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Primary Financial Statements

Date recorded:

Associates and joint ventures (Agenda Paper 21A)

Background

This paper had been carried forward from Agenda Paper 21F of the September 2021 meeting and initiated the Board’s redeliberations on the proposals set out in the ED relating to integral and non-integral associates and joint ventures.

Staff recommendation

The staff recommended that the Board proceed with the proposal to present income and expenses from equity-accounted associates and joint ventures outside of operating profit. However, the staff recommend that the Board does not proceed with the proposal to require presentation of the subtotal ‘operating profit or loss and income and expenses from integral associates and joint ventures’ and not to proceed with the proposal to require income and expenses from integral associates and joint ventures to be identified and presented separately from non-integral associates and joint ventures. Lastly, the staff recommend that the Board require income and expenses from all equity-accounted associates and joint ventures to be classified in a merged investing, associates and joint ventures category.

Board discussion

Most Board members agreed with the staff proposal to present income and expenses from equity accounted associates and joint ventures outside of operating profit and not to proceed with the proposal with the presentation of the subtotal ‘operating profit or loss and income and expenses from integral associates and joint ventures’ and not to proceed with the proposal to require income and expenses from integral associates and joint ventures to be identified and presented separately from non-integral associates and joint ventures. This is because the Board believe that the investors do not want to see income and expenses from investments in associates and joint venture above the subtotal of operating profit, particularly because the income and expenses from investments in associates and joint ventures is a post-tax figure. Some Board members acknowledged that users would prefer to have a distinction between integral and non-integral associates and joint ventures because it may be a requirement for certain jurisdictions and the company may view investments in associates and joint ventures as an extension of their main business activity. However, the Board members also said that many companies would not want to disclose non-integral associates and joint ventures because stakeholders may question why those investments are held in the first place and this could result in additional guidance from the Board on how to apply the distinction. Some Board members would not want to prevent entities from distinguishing integral and non-integral associates and joint ventures this would result in fair presentation of the financial statements but would not want to include this as a requirement in the Standards.  Some Board members supported the proposal to require income and expenses from all equity-accounted associates and joint ventures to be classified in a merged investing, associates and joint ventures category as this would simplify the requirements. However, some Board members expressed concerns with the proposal because users are comfortable with income and expenses from equity accounted investments in a separate line and these might not fit into investing category and by forcing preparers to include this in the investing category could create confusion. The staff clarified that there is no expectation to have categories labelled on the statements of financial performance and income and expenses from investments in associates and joint ventures would be shown as a separate line on the face of the statement of financial performance, the proposal is aimed to specify the order of placement (i.e. after operating activities). One Board member suggested that this issue may be resolved with specifying a subtotal of operating profit including equity accounted income and expenses from investments in associates and joint ventures.

Board decision

All Board members agreed with the staff recommendation to present income and expenses from equity accounted associates and joint ventures outside of operating profit and not to proceed with the proposal with the presentation of the subtotal ‘operating profit or loss and income and expenses from integral associates and joint ventures’ and not to proceed with the proposal to require income and expenses from integral associates and joint ventures to be identified and presented separately from non-integral associates and joint ventures.

6 of the 12 Board members (including the Chairman) would support the staff’s recommendation not to require income and expenses from investments in associates and joint ventures to be presented immediately after operating profit but that these are presented between operating profit and profit before financing subtotal.

Analysis of operating expenses—presentation in the statement of profit or loss (Agenda Paper 21B)

Background

This paper had been carried forward from Agenda Paper 21E of the September 2021 meeting and initiated the Board’s redeliberations on the proposals set out in the ED relating to the analysis of expenses classified in the operating category in the statement of profit or loss.

Staff recommendations

The staff recommended that the Board provide application guidance that builds on the description of the function of expense method in the ED to set out:

  • The relationship with expenses of the same nature, that is, typically expenses of the same nature would be allocated to more than one function
  • The attributes of functions, that is, they represent activities that are on-going and distinguishable from other activities of the entity
  • The interaction with the role of the primary financial statements and the principles of aggregation and disaggregation, which can result in aggregating functions but only to the extent such aggregation provides an understandable overview of the entity’s operating expenses.

The staff recommended that the Board does not develop a definition of ‘cost of sales’ as part of this project and, instead, provides application guidance to explain that, as a minimum, cost of sales would include inventory expense (if applicable), calculated in accordance with IAS 2. In addition, the staff also recommend that the Board explore an approach to analysing and presenting operating expenses in the statement of profit or loss that would:

  • Retain the proposal to require operating expenses to be analysed and presented based on their nature or function
  • Not retain the proposed prohibition on a mixed presentation in the statement of profit or loss and instead provide application guidance and disclosure requirements to improve comparability
  • Retain the proposal to provide application guidance on how to determine which presentation method should be used to provide the most useful information to users of the financial statements, with some modifications to the proposed application guidance as a consequence of not retaining the proposed prohibition on a mixed presentation

Board discussion

Board members generally agreed with the staff’s proposal to provide application guidance that build on the description of the function of expense method. Some Board members expressed the concern on the requirement for operating expenses to be ongoing activities of the entity may be too restrictive because there are activities that occur periodically on a regular basis but are not annual functions and whether these expenses would meet the definition. Some Board members questioned whether providing additional application guidance would add value. A Board member suggested the staff add explicit guidance about attribution of operating expenses to function and provide a frequently asked question guide about presentation by function. Most Board members supported the staff’s recommendation to develop a definition of ‘cost of sales’ because the most important aspect is to improve transparency and for entities to indicate and explain what is included in cost of sales. Some Board members expressed concern on what would be “at a minimum” because everyone has a different threshold. Overall, most Board members supported the inclusion of “at a minimum” because even entities within the same group could have different cost accounting practices and systems and this would prevent entities from having to change their accounting systems. Board members supported the staff’s recommendation to explore an approach to analysing and presenting operating expenses in the statement of profit or loss. However, they cautioned that this is not a free choice to provide a mixture of presentation of expenses by nature or by function but rather it is permitted by minimum line items. Board members also asked the staff to consider whether there should be conditions for how often an entity can change its presentation and include similar disclosure requirements for change in accounting policies such as reasons for the change and why the change would result in more reliable or relevant information. Some Board members questioned whether there are minimum line items for presentation by function or by nature and if there is no prohibition of mixed presentation, what that would mean for the requirement to present by nature in the notes to the financial statements (i.e. how much the presentation has to be by function for it to trigger the requirement to present by nature in the notes). Some Board members believe that the staff’s proposal of providing application guidance on when to use mixed presentation is not relevant because most entities would not need to perform a formal assessment to determine whether they should be presenting by nature or by function because it is driven the entity’s operations.

Board decision

9 Board members agreed with the staff’s proposal to provide application guidance on the functional expense as set out in the ED. 

All Board members agreed with the staff’s recommendation not to develop a definition of the term ‘cost of sales’.

8 Board members agreed with the staff’s recommendation to provide application guidance to explain that, as a minimum, cost of sales would include inventory expense (if applicable), calculated in accordance with IAS 2.

All Board members agreed to explore an approach to analysing and presenting operating expenses in the statement of profit or loss that would:

  • Retain the proposal to require operating expenses to be analysed and presented based on their nature or function
  • Not retain the proposed prohibition on a mixed presentation in the statement of profit or loss and instead provide application guidance and disclosure requirements to improve comparability
  • Retain the proposal to provide application guidance on how to determine which presentation method should be used to provide the most useful information to users of the financial statements, with some modifications to the proposed application guidance as a consequence of not retaining the proposed prohibition on a mixed presentation

All Board members agreed with the staff’s recommendation to explore additional guidance and disclosure requirement to improve comparability. The Board did not vote on whether additional application guidance to help entities determine when to use a mixed method.

Analysis of operating expenses—disclosure in the notes (Agenda Paper 21C)

Background

This paper accompanied Agenda Paper 21B and discussed the proposal to require an entity that presents an analysis of operating expenses by function in the statement of profit or loss to also disclose, in a single note, an analysis of its total operating expenses by nature.

Staff recommendations

The staff recommended that the Board explore providing a partial cost relief from the proposed requirement for an entity that presents an analysis of operating expenses by function in the statement of profit or loss to also disclose an analysis of its total operating expenses by nature. In particular, the staff recommended a partial cost relief that would exempt entities from disclosing information about operating expenses by nature if, and to the extent that, such disclosure would involve undue cost or effort but this cost relief would not apply to depreciation, amortisation or employee benefits expenses or any other operating expenses by nature that are subject to specific disclosure requirements in IFRS Standards. The staff recommended that the Board reconsider its previous decision not to require an analysis of each functional line item by nature if they agree to explore a partial cost relief.

Board discussion

Board members expressed concerns that an entity would present by function because it is how their operations are managed and by requesting entities to provide information by nature would not result in partial cost relief. Therefore, some Board members suggested that the proposal should identify certain operating expenses to be presented separately e.g. depreciation and amortisation. Some Board members also expressed concerns that some entities can present an analysis of operating expenses both by nature and by function if that is how their accounting systems have been set up. However, this is likely not to be the case for many entities and this requirement could result in additional costs for the companies. They expressed concern that most preparers would claim that this cannot be done because of undue cost or effort. As a result, some Board members suggested that there should not be any partial cost relief and instead to allow a longer transitional period or permit partial relief on specific circumstances. Other recommendations by some Board members were to identify characteristics of items that are important to the user’s analysis of expense and require preparers to present those specific expenses. Therefore, the Board asked the staff to explore whether providing more general disaggregation guidance could help companies disclose expenses which are useful to the stakeholders and if expenses could be provided in such a way that provides linkage to presentation on the statement of cash flows.

Board decision

The Board did not vote on whether to provide partial cost relief from the proposed requirement for an entity that presents an analysis of operating expenses by function in the statement of profit or loss to also disclose an analysis of its total operating expenses by nature. The Board asked the staff to do further research and the Board deferred the decision on the disclosure of expenses by nature in the notes pending further exploration of the feedback in this area.  

Operating profit or loss before depreciation and amortisation (Agenda Paper 21D)

Background

This paper set out the staff analysis and recommendation on whether the Board should specify an operating profit or loss before and amortisation subtotal that excludes impairments, how such a subtotal could be labelled and whether such a subtotal should be an additional specified subtotal or replace the specified subtotal proposed in the ED. In addition, this paper also set out the staff analysis and recommendation on whether the Board should prohibit EBITDA as a label for an operating profit or loss before depreciation and amortisation subtotal and require its presentation or disclosure.

Staff recommendations

The staff recommended that the Board amend the definition of the specified subtotal ‘operating profit or loss before depreciation and amortisation’ to also exclude impairments of assets within the scope of IAS 36 and label that subtotal ‘operating profit or loss before depreciation, amortisation, and specified impairments’. In addition, the staff recommended the Board not specifically prohibit the use of the label EBITDA for the subtotal and confirm the proposals to permit, but not require, presentation or disclosure of the subtotal in the statement of profit or loss or in the notes to the financial statements.

Board discussion

Some Board members did not agree with the staff’s recommendation to amend the definition of the specified subtotal ‘operating profit or loss before depreciation and amortisation’ because based on the fieldwork performed, many companies did not choose EBITDA as a metric. However, many Board members supported the staff’s proposal because current research shows that there is diversity in practice and this proposal would provide a consistent anchor and improve the utility of the measure. The staff also clarified that the proposal is not intending to specify whether an entity should adjust depreciation and amortisation which is capitalised as part of cost of sales and would allow this as an accounting policy choice. Similarly, the staff did not intend to specify whether an entity should include or exclude impairment expense and instead the proposal is aimed to provide an anchor for basis of reconciliation. Some Board members asked a question about an entity that has impairment losses but does not have any income or expenses from investments or from equity accounted associates and joint ventures and the operating category does not include any interest income or interest expense. It was asked whether that entity would be allowed to use EBITDA as a measure that excluded impairment and if this would be a subtotal that meets the requirement of faithful representation. The staff clarified that these circumstances are rare but EBITDA in this case may meet the faithful representation criteria. In addition, the staff confirmed that they are not defining EBITDA. Some Board members stated that the staff’s recommendation not to prohibit EBITDA as a label for an operating profit or loss before depreciation and amortisation subtotal is only possible if the entity presents its expense by nature. Therefore, the staff should explain that this would only be possible if, and only if, the entity meets the definition of that subtotal and clarify in the Basis for Conclusions (BC) that these circumstances are expected to be rare. In addition, the Board asked the staff not to refer to EBITDA in the BC but only explain faithful labelling. The staff asked the Board whether they would want a specific requirement for the presentation or disclosure of the specified subtotal if material. Most Board members believe that general materiality requirements do not give rise to an obligation to provide subtotals that are not otherwise already specified. Therefore, most Board members agreed with the staff’s recommendation to permit EBITDA as a specified subtotal and that it is not a management performance measure (‘MPM’) and that no reconciliation is required.

Board decision

11 Board members agreed with the staff’s recommendation to amend the definition of the specified subtotal ‘operating profit or loss before depreciation and amortisation’ to also exclude impairments of assets within the scope of IAS 36 and label that subtotal ‘operating profit or loss before depreciation, amortisation, and specified impairments’.

All Board members agreed with the staff’s recommendation not to prohibit the use of the label EBITDA for the operating profit or loss before depreciation and amortisation subtotal.

11 Board members agreed to confirm the proposals to permit, but not require, presentation or disclosure of the subtotal in the statement of profit or loss or in the notes to the financial statements.

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