Primary Financial Statements project - Substantial changes have been proposed regarding the reporting of financial performance under IFRS, leading to a proposed new IFRS that will replace IAS 1

Important proposals have been announced for IFRS-reporters that will lead to fundamental changes as to how entities will be required to present information within their primary statements, particularly within the statement of profit or loss when reporting on financial performance. The most significant areas of change, which will result in entities needing to change their existing presentational and reporting practices, relate to: fewer presentational options within the statement of profit or loss; mandating certain subtotals within the statement of profit or loss; enhancing presentation and disclosures for integral investments in associates and joint ventures; prohibiting the use of non-descriptive labels such as ‘other’; prohibiting ‘unusual’ items being presented in the statement of profit or loss; and bringing the reporting of Management Performance Measures into IFRS (and hence the remit for audit).

Introduction

As part of the International Accounting Standards Board (“IASB”) work plan on Better Communication in Financial Reporting, it has published an exposure draft: General Presentation and Disclosures in conjunction with the Primary Financial Statements project (“PFS”). The comments period runs until 30 June 2020.

The exposure draft proposes to replace IAS 1 Presentation of Financial Statements (“IAS 1”) with a new IFRS to be named General Presentation and Disclosures, although many of the provisions of IAS 1 will be retained in the new standard or transferred to IAS 8 (which will be renamed Basis of Preparation, Accounting Policies, Changes in Accounting Estimates and Errors). The new requirements are expected to be applied, on a retrospective basis, no earlier than the 2024 financial year; this being on the basis of the IASB’s normal due process and the period of time that will have to be allowed for entities to make the changes that the new standard may entail). Amendments are also proposed to several standards affecting the presentation of financial statements, including IAS 7 Statement of Cash Flows (“IAS 7”) and IFRS 12 Disclosure of Interests in Other Entities (“IFRS 12”).

Improving comparability and transparency

In the main this exposure draft aims to improve the comparability of the statement of profit or loss (and, to a lesser extent, the statement of cash flows) by setting out new requirements on their structure and content that will be more detailed and prescriptive than those currently set out in IAS 1. The IASB is also keen to improve the transparency of disclosures particularly in relation to performance measures and, accordingly, this exposure draft includes new requirements surrounding Management Performance Measures (“MPMs”).

What changes does the exposure draft propose

Here we take a look at the detail of the proposals, considering the key provisions and highlighting the significant changes that are expected to be introduced for entities.

(1) Towards a more structured statement of profit or loss

The IASB’s decision to focus on the standardisation of the presentation of the statement of profit or loss results from extensive consultations and the identification of requirements of all the stakeholders involved (including analysts, investors, issuers and regulators) over the past several years. It was in 2016, following the IASB’s 2015 consultation on its 2017-2021 work plan, that it decided to launch the active research phase of its PFS project.

As a result, the IASB found that subtotals of income and expenses were among the most important indicators for users and are the preferred measures for comparing and shedding light on the performance of entities.

In the absence of prescribed requirements in the existing IFRSs, the IASB observed a very wide diversity of practices in the presentation of these subtotals in the statement of profit or loss, sometimes within the same business sectors. Given the confusion that these diverse practices cause, the IASB decided that a common set of principles was required. The exposure draft therefore proposes the following:

Fewer presentation options for entities

To improve comparability of the statement of profit or loss:

• Classification of items as operating, investing and financing – Including new definitions of categories for items as operating, investing and financing as follows: 
  • an Operating category defined as a residual, i.e. what is left once income and expenses have been allocated to the investing and financing categories (see definitions below), and excluding the share of the net gain of equity-accounted entities classified as “integral” (see below);
  • an Investing category, presenting returns from investments that generate a return individually and largely independently of other resources held by the entity, for example, income and expenses generated by financial assets other than cash and cash equivalents; the share of profit of loss from equity-accounted entities classified as “non-integral” (see below); and
  • a Financing category, presenting income and expenses on assets and liabilities arising from financing activities, such as income and expenses from cash and cash equivalents in accordance with IAS 7 and liabilities arising from financing activities (including lease liabilities arising from the application of IFRS 16 Leases);
• Presentation of new subtotals – Including three new subtotals to be shown on the face of the statement of profit or loss:
  • Operating profit or loss (noting that this does not include the share of profit or loss from investments in associates and joint ventures accounted for using the equity method);
  • Operating profit or loss and income and expenses from integral associates and joint ventures; and
  • Profit or loss before financing and income tax (noting that this includes income from investments as well as the share of profit or loss from non-integral investments in associates and joint ventures).

None of these subtotal amounts, including the operating profit or loss subtotal, shall include the impact of discounting long-term provisions, whether or not operational (such as a dismantling provision) and the net interest/income on the liabilities/assets on defined benefit plans, all of which are proposed to be classified under the financing category i.e. before profit or loss before financing and income tax.

Specific provisions for presenting the share of the profit or loss from investments in associates and joint ventures

The share of profit or loss from investments in associates and joint ventures accounted for using the equity method and that are part of the business’ main activities business will be presented below the operating profit or loss subtotal and in a separate category on the face of the statement of profit or loss, as “share of profit or loss of integral associates and joint ventures”. The “share of profit or loss of non-integral associates and joint ventures” will be presented in profit or loss before financing and tax, in the investing category.

A retained latitude in the presentation of additional subtotals

Entities will still be permitted to present additional subtotals, other than the three required subtotals proposed, provided that these subtotals fit with the structure of the statement of profit or loss proposed by the IASB and that they meet the requirements of IAS 1 regarding the presentation of additional subtotals (i.e. that such presentation is relevant to an understanding of the entity’s financial performance).

By way of an example, in practice it will therefore no longer be possible to present a cost of net financial debt in profit or loss, insofar as this subtotal could contain items belonging: (i) in the financing category (since it includes income and expense from cash and cash equivalents under IAS 7); and (ii) in the investing category (for the income and expense generated by other financial assets, i.e. other than cash and cash equivalents), as defined by the IASB.

Presenting unusual items

It is important to note that when calculating these subtotals, entities will no longer be permitted to exclude certain unusual items, particularly when presenting current operating profit or loss. Further information about the new prescribed requirements for defining and presenting unusual items is provided below.

(2) Improving the aggregation and disaggregation of information presented

The exposure draft proposes new principles for the aggregation and disaggregation of the information presented in all the primary financial statements by:

• setting out an approach to the application of these principles to ensure that:
  • items on the same line of a given primary financial statement will share at least one characteristic; and
  • these aggregated items, where material, will subsequently be described in the notes on the basis of other characteristics.
• clarifying the respective roles of the primary financial statements and the notes so that entities will be able to decide where to report the information in question; and
• limiting the use of non-descriptive labels, such as ‘other’, by establishing principles for the aggregation of dissimilar and immaterial items in the primary financial statements.

Prescribing new requirements for operating expenses and unusual items

The proposals include prescribed new requirements for the following two areas:

• Presentation of operating expenses by nature and function – The new requirements change some key elements of the current requirements of IAS 1 and prohibit a ‘mixed’ presentation of operating expenses in the statement of profit or loss (i.e. presentation by both nature and function).
• Presentation of unusual items – The new requirements include prescribe disclosure and presentation requirements for unusual items, defining them as “income and expenses with limited predictive value”; thereby it being reasonable to assume that similar items, in terms of their amount or their nature, would be unlikely to arise for several future periods. For example, the IASB does not expect changes in value following recurring remeasurements of items in the financial statements to be classified by their very nature as unusual items. Each unusual item will be presented in the relevant category of the statement of profit or loss (as described above), depending on their nature or function. The IASB believes that a description of the unusual items in the notes would provide the most complete information for users and meet the concerns of some stakeholders as to the significance that might otherwise be ascribed to these items (i.e. if presented directly in the statement of profit or loss). The IASB has also clarified that disclosures on unusual items should be both qualitative and quantitative, describing the impacts on each line of the statement of profit or loss concerned.

(3) Increasing the transparency of performance measures reflecting financial performance

While recognising the need for management to retain some latitude in its use of performance measures, and the usefulness of information specifically provided to this effect for investors, the IASB are aiming to mitigate the absence of transparency and discipline sometimes surrounding the publication of “non-GAAP” indicators within these proposals. The IASB has therefore considered ways of increasing the understanding and reliability of performance measures (management performance measures (“MPMs”) as termed in the exposure draft) and proposes to make it mandatory to publish information about these indicators in a single note.

The IASB’s aim: a focus on Management Performance Measures

The exposure draft defines MPMs as subtotals of income and expenses that:

• are used in public communications outside financial statements;
• complement the totals or subtotals specified by IFRS Standards;
• communicate management’s view of a given aspect of the entity’s financial performance;
• correspond neither to the subtotals required in the statement of profit or loss, nor to other subtotals listed in the exposure draft, namely:
• gross profit or loss (revenue less cost of sales) and any similar subtotal,
• the Operating profit or loss (as the required subtotal on the IFRS statement of profit or loss, as defined in the draft text) before depreciation and amortisation,
• profit or loss from continuing operations, and
• profit or loss before income tax.

Presentation of a single note on MPMs in the notes to the audited financial statements

To encourage transparent communication on MPMs, the IASB proposes to introduce a minimum list of mandatory disclosures that must appear in the notes to the financial statements (and hence be audited) for all the MPMs used by the entity (although it should be noted that some arrangements apply if one or more MPMs are also segment indicators disclosed by the entity in applying IFRS 8 Operating Segments).

For each MPM, the following disclosures will be required:

• the definition of the MPM and its calculation method, including the explanation of any changes in its definition, where applicable;
• an explanation of how the MPM provides useful information about the entity’s performance;
• a cautionary statement to readers that the MPM communicates management’s view and is not necessarily comparable with measures sharing similar descriptions provided by other entities;
• a reconciliation of the indicators defined in IFRSs (i.e. the subtotals or totals that are most directly comparable). This reconciliation should present the income tax effect and of the effect on non-controlling interests for each reconciling item, including for those indicators not affected by these effects (such as indicators of operating performance).

The IASB believes that including this information directly in the notes to the financial statements will make it possible to provide MPMs to the appropriate level of analysis and to therefore meet the expectations of investors, given that the disclosures will be subject to audit.  

(4) Targeted improvements for the statement of cash flows

In the case of the statement of cash flows, the IASB chose to focus on targeted improvements and propose only the following significant changes:

• Cash flows from operating activities – mandating the use of the ‘operating profit or loss’ subtotal as a single starting point for entities using the indirect method of reporting cash flows from operating activities; 
• Cash flows from integral and non-integral investments in associates and joint ventures – mandating the separate presentation of cash flows from equity-accounted investments within cash flows from investment activities, in line with the distinction between integral and non-integral investments applied in the statement of profit or loss; and 
• Classification of interest and dividends – removing the choices previously available to for the classification of cash flows in respect of interest and dividends received and paid. The proposals mandate entities, which are not financial institutions, to present interest and dividends paid in the financing category, and interest and dividends received in the investing category. Financial institutions will have a choice depending upon classification within of the related income and expenses within the statement of profit or loss.

Additionally, it should be noted that the definitions of operating, investing and financing activities used in the statement of cash flows have not been aligned with those proposed for the operating, investing and financing categories in statement of profit or loss.