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Primary Financial Statements [IASB only]

Date recorded:

Preliminary analysis on applying project proposals to financial entities (Agenda Paper 21A)

Background

Staff preliminary analysis of application of tentative decisions to financial entities

The staff’s preliminary analysis of which of the tentative decisions made to date for non-financial entities could apply, with little or no change, to financial entities were discussed. The specific project areas are:

  • Management performance areas
  • Aggregation and disaggregation—principles of disaggregation in the financial statements
  • Aggregation and disaggregation—disaggregation of expenses by nature and by function
  • Other comprehensive income (OCI)

Management performance areas

The staff believe that the proposals for all non-financial entities to identify a measure or measures of profit or comprehensive income and that there should be no constraints on what could be identified as a management performance measure could apply to financial entities as well. This issue will be considered at future Board discussions on alternative approaches to subtotals for financial entities, in particular the issue around net interest income.

Aggregation and disaggregation—principles of disaggregation in the financial statements

For non-financial entities, the Board has tentatively decided to develop additional guidance on aggregation and disaggregation and also decided to provide a principle for determining whether information should be presented in the primary statements or in the notes. The staff believe these tentative decisions could apply equally to financial entities and would assist in providing relevant information, particularly where disaggregation of financial instruments is poor.

Aggregation and disaggregation—disaggregation of expenses by nature and by function

For non-financial entities, the Board has tentatively decided to provide more guidance on disaggregation of expenses within the business profit subtotal profit in the statement(s) of financial performance. Additionally, the Board tentatively decided that entities that provide a functional analysis of expenses should disclose additional information about the nature of those expenses in a single note. The staff believe the proposals for disaggregation of expenses by nature and by function could apply to financial entities as well, however further assessment would be required with the approaches to subtotals and for more complex entities.

Other comprehensive income

The staff believe that the tentative Board decision to rename the two categories in the OCI section of the statement(s) of financial performance to

  • ‘Remeasurements reported outside profit or loss’ (currently ‘OCI items that will not be reclassified subsequently to profit or loss’) and
  • ‘Income and expenses to be included in profit or loss in the future’ (currently ‘OCI items that will be reclassified subsequently to profit or loss’)

could be useful for financial entities as well. The proposed new labelling could be even more useful for financial entities as they are more likely to have large gains and losses reported in OCI.

Alternative approaches for adjusting tentative decisions for financial entities

The staff’s preliminary analysis of tentative decisions that have been made to-date and would require adjustment for financial entities include EBIT subtotal, income and expenses from investments and statement of cash flows.

EBIT

The staff believe that putting all interest expense below EBIT would not achieve the Board’s objective of presenting the measure before effects of financing. The Board’s tentative decisions on EBIT would not provide relevant information to users of financial statements. Alternative approaches considered by the staff are:

  • Require EBIT for all entities, but permit some financial entities to exclude items from the interest bit of EBIT
  • Require EBIT for all entities, but define interest differently for some financial entities
  • Require a different subtotal for some financial entities
  • Not require EBIT for some financial entities

Income and expenses from investments

The Board’s definition of income and expenses from investments would capture many assets that financial entities consider part of their main activities. The Board’s intended objectives would therefore not be met in the case of financial entities. The staff considered the following alternatives:

  • Require presentation of income and expenses from investments for all entities, but permit some financial entities to exclude items which they consider part of their main activities
  • Require presentation of income and expenses from investments for all entities, but define it differently for some financial entities
  • Not require presentation of income and expenses for some financial entities

Statement of cash flows

The Board’s tentative decisions to remove options for the classification of interests and dividends paid and interest and dividends received and instead prescribe a single classification for those items might not always result in relevant information for all financial entities. The staff therefore conclude that the proposals for the cash flow statement would not apply to financial entities without adjustment. Alternative approaches, if any, will depend on the Board’s decision relating to subtotals in the statement of financial performance.

Staff recommendations

The paper did not contain any staff recommendations. The staff asked the Board whether they have any comments or questions on the staff’s preliminary analysis of the issues in the paper.

Board discussion

Staff preliminary analysis of application of tentative decisions to financial entities

Most Board members agreed with the staff’s proposed approach for management performance measures and concurred with the staff’s preliminary analysis that gross profit may not be relevant for financial entities. One Board member did not agree that net interest income would be a management performance measure that would require reconciliation as this approach assumes this performance measure would need to be reconciled to EBIT. The staff’s preliminary research revealed that there is diversity in practice of how net interest income is presented and therefore some entities may not require a reconciliation. 

One Board member expressed concern that disaggregation by nature and function could be time-consuming however agreed on the approach regarding other comprehensive income. One Board member expressed concern about forcing companies to present their primary financial statements in one format given the diversity of presentation in practice.  One Board member expressed concern that disaggregation by nature and function needs to be clearly defined. 

The Board discussed that, before further research was undertaken, additional discussions and decisions were required, in particular, whether a principles-based approach would be applicable or whether the Board would take the approach of defining specific subtotals.

Alternative approaches for adjusting tentative decisions for financial entities

A Board member indicated that when the scope for alternative approaches is defined, the definition should not be by the type of entity (i.e. if the entity is a financial institution or not) but by whether the activities undertaken, such as investing activities, are the primary activities of the entity. Two Board members believed that EBIT is not relevant for financial institutions, in particular when line items are presented by nature and function. Some Board members agreed with the approach of not requiring EBIT for financial entities. One Board member indicated that line items should be more visible so that even if items are presented differently, there can be more comparable information.

One Board member indicated that as part of the next steps, it would be important to have user output to understand key metrics and also the spectrum of issues pertaining to conglomerates. One Board member agreed with this approach but believed there could be difficulty in applying a definition of what constitutes primary financial activities. One Board member indicated that the approach should not be to define whether an entity is a financial or non-financial entity but management should make a judgement regarding nature of business. One Board member drew the distinction that some companies, in particular within their statement of cash flows, present information (finance income) very closely to regulatory capital. However, within the income statement, EBIT is not presented and therefore companies draw a distinction of their operations in practice.

The Board discussed that given the diversity of viewpoints, the focus should be on proceeding with the development of the project for non-financial institutions and the same approach would be adopted for financial institutions where specific items could be universally applied. All Board members agreed that separate disclosures are required and that further work is required for financial institutions. One of the key items discussed was understanding what type of entities would be in scope of the preliminary decisions made to date for non-financial entities.  One Board member suggested to keep a set of requirements that applies to all entities and potentially have different subsets, such as the business profit line and profit before tax line which could apply to all entities. The Board member believed that definitions needed to be refined and the introduction of business activity criterion could direct companies to different subtotals. To conclude the discussion, one Board member summarised three broad approaches that could be taken from the discussion, namely to:

  1. Scope out EBIT from financial institutions and focus on improved disaggregation
  2. Retain the basic ideas that EBIT and investing should be separate, but for financial institutions to have further criterion if investing and financing are not part of an entity’s core business
  3. Scope financial institutions out of the EBIT approach and development a specific guidance for financial institutions

The second approach aforementioned was more in line with views of other Board members and would also potentially addressed the specific issues pertaining to conglomerates. One Board member disagreed with this approach due to difficulties in determining core and non-core operations for a banking business.

The staff action items from the meeting entailed:

  • Assessing the scope of impact of tentative decisions made to date
  • Performance of additional research and specifically detailing which of these are conglomerates
  • Refining areas that are applicable to financial and non-financial entities on disaggregation
  • Assessing disaggregation by nature and function and how this applies across all types of entities
  • Further focus on investor outreach to understand where useful areas of impact are

Board decisions

No Board decisions were made at this meeting.

Financial entities—preliminary findings on current reporting practice (Agenda Paper 21B)

Background

The staff have analysed a small number of financial entities’ current reporting practice in areas including the structure and content of the statement(s) of financial performance and common key performance measures. For entities with financial and non-financial activities, a variety of reporting practices were found and common key performance measures included net profit, adjusted net profit, EBIT and adjusted EBIT and net interest margin for entities with a banking subsidiary. For banks analysed, common key performance measured included net interest income, operating and adjusted operating profit and net profit.

Staff recommendations

The paper did not contain any staff recommendations. The Board was not requested to make decisions at this meeting.

Board discussion

The Board discussed the scope of the staff’s research, in particular why investment property companies were included as part of the sample selected for research. The staff indicated that some of the proposals for non-financial entities may not be applicable for real estate companies, and that these companies have similar considerations as banks and insurers. The findings from the staff paper indicate that financial entities (which included real estate investment companies) present subtotals in a different manner to commercial and industrial entities and therefore, having one template may not be appropriate. One Board member indicated that a decision has been made to not define specific line items and therefore, if subtotals were defined, these may not be relevant for certain companies.

The Board discussed that entities that have financial institutions as part of their operations present different challenges and that there is diversity in practice. There were a number of different views from the Board, in particular:

  • One view was that most conglomerates with financial services could fit into the current proposed template, however this would require stratification of the population
  • One view was that some conglomerates could choose to present line items by nature however others, could choose to present line items by function
  • One view was that interest income and income expense should not be included within gross profit as this presentation would not make their financial statements comparable

One Board member indicated that there is lack of transparency and comparability between banks and even measures such as net interest are not presented consistently. Additionally, disaggregation within banks was a concern and therefore one possible solution for banks specifically, was to have greater disaggregation and good segment reporting.

Board decisions

No Board decisions were made at this meeting.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.