS could be reconciled back to the MPM to give users further information without the calculation difficulties in the current proposals.

Board decisions

The Board approved all of the staff recommendations: Eight members supported (a)(i), subject to consultation in a discussion paper. Ten members supported (a)(ii). All members supported (b) and (c) and no members supported (d).