Date: 9 December 2019
Where: Washington DC, USA
Vice-Chair of the International Accounting Standards Board (Board) Sue Lloyd delivered a speech at the annual conference on regulatory developments organised by the American Institute of Certified Public Accountants. With a new decade on the horizon, she set out the Board’s near-term priorities and reflected on how the Board's work is evolving.
It’s always a great experience to present at the AICPA conference. I get to speak at many events around the world, but there’s nothing quite like this one for its sheer scale and quality.
We’re less than a month away from the turn of a new decade. From an International Accounting Standards Board’s perspective, the past two decades have been significant. During the 2000s, we saw the promise of international accounting standards become a reality, and during the 2010s we further enhanced the quality of IFRS Standards by introducing major upgrades to the accounting for financial instruments, revenue recognition, leasing and insurance contracts.
As we look to the 2020s and beyond, how should the IASB prioritise its time? To be honest, it’s probably a little too soon to answer that question. Every five years, the Board consults on its future agenda, and the next consultation is scheduled to take place towards the end of next year. I really would encourage all of you to read through our consultation document when it comes out. Although the US isn’t an IFRS jurisdiction, American investors are prolific investors in companies that report using IFRS Standards. And more than 500 international companies with a dual listing in the US report using IFRS Standards. As such, I’m keen to hear your views on our future work programme.
What I can talk about today is the near term—what’s on our plate right now, and indeed what will continue to be our priority for at least the next couple of years.
I’ll focus on three topics that illustrate how our work is evolving with changes in the financial reporting landscape. First, an important overhaul of the way companies provide information in the financial statements—what we call our Primary Financial Statements project which focuses on performance reporting. Second, I’ll talk about our work to provide appropriate linkage between financial and non-financial reporting. And finally, I’ll cover what we’re doing to help support consistent application of IFRS Standards.
Primary Financial Statements
Let’s begin with our Primary Financial Statements project. As a standard-setter, I’m often asked whether financial reporting is as relevant as it once was. It’s a fair question. Investors have a multitude of different performance metrics to look at when deciding how to allocate their capital. Some of this information can help them peek ahead into the possible future prospects for a company, while non-GAAP performance metrics can provide useful context in addition to what is provided through the statutory numbers reported using IFRS Standards.
How are we adjusting in response to this new environment? The short answer is that as the information needs of the market evolve, so does our work. Our work has always been about setting requirements to meet the information needs of those making investment decisions—this is reflected in our Mission Statement and in our Conceptual Framework.
These information needs continue to be our focus—but within the context of changing investor needs, the glamour of non-GAAP performance metrics can make it appear that the traditional financial statements are becoming less relevant to investors. Our work related to the traditional financial statements continues to be important as those financial statements remain the core of investment analysis. Evidence from a 2016 survey by CFA Institute, the leading professional body for investors globally, indicated that almost 90% of respondents ranked the annual financial report as a very important or important source of information. That number has remained pretty constant since CFA began asking that question back in 2007.
However, even though traditional financial statements are still used extensively, the way in which that information is consumed has evolved. Many, if not most, institutional investors will now extract this information electronically either directly or through data aggregators. This is one reason the Board continues to maintain and develop its IFRS Taxonomy.
In this environment of data extraction, having proper structure and comparability of the financial information provided by companies is especially important. This enables information to be extracted in a manner that allows valid comparisons to be made between companies. Performance metrics such as profit subtotals are amongst the measures that are important to investors in comparing and contrasting the performance of companies.
Traditionally, the IASB has not been very prescriptive about these subtotals. Today a company preparing an income statement using IFRS Standards is required to present net profit or loss but other performance subtotals are not specified. To fill the gap, some companies provide additional subtotals in the income statement. However, different companies make different choices—even when they are operating within the same industry sector. Indeed, our own research of 100 companies found that more than 60 provide an operating profit measure, using at least nine different definitions of the operating profit subtotal. Not surprisingly, this can be quite confusing for investors, so it makes sense for us to standardise some additional subtotals on the face of the income statement.
In particular, we are proposing that income and expenses be allocated between operating, investing and financing categories—a split that is consistent with much investment analysis. And we are proposing that operating profit and an EBIT-like subtotal (profit before financing and income tax) be mandated on the face of the income statement.
Today many companies provide such subtotals – including subtotals with these names. But our proposals would standardise the use and definition of these subtotals, such that they are calculated in a comparable way by all companies.
While standardisation has an important role to play, as a standard-setter we recognise the need to allow for continued management discretion in the use of some performance metrics. Investors tell us that management’s explanation of performance using measures they have defined themselves can provide useful information and insights.
However, we continue to hear concerns that non-GAAP measures tend to be on the rosy side and that they can lack transparency and discipline. An example of the prevalence of these measures is provided by a Deloitte report from 20181. They surveyed the annual reports of 100 listed companies in the UK and found that 96 presented financial alternative performance measures in an upfront financial highlights section, and that 91% of them included adjusted profit measures.
In our own research of 100 companies, we found that one third of companies included an ‘adjusted profit’ measure. Many also reported measures called ‘adjusted operating profit’, ‘adjusted EBITDA’ and ‘adjusted EBIT’. Many reconcile back to IFRS numbers, but others don’t.
On balance, we have decided that the IASB has a role to play here and that use of management performance measures needs to be anchored in some way to the IFRS financial statements. So, in addition to the IFRS-specified subtotals I just talked about, we are proposing to require a new footnote disclosure related to company-specific profit subtotals—we call the non-GAAP measures we are focusing on management performance measures, or MPMs for short.
Not every jurisdiction in the world has SEC-like regulation over non-GAAP measures. This footnote would explain why management believes the subtotal is a relevant measure of performance, explain how it is calculated, and provide a reconciliation to the closest IFRS-specified subtotal. It also has the advantage of providing discipline by bringing this information into the scope of the financial statements.
This is another example of us responding to changing investor information needs. Our proposals will reflect the growth in the use of these measures in the market and their relevance for investors.
The feedback on this will be interesting. We already know that there are differences of opinion on whether bringing management performance measures into the ‘official financial statements’ is a good idea. Some are concerned that it might give these management metrics inappropriate elevation and tacit endorsement. From the IASB’s perspective—given the investor interest in these metrics—we think it is important they are subject to appropriate scrutiny. And that there is transparency about what exactly is included and excluded from these numbers to reduce the risk of investors being misled.
These and other related proposals form part of our Primary Financial Statements project. We plan to publish these proposals in an exposure draft around the end of this year, with a six-month comment period. Please do let us know what you think.
Let me now turn to the second topic I wanted to cover—the relationship between financial and non-financial reporting.
It is worth noting that there are circumstances in which the traditional financial statements are already required to incorporate information about risks such as climate change. For example, a company affected by climate-related risks should explain how those risks have been considered when undertaking its impairment assessments when that is material. A few weeks ago, one of our Board members, Nick Anderson, posted an article on our website explaining this.
However, the boundaries of financial reporting have expanded beyond the traditional financial statements.
There are many different initiatives and a huge variety of information is being provided in this ‘wider corporate reporting’ space, but this information can be classified broadly into two types: First, information about how the company affects the world. And second, information about how the world affects the company.
While the first set of information—reporting about the effect of the company on the world—is valid and can be very useful, including from a public policy perspective, it is the second set of information—reporting about the effect of the world on the company—where the IASB has decided it can and should play a larger role.
As I said before, the IASB exists to write Standards that result in investors getting the information they need to make their investment decisions. We know that in order to make informed investment decisions, investors need information that goes beyond the boundaries of that captured within the traditional financial statements. Investors need information about items that are not recognised and measured for accounting purposes, but that can affect the company’s future cash flows and the value of its equity.
Consistent with our investor perspective and this evolving information need, we are updating our non-mandatory Management Commentary Practice Statement—our guidance on what you would more commonly call the ‘MD&A’ here.
That does not mean that we are busy at the IASB working on new climate risk disclosures or the like. But we are working on updating our guidance, so that investors have visibility of factors that may affect a company’s future cash flows but may not yet be reflected in the financial statements—such as climate change and the risks and opportunities associated with the company’s intangible assets.
We will emphasise the need to consider the potential long-term risks and opportunities for value creation—not by forecasting future profits, but by reminding management to think about the factors that are critical for investors to understand about the company’s long-term prospects for value creation.
We are keeping to a principle-based approach. This means that a company applying our Practice Statement, having identified a relevant topic that investors need to understand, could then turn to more specific guidance and requirements established by other bodies to meet the principles in the Practice Statement.
Our next step in this project will be to publish an exposure draft proposing changes to our Management Commentary Practice Statement in 2020.
So as you can see, we are working on some interesting new topics that push the boundaries of our traditional work while keeping a firm focus on our usual role of meeting the information needs of investors.
Supporting consistent application
The third and final topic I wanted to cover is our work to support consistent application of IFRS Standards.
While new information needs are developing, there is a continuing need for investors to be able to make comparisons between companies across the world. One of our key strategic objectives at the IASB is to proactively support the consistent application of our Standards. We know it is important that investors can be confident that financial statements prepared in accordance with our Standards are comparable not only in theory but also in practice.
One of the main ways we support the consistent application of our Standards is through the work of our Interpretations Committee, which I chair. Over the past few years, we have worked hard to ensure that we provide timely responses to questions submitted to the Committee. In addition, we are maximising the opportunities to use the work of the Committee to provide more information about how to apply our Standards.
The Committee discusses all questions that it receives. And the most critical decision the Committee makes is whether standard-setting is required in order to address the question. For example, does the question reveal a gap in our Standards that needs to be addressed? Whenever the Committee decides that standard-setting isn’t required, it issues an agenda decision.
The most common reason for deciding that standard-setting isn’t required, and therefore for issuing an agenda decision, is because the Committee concludes that the principles and requirements in IFRS Standards provide an adequate basis to answer the question submitted. Rather than just stating that, in order to improve the understanding of the existing requirements and to support consistent application, the Committee usually explains how the question can be answered using the existing requirements. This provides additional insights and understanding about the existing requirements. Given the importance of agenda decisions, a draft is always put out for public comment for 60 days before being redeliberated by the Committee.
Agenda decisions are important for IFRS preparers. In some cases, the insights provided by an agenda decision may mean that a company needs to change its accounting policies to align with that agenda decision. To facilitate such changes, even though these agenda decisions explain existing requirements, the IASB has confirmed that companies are not expected to immediately change their accounting. Rather, the IASB expects companies to be allowed sufficient time to implement any necessary changes in accounting policy. It may be necessary to gather additional data or to adjust systems to support the change in accounting. All of the Committee’s agenda decisions and further information about what ‘sufficient time’ means can be found on our website.
In summary, this is an important time for setting the future direction for financial reporting. These changes could have important effects on the work of the accounting profession. We will soon publish a number of proposals that reflect how we at the IASB think financial reporting under IFRS Standards should evolve to respond to this changing environment. This is an important moment for financial reporting and I really encourage all of you with an interest in financial reporting to participate in the debate by responding to our proposals. On a more granular level, the basics of debits and credits in the traditional financial statements still matter too. And agenda decisions are important, so please do watch the work of the Interpretations Committee and comment on tentative agenda decisions that are relevant to you.
Thank you for listening and I wish you a very successful conference.