When: 9 November 2017
Where: 14th international CPC seminar, Sao Paulo, Brazil
In a speech delivered at The Brazilian Accounting Pronouncements Committee’s (CPC) 14th international seminar, Chair of the International Accounting Standards Board (Board) Hans Hoogervorst discusses how to improve communication in financial reporting, implementation support for IFRS Standards, and the role of the Board in wider corporate reporting.
Ladies and gentlemen, fellow standard-setters,
Acabo de passar o fim de semana no Rio de Janeiro. O Rio é maravilhoso e agradável como sempre. Eu viajo para todas partes do mundo e visitei mais de 65 países, mas nunca vi uma cidade tão linda e impressionante como o Rio. Mas agora é hora de trabalhar, e por isso estamos hoje em São Paulo. São Paulo é o coração econômico do Brasil e sempre é um grande prazer estar nesta cidade dinâmica.
It is a special pleasure to address this 14th CPC seminar. Brazil has for many years been very engaged in the International Accounting Standards Board’s work and an active contributor in our various consultative and advisory groups (Capital Markets Advisory Committee, Global Preparers Forum, IFRS Advisory Council, Accounting Standards Advisory Forum). Brazil has been a leading force in Latin America’s move to adopt IFRS Standards. Only last month, I had the pleasure to meet a big contingent from Brazil during our annual gathering in London of standard-setters from all over the world. We always get insightful comments from Brazil to our consultations. That is very important, since we need to make sure that our Standards can be applied properly in all parts of the world.
I will cover three topics in my remarks today. First, I will talk about the central work stream of the IASB, namely: Better Communication in Financial Reporting. Second, I will reflect on how we support implementation and application of IFRS Standards. Last but not least I will touch upon the IASB’s role in wider corporate reporting—in other words, reporting that goes beyond the financial statements.
Better Communication in Financial Reporting
As you are well aware, the IASB has created some big Standards over the past few years: IFRS 9 Financial Instruments, IFRS 15 Revenue from Contracts with Customers, IFRS 16 Leases and IFRS 17 Insurance Contracts. Companies around the world are very busy implementing these important and far-reaching standards. We are aware that our constituents need time to digest these big changes and that we cannot keep on churning out new, big Standards that revolutionise how companies report. The world needs a period of calm.
However, this period of calm does not mean that the IASB can go on a prolonged vacation. While we feel we now have a good suite of Standards that cover the vast majority of transactions, it is equally clear that there is still ample scope for improvements in financial reporting.
The central theme of our current work plan is Better Communication in Financial Reporting. This theme will guide our work in the coming years. As the name indicates, the purpose of this work stream is to improve the communication effectiveness of financial reporting. We must recognise that companies sometimes experience financial reporting as too much of a compliance exercise. Investors sometimes believe that the financial statements depict performance in an insufficiently clear manner.
Valuable information gets drowned out by ‘tick the box’ disclosures and voluminous, but poorly organised and presented, financial data. Our Standards are partly to blame for that. The fact is that IFRS Standards prescribe very little in the way of formatting the income statement. We define revenue, we define profit or loss, but we do not define very much in between.
For these reasons, we will prioritise better presentation and formatting of the information in the financial statements rather than developing new, big Standards with focus on recognition and measurement.
So what will this Better Communication theme mean in practical terms?
We will not propose to cut back the information provided, nor to dramatically increase it. But we are going to look at how this information is presented, how it is grouped together, and in what form it is made available. The objective is to make sure that companies can better tell their story through the financial statements, in a way that is clear, objective and consistent.
The central building block of this work will be our Primary Financial Statements project. This project will potentially result in a facelift of what is often called the ‘face of the financial statements’.
Today, we require companies to report revenue and profit or loss in the income statement but not much else. We know that investors would like to see more structured and disaggregated information.
The IASB’s current discussions have focused on whether we should define EBIT, earnings before interest and tax. EBIT is a subtotal that is close to operating income and shows the performance of a company separate from financing. It is a subtotal that is reported by most businesses, but we know that one company’s EBIT can differ quite a lot from another company’s EBIT. We are therefore looking at the possibility of defining EBIT (or something similar) so that it becomes a comparable and transparent figure.
Companies also like to present earnings subtotals that are adjusted for infrequently occurring items. These adjustments can be useful to gain insight into the persistence of earnings, but they tend to give a rosy picture of a company’s performance. We will therefore look at developing guidance for the presentation of such adjusted earnings. For example, we could determine that if a company wants to list an expense as infrequent, this must be complemented by multi-year disclosures.
A second strand of work under the Better Communications theme is our work on disclosures. Amaro Gomes, my fellow Board member, will cover this issue in more detail later today, so I will just give you some general comments. Those who follow us closely will know that this is not a new area to us. Already in 2014, we amended IAS 1, so as to make clear that only material information should be included in the financial statements.
In 2017, we have moved this project forward. We have published the Materiality Practice Statement to help companies make materiality judgements. We know this can be tricky. Judging whether something is material or not is important, because it determines whether information is included or excluded from the financial statements. The guidance should also help companies to remove clutter from their financial statements.
Another helpful tool published this year is a report that essentially shows how a handful of companies have improved their disclosures. All these companies embarked on a journey to make the notes to the financial statements easier to consume for investors and others. The report has some illustrations that show the before and after. It also makes it clear that relatively small steps can make a big difference. I hope this report can inspire and encourage other companies to start their own improvement projects. There is no doubt that formatting, clear language, a logical structure and informative graphs can help people to understand how a company is faring financially.
The third, and final, strand under the Better Communication theme is our ongoing work to ensure we have a good IFRS Taxonomy that allows electronic tagging of the IFRS financial information. More and more financial data is consumed electronically. We as the international standard-setter will have to bear that in mind and make sure we help facilitate electronic consumption of financial information. That is why we keep developing the IFRS Taxonomy. Regulators are starting to mandate the use of our Taxonomy—for example the European Securities and Markets Authority (ESMA) in Europe and the Securities and Exchange Commission (SEC) in the US.
Overall, we hope that this work under the Better Communication theme will make the financial statements easier to use and more informative. In other words, become better communication tools.
Supporting implementation and maintaining Standards
Let me now go back to the topic of the Standards that we have already created. One key priority for us is to make sure that we help jurisdictions implement them. At the same time as helping with the implementation of new Standards, we are supporting application of our existing Standards. Maintaining our Standards is also important.
I would like to briefly talk about how we do this.
In the past, we just used to set our Standards and then let our constituents get on with it. But ‘setting and forgetting’ is a thing of the past. We do a lot more to support implementation than previously. A lot more staff resources are earmarked implementation support. We devote a big part of the website to new Standards and organise a lot of educational activities. For complex Standards, such as revenue recognition and insurance, we have launched transition resource groups. These are forums for discussing implementation issues during the implementation phase of a Standard.
The IFRS Interpretations Committee plays a key role in the maintenance of our Standards. As you know, the Interpretations Committee is a group of preparers, auditors, academics and regulators, currently chaired by IASB Vice-Chair Sue Lloyd. The remit of the Committee is to deal with questions about implementation or application that arise in practice. Anybody can submit a question to the Committee for consideration and the outcome could be an amendment to a Standard or an Interpretation.
However, many of the questions that come to the Committee don’t require any standard-setting. Even though the Committee is called the Interpretations Committee, it does a lot more than develop Interpretations.
If the Committee reaches the conclusion that an answer to the question raised can be found in the Standard or Standards, the Committee will publish what is called an agenda decision. These agenda decisions can be incredibly helpful, as they contain educational information, explaining how a company should apply the requirements.
These agenda decisions are all available on our website and also in the Green Book—the published book that contains all our Standards as well as cross-references, examples etc.
The Interpretations Committee is important. It plays a key role in supporting consistent application of our principle-based Standards around the world. That is central to the IASB’s mission.
Wider corporate reporting
As a last point in my address today, I would like to talk about corporate reporting in a wider sense. I know that this is a big topic here in Brazil. Several Brazilian companies took part in the International Integrated Reporting Council’s (IIRC) pilot programme; pension funds here have been required since 2009 to state whether they take into account social and environmental issues in their investment practices1; and the regulator has since last year required companies to disclose social and environmental information on a ‘report or explain’ basis.
The IASB is often asked questions about what our role is in this space. Some would like the IASB to play a more central role in trying to create more uniformity in the multitude of sustainability standards.
Let me be clear; we do not plan to get into environmental and sustainability reporting. That is not our area of expertise. There are many other players. Our remit is, and will remain, financial reporting—with focus on the participants in the capital markets. That is investors and potential creditors.
Having said that, the IASB knows that financial reporting in the narrow sense has its limitations. There are many elements of value creation which are important to the investor but which are not adequately captured in the financial statements. Investors need to understand a company’s business model and its strategy for long-term value creation. They need to understand the intangibles that are vital to their business model. And, yes, sustainability issues can also be important for long-term value creation in certain industries, just think of mining and car manufacturing.
As it is very difficult to measure intangibles reliably, such topics are often best covered in the management commentary section of the financial report.
Our awareness of the limitations of financial reporting in the narrow sense is one of the reasons that the IASB issued its non-mandatory Management Commentary Practice Statement in 2010. This Practice Statement encourages management to provide context to the financial statements. It encourages management to report on the nature of the business, on its objectives and strategies, critical financial and non-financial resources, principal strategic, commercial, operational and financial risks, performance indicators and information about the company’s prospects.
However, there has been a lot of development in this area since 2010. There is an increasing interest in integrated reporting with its focus on long-term value creation and a greater emphasis on connectivity, for example on how external developments affect a company’s strategy. Several important documents have been produced that have further developed thinking on integrated reporting—for example the <IR> Framework by the IIRC.
It is also clear that there is increased awareness about how the environmental and societal restrictions have an impact on long-term value creation. The establishment by the Financial Stability Board of the Task Force on Climate-related Financial Disclosures is a notable example of this trend. Our Management Commentary Practice Statement is silent on these issues. Because of all the changes in recent years, the IASB is considering whether we should update our Practice Statement to capture the developments.
That brings me to the end of my address. I would like to—again—thank everybody here in Brazil for the active involvement in the IASB’s work. Please do keep it up.
And rest assured; Brazil is well represented across all levels of our organisation. We’ve got Brazilians on the Board, among the Trustees of the IFRS Foundation, on our formal advisory body—the IFRS Advisory Council, on the Monitoring Board that oversees the Trustees’ work, and on various other advisory groups and discussion forums.
Next month, the Emerging Economies Group will meet here in Brazil so some of my colleagues will be back here for more discussions then.
I hope you have a good seminar. Thank you.