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Primary financial statements

Date recorded:

Amending proposals for management performance (Agenda Paper 21A)

Background

This paper discusses the need for amendments to the Board’s proposal on management performance measures (MPMs) in light of feedback received on the proposal and tentative decisions made since the last discussions held by the Board.

Staff analysis

The regulators have expressed concerns that MPMs may not be comparable between entities and may give undue legitimacy and prominence to a non-IFRS measure. Furthermore, the regulators believe that auditing MPMs may be challenging and in the absence of specific constraints on MPMs could lead to entities disclosing some misleading MPMs. The staff do not think that this should prevent entities from including MPMs in the financial statements because the fundamental characteristics of financial statements are relevance and faithful representation and an MPM is a measure that complements IFRS-specified subtotals, which are comparable. The staff do not believe that undue legitimacy and prominence will be given to MPMs because the proposal clearly requires the entity to disclose the fact that management defines the measures. The staff acknowledge that the audit work may be restricted to checking that the MPM has been calculated in accordance with the entity’s definitions of the measure and the entity has complied with the disclosure requirements for MPMs. However, the staff said that this should not deter the presentation of MPMs. The staff have considered, but decided against, introducing constraints for MPMs because “misleading” is not a defined term. Furthermore, some regulators have already defined “misleading” and introducing constraints will result in diversity in practise across different jurisdictions. The staff recommend that the MPMs should be aligned with public communication outside the financial statements to users because it avoids the risk of entities providing two sets of performance measures and it is consistent with the Board’s definition of MPMs. The staff believe it would be useful for entities to identify any income or expenses excluded from MPMs that meet the definition of unusual items. However, the staff note that the principle of disaggregation would need to be applied in determining which income or expense should be excluded from MPMs.

Staff recommendations

The staff recommend that the Board clarify that MPMs are subject to the general requirement that information included in the financial statements must provide a faithful representation. The staff further recommended that the Board make no specific statement that MPMs should not be misleading and do not place specific constraints on how MPMs should be calculated. Lastly, the staff recommend that entities can only identify a measure as an MPM if they use the same measure in their public communications with users outside the financial statements and entities should identify any income or expenses that meet the definition of unusual items that are excluded from the entity’s MPMs.

Board discussion

The Board agree that it is useful to provide a reconciliation of MPMs to GAAP measures and to link this to faithful representation. Some Board members expressed concerns that MPMs is a measure that tend to be biased and there is a risk that by presenting partial information, this would not correctly depict the financial performance of the entity. Therefore, the Board recommended to narrow the application of faithful representation to the labelling of the MPMs. The staff disagrees with this and said that most required subtotals in the statement of financial performance are already a partial measure of an entity’s financial performance but collectively, present the whole picture. The staff agreed to clarify that faithful representation means that the measures the entities provide should represent financial performance of the entity to the users of the financial statements and to clarify that there will be no additional constraints placed on how MPMs should be calculated. The Board also expressed concerns that an unsophisticated user of the financial statement could misinterpret MPMs as an IFRS compliant measure. However, the staff said that the definition of MPMs is consistent with IAS 1 Presentation of Financial Statements, in that the preparer could provide additional information if they believe it would be useful. Furthermore, reconciliations to GAAP measures will be required for MPMs presented, which will mitigate the risk.

The Board recommended that an entity only be permitted to identify a measure as an MPM if they use the same measure in their public communication and after this has been approved by their regulators.

Furthermore, the Board believe that a good reconciliation of MPM should already explain any unusual items included as part of the measure and propose not to explicitly include this as a requirement.

Board decision

12 Board members agreed that MPMs are subject to the general requirement that information included in the financial statements must provide a faithful representation. 11 Board members voted in favour that no specific statement that MPMs should not be misleading and 13 Board members agreed to not place any specific constraints on how MPMs should be calculated. All Board members agreed that entities be permitted to identify a measure as an MPM only if they use the same measure in their public communications with users outside the financial statements. However, only 4 Board members agreed that entities should identify any income or expenses that meet the definition of unusual items that are excluded from the entity’s MPMs.

Outstanding issues for financial entities (Agenda Paper 21B)

Background

This paper addresses the outstanding issues relating to the proposals for financial entities.

Staff analysis

Some entities hold cash and cash equivalents for operational reasons and not as part of their capital structure. Therefore, the Board’s February 2019 tentative decision (after which most entities are required to

present income from cash and cash equivalents below the ‘profit before financing and income tax’ subtotal), would result in the presentation of an “operating profit” subtotal that would not reflect the entity’s result from operating activities. The staff recommend modifying the existing principle to capture the financial entities as intended by the Board. The proposed change is to update the existing principle from “entities that, in the course of their business activities, invest in assets that generate a return individually and largely independent of other entity resources” to “entities that, in the course of their business activities, invest in financial assets that generate a return individually and largely independent of other entity resources.”

Some Board members expressed concern that the tentative decision in February 2019 would not result in useful information for investment contracts with participation features accounted for in accordance with IFRS 9 Financial Instruments. The staff have considered two approaches to address this issue, including introducing a principle that “expenses related to financing from customers should be included in operating profit” or introducing an exception, that “an entity is required to include in operating profit expenses related to liabilities arising from investment contracts with participation features it issues that are in the scope of IFRS 9.” The staff believe that the second approach (i.e. an exception) is preferable because it is targeted to specific contracts, will not disrupt the Board’s model for the statement(s) of financial performance for non-financial entities, uses existing concepts in IFRS 17 Insurance Contracts and is consistent with that of the Board’s intentions.

The staff do not recommend that the Board define “main business activities” but rather to provide guidance to help entities assess whether they meet the definitions of provide financing to customers as a main business activity and whether they invest in the course of its main business activities in assets that generate returns individually and largely independent of other entity resource.

Staff recommendations

The staff recommend that the Board require entities to include income from cash and cash equivalents in operating profit if the entities invest in financial assets that generate a return individually and largely independent of other entity resources, in the course of their main business activities. The staff further recommended the Board require entities to include in operating profit expenses related to liabilities arising from investment contracts with participation features they issue that are in the scope of IFRS 9 and clarify the entities which the Board is referring to when discussing “main business activities”. The staff also recommend that the Board specify that when a business activity constitutes a separate reportable segment applying IFRS 8 Operating Segments, this might indicate that the activity is a main business activity.  And lastly, clarify that income, expense and dividend cash flows from associates and joint ventures not accounted for using the equity method must be classified in the same way as income, expense and dividend cash flows from other investments.

Board discussions

A Board member highlighted that the approval of this proposal is subject to successfully defining “a main business activity.” The Board agree that guidance should be provided on what “a main business activity” means and in particular, for entities with multiple business activities.

Board decision

13 Board members agreed to require entities to include income from cash and cash equivalents in operating profit if the entities invest in financial assets that generate a return individually and largely independent of other entity resources, in the course of their main business activities. 13 Board members agreed to require entities to include in operating profit expenses related to liabilities arising from investment contracts with participation features they issue that are in the scope of IFRS 9. All Board members agreed to clarify what the is meant by “main business activities” and to specify that when a business activity constitutes a separate reportable segment applying IFRS 8 Operating Segments that this might indicate that the activity is a main business activity.  All Board members agreed to clarify that income, expense and dividend cash flows from associates and joint ventures not accounted for using the equity method must be classified in the same way as income, expense and dividend cash flows from other investments.

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