The push to improve communication in financial reporting

Investors are increasingly relying on alternative sources to judge a business's performance

Improving communications in financial reporting is a key focus of the International Accounting Standards Board’s latest work plan, but the push for clarity has its challenges.

These days, investors and other stakeholders are almost spoilt for choice when it comes to learning more about an organisation’s financial metrics. The technology-driven explosion of digital communications means that there are now multiple information sources on a company’s performance, above and beyond the conventional, periodic financial statements.

There are clear signs that people are looking beyond traditional means to glean information. The performance of share prices in response to analysts’ recommendations, for instance, indicates investors are increasingly relying on alternative sources to judge a business’s performance. Company preliminary announcements and briefings can also provide information beyond required reporting standards.

The proliferation of non-GAAP measures within financial reports – those that go beyond generally accepted accounting principles (GAAP) – also point to a growing desire by companies to present performance information above and beyond that prescribed by International Financial Reporting Standards (IFRS) and other GAAP frameworks. Such developments challenge the relevance of IFRS-based financial reporting.

In response, the International Accounting Standards Board (IASB) has made improving the communication value of financial statements one of the key priorities of its recently released work plan for 2017 to 2021. It will occupy a lion’s share of the board’s time and resources over the next five years.

“Investors told us that, at present, valuable information is often hidden by ‘boilerplate’ disclosures and that financial information is often poorly presented.” IASB work plan

In the wake of a year-long consultative process with key stakeholders, “Investors told us that, at present, valuable information is often hidden by ‘boilerplate’ disclosures and that financial information is often poorly presented,” the IASB work plan states.

The IASB has already published major new standards on financial instruments, revenue and leasing. Soon to land is a new insurance contracts standard and an updated Conceptual Framework for Financial Reporting – both are expected in the first half of 2017. This leaves the board time to focus on the strategic theme of better communication, along with several other central themes.

Financial statement overhaul to improving communication value

This push to improve communications in financial reporting includes a number of projects, some of which have already been kicked off by the IASB and others that are in the pipeline.

Central to this push is the board’s reconsideration of primary financial statements. It has already started a project to address shortcomings identified in the presentation and definition of line items and the structure of the four primary financial statements: the income statement, the cash flow statement, the balance sheet and the statement of changes in equity.

For example, many users of financial statements find the operating profit and earnings before interest and tax (EBIT) sub-totals very valuable, but neither are currently clearly defined or required within the IFRS framework.

There is also inconsistency in the presentation of line items. Some companies include impairment of intangible assets in arriving at adjusted operating profit, while others do not. To better suit user needs, the IASB is proposing to address such inconsistencies through improved structuring, additional line items and sub-totals.

“We share the SEC’s concern that non-GAAP generally paints a rosier picture of a company’s performance than GAAP.” Hans Hoogervorst, IASB

The project also seeks to formalise into IFRS some of the more commonly used alternative performance measures, including some non-recurring, unusual or infrequently occurring items.

This exercise is aimed at addressing companies’ prolific use of alternative performance measures in addition to IFRS-based measures. However, the IASB does see a continuing role for non-GAAP measures and supports non-GAAP measures that complement the IFRS-based financial statements.

The IASB’s main concern, shared by many corporate regulators around the world, is that non-GAAP measures may be used to paint a flattering picture that sometimes can hide the truth.

Speaking at an AICPA Conference in Washington, DC, late in 2016, IASB chair Hans Hoogervorst said: “Let me make it clear that we do not intend to ban alternative performance measures, because some of them clearly have added value. Yet, we share the SEC’s [Securities and Exchange Commission, the United States securities regulator] concern that non-GAAP generally paints a rosier picture of a company’s performance than GAAP.”

The problem of profit and loss

There are some knotty challenges facing the IASB. The question of whether non-recurring, exceptional items should be excluded from operating profit needs to be answered, although the IASB’s current thinking indicates it would prefer to include such items in arriving at operating profit. The board is considering allowing an option to include an “adjusted” operating profit sub-total that excludes non-recurring, exceptional items.

Many stakeholders who provided input on the development of the updated Conceptual Framework for Financial Reporting wanted the IASB to define profit or loss and other comprehensive income (OCI). There is concern that without a principle defining profit and loss and OCI there is no consistency in dividing income and expenses between the two categories.

Professional Development: Preparing annual financial statements: learn to compile financial statements using a final trial balance and other background information and the sundry disclosures required for a set of financial statements.

IASB attempts to define profit or loss and OCI have so far borne no fruit. Consequently, the quest for defining operating profit is also likely to remain challenging. Although the better communication project will seek to improve the presentation of items currently reported in OCI, the focus will not be on which items should be included in OCI.

Too often, the preparation of financial statements is viewed as a compliance exercise. There is an over-reliance on checklists, resulting in financial reports that are full of clutter and complexity.

Keeping IFRS fit for purpose

With 125 jurisdictions committed to using IFRS, the IASB’s role as the global standard-setter, and its pipeline of projects, is crucial to ensuring IFRS-based financial reporting remains fit for purpose.

“While dealing with problems within the current framework of accounting standards is necessary, identifying initiatives that challenge the status quo is even more necessary,” says Alex Malley, former chief executive of CPA Australia.

“The IASB is well placed as the global leader on financial reporting to obtain empirical evidence on the usefulness of financial reporting in its current form and what should be done in evolving financial reporting to the next stage.”

Ram Subramanian is CPA Australia’s policy adviser, reporting.

Read next: General purpose financial statements new accounting standards

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