april 2016 - Issue 27
RSM reporting Technical developments in global accounting and reporting.
THE POWER OF BEING UNDERSTOOD AUDIT | TAX | CONSULTING
Welcome Dear reader, We have previously addressed the fact that the contents of corporate reporting are becoming more and more comprehensive in depicting a company’s performance, situation and strategic perspective. However, the forces driving this continuous development of the corporate reports are never explored enough! An important driving force is the International Integrated Reporting Council’s (IIRC) relentless advocating for more integrated and standardised corporate reporting. As we reported about the IIRC’s plans and ambitions a year ago, we follow up in this issue with a highly inspiring interview with Paul Druckman, CEO of the IIRC. Also in this issue, we follow up on the accounting treatment of investment properties, with the latest insights explained by our ‘veteran’ author Simon Fisher, who shares with us his valuable expertise based on a long and successful career. Joelle Moughanni addresses the concept of ‘materiality’ in five key questions. Her style is, as ever, very practical and to the point, allowing for immediate applicability of her explanations. As Joelle mentions in her article, RSM has continued contributing to the global debate on the developments of IFRS by issuing comment letters and by providing technical advice to its member firms – both these activities are reported on at the end of this issue. Enjoy your reading! Marco
Dr Marco Mongiello ACA m.mongiello@surrey.ac.uk
IFRS Conference Once again, RSM is proud to sponsor the IFRS Foundation Conference. This year it is to be held in Zurich, Switzerland, between 30 June and 1 July. The conference brings together leaders in financial reporting from the private sector, regulatory bodies and members of the IASB, as well as accounting professionals and others with an interest in IFRS. RSM staff and friends of RSM receive a 30% discount on tickets. For more information, please contact: joelle.moughanni@rsm.global
“As we reported about the IIRC’s plans and ambitions a year ago, we follow up in this issue with a highly inspiring interview with Paul Druckman, CEO of the IIRC.”
Paul is Chief Executive Officer of the IIRC. Paul is well known and respected in business and in the accounting profession worldwide. Following an entrepreneurial career in the software industry, Paul operated as a nonexecutive chairman and director for companies in a variety of sectors until taking over this post. Formerly a Director of the UK Financial Reporting Council; member of the City Takeover Panel; and President of the Institute of Chartered Accountants in England and Wales (ICAEW). Other interests have included chairing The Prince’s Accounting for Sustainability Project (A4S) Executive Board.
A Conversation with paul Druckman, on IIRC and the ‘shifts’ in the corporate world
asset owners, asset managers, companies, regulators and NGOs. Keeping all of them engaged and on side is one the biggest achievements of IIRC. Prior to the IIRC, many of these organisations were not collecting and publishing information (which is relevant to the different capitals and, therefore, to the value of these entities) in a multi-lateral format. They may have collected occasionally, creating a fragmented landscape of reports.
by Marco Mongiello, Editor
The second element of achievement has to do with adoption. I think that having created an awareness, not just around integrated reporting, but around the multi-capital approach and the whole idea of value creation in the short, medium and long term, is something that we (at the IIRC) should be proud of. It is this awareness that has impacted many agendas, many of which we are not necessarily aware of. This is evident in the many articles and policy statements from other organisations which are actually using the <IR> language and concepts. Associated with that, I also observe a greater than expected number and spread of integrated reports, even if often they are not called integrated reports. So, integrated reporting has gained in breadth and depth.
Exactly a year ago we reported on the ambitions and developments of the International Integrated Reporting Council (IIRC). The IIRC had already begun to influence the corporate world and was set to strengthen its agenda and widen its impact. A year later, and in coincidence with the announcement of the forthcoming succession of its CEO, it seems the appropriate time to look at the effects that Integrated Reporting (<IR>) thinking is having on corporate reporting. So, I reached out to Paul Druckman (CEO, IIRC) and asked for a follow-up of our previous conversation. Being an uncompromisingly goal-oriented person, Paul wanted to share his evaluation of the progress that has happened on his watch, but the conversation reached different heights, providing a deep insight into how corporate thinking has been shifting and what this means for our profession. MM: <IR> has received recognition the world over, from various different sources: prime ministers, regulators, standard setters, etc. This is testament to the tremendous impact that <IR> is having on the global business environment. What are the main achievements that you think are best at describing the success of <IR> since its inception? What are the goals (if any) that you would have wanted to achieve but did not (or did achieve but to a lesser extent than envisaged) prior to stepping down? PD: I would say that there are two elements of achievements that describe the success of IIRC well. The first is around keeping and extending the coalition, the IIRC family, which encompasses a wide diversity of key capital market players:
There are other aspects where I would have wanted to see the IIRC achieve more. For example, I find it slightly disappointing that there is not more cohesion around the numerous initiatives in the sustainability space. Another aspect that disappoints me is that there is a lot of re-inventing in corporate reporting, too. I would encourage players to pick a ‘winner’ approach and adapt it and build on it. I am not advocating a standardisation of the language of integrated reporting, I am wishing for a standardisation of the language in the corporate reporting space as a whole. I think that one of the contributions of <IR> is to have one concept of integrated reporting, rather than many fragmented initiatives. What we have tried to do is to be inclusive of many existing good ideas, rather than generating confusion by creating new ones. This is a similar challenge right across the corporate reporting agenda; we should ask ourselves how much of this ‘competition’ of initiatives drives the public interest.
MM: Why do companies come up with new ways of reporting, if they could simply adopt <IR>? PD: Partly, this is down to leadership at the very top. Many leaders and organisations are not willing to take on something new – particularly in a highly regulated area – unless it has the blessing and active support of the CEO. It is therefore incumbent on the leadership of organisations to drive innovation in corporate reporting and view reporting as a key strategic tool that is a critical part of driving overall performance. MM: Do you think that IIRC could perhaps try to create more consensus and awareness? PD: The proliferation of too many (and fragmented) ideas is in the different capitals, more than in the direct space of the IIRC. Also, it is disappointing that there has been a lack of development of the less developed capitals, e.g. intellectual capital. There’s a lot of work in the natural and social capital space, there’s a lot of work in financial, but I would have hoped to see development in the other capitals alongside this. I haven’t been able to make this happen in my time. With respect to core manufactured capital, i.e. infrastructure, I am not aware of guidance on how investors should understand that. I have been talking endlessly about intellectual capital (brand, IP), but I have yet to see how this is reported apart from a few exceptional cases. The World Intellectual Capital Initiative (WICI) is one that works, but there is nothing that has grabbed the attention of companies. That’s why the debate is constantly focused on the financial aspect at the expense of a discussion around the broader capitals. MM: In your opinion, how has the global business environment changed in the past five years, regarding the global awareness of the importance of a responsible approach to business? In particular, I am referring to the examples from <IR> database, where reports keep being added, demonstrating that more and more companies espouse the <IR> values.
PD: What we have been trying to do is, not so much bring new thinking, but rather bring thinking that has already happened to the fore, ensuring that it is related to something pragmatic. This is reflected on the types of companies that are in our database (which collects the integrated reports of companies that produce and file them); I think of them as innovators and early adopters. The innovators are those who were already thinking of doing this type of reporting and we captured what they were already doing by giving best practice guidance, helping them to articulate something in a way that is coordinated and understood by a broader readership. The early adopters are the companies that were able to start their integrated reporting, but only since <IR> has provided structure and awareness about it. This has been exciting: companies have embraced <IR> thinking and utilised the way that it suits them. There is lots of evidence, including the likes of Generali, the World Bank and EnBW, where the application of the <IR> framework has allowed businesses to articulate the message they are trying to communicate much more effectively. In more general terms, there is more and more evidence from research of a positive correlation between companies <IR> score and their value. That evidence is demonstrating that <IR> matters more than can be measured by the number of companies adopting it1. I personally debated at length with our Chairman, Mervyn King, on whether the IIRC’s performance should include KPIs that measure the number of <IR> reports, but I do not think that numbers matter that much if they merely measure how many reports are called ‘integrated reports’. KPIs may be dangerous as they could drive bad behaviour, whereas it is the quality of adoption of <IR> that drives higher company value. Therefore, the value of the examples in the IIRC database is that those companies actually espouse the <IR> thinking, rather than simply comply with <IR> as a tick box.
1 Mary Barth et al., 2015, The Economic Consequences Associated with Integrated Report Quality: Early Evidence from a Mandatory Setting. Social Science Research Network. George Serafeim, 2014, Integrated Reporting and Investor Clientele. Social Science Research Network. Gillian Yeo et al., 2014, Integrated Reporting and Corporate Valuation. The Singapore Accountancy Commission and The Institute of Singapore Chartered Accountants.
In other terms, companies with a higher <IR> score are better reporters across the whole corporate reporting and are more valuable. <IR> is not creating something new, but enables companies to increase value from a higher quality reporting. If you refer to ‘the shifts’, the two central ones are around inclusive capital (stewardship code, corporate governance code, etc). These shifts are happening in the financial markets2. <IR> is not driving them, but <IR> contributes to make them happen, making <IR> an essential component of these global movements. Personally, I have always tried not to create a market, but to look for things that have happened and that I think fit into what we want to happen. Then, I pick them up and drive them forward. <IR> has the ability to harness ideas, not create them. MM: Your successor will have a very difficult act to follow, and you will no doubt provide a comprehensive handover. If you were to summarise the handover, what would you say? PD: It may sound nitty-gritty, but there are two structural things that I have put in place: We created the new constitution with a much more independent and high profile board and a much better governance system. We made sure that there is a very strong management team in place, which is capable of running and driving forward the IIRC. Although I am the face of the IIRC, I am not the heart and soul of it. The idea of the three shifts, for example, wasn’t my idea; it was the Chief Strategist’s. I probably had the innovative thinking but it is the management who made it happen. This is the legacy. If I had something to say to the person who is appointed, it is to be careful to maintain the IIRC’s independence and empowered management team. MM: Of all the work that accountants produce, corporate reports have probably the widest dissemination and broadest readership. Reflecting on the forces that determine how corporate reports develop, and which make the context where regulators and standard setters operate, is therefore a useful insight. Along these lines, the conversation with Paul Druckman is both humbling and uplifting. Humbling, because it makes us realise that ‘shifts’ in corporate thinking are massively powerful movements, whose effect on corporate reporting is only the most evident type. Uplifting, because we see how good values and positive energy may significantly influence our profession in such a short period of time.
2 See global initiatives like ‘Inclusive Capitalism’ and the Canadian pension funds’ pledge to long termism.
INVESTMENT PROPERTY – ISSUES ENCOUNTERED IN PRACTICE By Simon Fisher, Partner, RSM Eastern Africa IAS 40 was first issued in 2000. The standard requires an entity to determine whether property (land and buildings) should be classified as investment property, defined as property held to earn rentals or for capital appreciation (or both). If so, the entity then has a choice of whether to account for it using the cost model or the fair value model. Since fair value gains on property can be significant, the appropriateness of the classification is important. The standard was revised in 2003 to allow property held under an operating lease, that otherwise met the definition of investment property, to be classified as investment property. The revision also brought investment property under construction within the scope of the Standard. In the last ten years, however, there has not been any significant change to the Standard. There is therefore plenty of implementation experience, but issues of interpretation and implementation still arise in practice, while the Standard itself recognises that judgement is needed to determine whether a property qualifies as an investment property. Our first example of this relates to investment property under construction, where an entity has purchased land for development and has, say, entered into a contract for the
construction of a building. Classification on initial recognition and subsequent measurement of this property will be dependent on whether the property, when developed, will: be occupied by the owner (own use), in which case it will be classified as property, plant and equipment and measured in accordance with the entity’s accounting policy (cost or revaluation model); be sold, in which case it will be classified as inventory and measured at the lower of cost and net realisable value; or be held to earn rentals or for capital appreciation or both, in which case it should be classified as investment property, and could be measured at fair value if that can be measured reliably. If the entity wanted to subsequently reclassify such property, IAS 40 requires such a change to be supported by evidence. At present, the Standard is specific in saying that inventory can only be reclassified to investment property on commencement of an operating lease. A recent exposure draft proposed a relaxation of this whereby it would be
recognised that there could be other examples of evidence that could support reclassification, but a change in intention is not sufficient – it must be supported by appropriate evidence. IAS 40 is silent, however, on the need for any evidence to support the classification on initial recognition. So, can that be based purely on management’s representations as to their intentions? Our view is that management would still be expected to provide supporting evidence: for example, do management’s cash flow projections support their intention to hold the property for rental subsequent to completion, or is there a need to sell the property on completion to meet financing obligations? Is the entity already looking for a buyer, or tenants? Suppose that management has simply not decided whether to sell the property on completion of the development, perhaps because the decision will depend on the strength of property prices around the time of completion, or on the entity’s other financing needs at that time. IAS 40 provides examples of investment property, which include ‘land held for a currently undetermined future use’ and ‘property that is being constructed or developed for future use as investment property’. Note that the first example refers only to land (presumably undeveloped) and excludes buildings. So there is no guidance on how to classify property that is being constructed or developed for undetermined future use. It is therefore an area where judgement would need to be exercised, taking into account all the facts and circumstances, but clearly the more prudent approach would be to classify such property as inventory until such time that there is evidence to support its reclassification to investment property. Another issue that has arisen in practice is whether land and buildings should be treated as separate assets when determining their classification. IAS 16 Property, Plant and Equipment (PPE) requires that land and buildings be accounted for separately, even when acquired together, but this is because the useful life of each component for the purposes of depreciation is likely to be different. IAS 40 does not require such separation for classification purposes, but if investment property is accounted for using the cost model, then IAS 16 would apply. Instead, IAS 40 refers to ‘portions’ of properties and states that if these portions could be sold separately then an entity accounts for the portions separately, and hence would determine the classification of each portion separately. An obvious example is land surrounding a factory that is surplus to the entity’s requirements. If the surplus land could be sold separately, and is of undetermined future use, then it should be classified as investment property, whereas the factory and the portion of land on which it stands would be classified as PPE. However, it could also be argued that a finance lease for the factory building could be sold to a third party and the whole of the land could be sold to a different third party. In our view, judgement needs to be exercised to consider whether selling each portion separately is a realistic option, not just legally possible.
IAS 40 states that if the portions cannot be sold separately, the property is investment property only if an insignificant portion is held for use in the production or supply of goods or services or for administrative purposes. As with other IFRS, no quantitative guidance is given as to what might be considered ‘insignificant’. In this case, neither does the Standard provide any guidance on how the significance of a portion might be measured. In a simple situation of an office building, where some of the lettable space is occupied for own use, then one would probably consider the lettable space (e.g. floor area) occupied as a percentage of the total lettable space in determining whether the ‘own use’ portion was significant. In other circumstances it might be more appropriate to consider the values of each portion. An example might be an old building on a plot of land, which cannot be sold separately, but where the value of the building is an insignificant portion of the value of the plot. IAS 40 makes it clear that classification on consolidation by a parent may need to be different from the classification in a subsidiary entity that owns the property. Thus, if entity C, which is 60% owned by entity A and 40% owned by entity B, owns property of which, say, 20% is leased out to entity A and 80% to entity B, entity C should classify the property as investment property and could apply the fair value model. Assuming that entity A controls entity C, then in its consolidated statement of financial position, entity A would need to classify the property as property, plant and equipment under IAS 16, since it occupies a significant portion of the property. On the other hand, if entity B accounts for its interest in entity C using the equity method, then it could recognise its share of the fair value gain on the property, even though it occupies 80% of the property. This difference occurs because C’s property does not appear in B’s statement of financial position, so the issue of classification does not arise for entity B. There could also be a situation where a subsidiary is developing a property for future use as an investment property, but the parent has the firm intention to sell its interest in the subsidiary as soon as the development is complete. Judgement would have to be exercised to determine whether in this case the parent entity should classify the property as inventory in its consolidated statement of financial position.
materiality in five questions and answers by Joelle Moughanni, Technical Consultant, RSM The International Accounting Standards Board (IASB) recently issued a Draft Practice Statement proposing (non-mandatory) guidance to help management use judgement when applying the concept of materiality in order to make financial reports, prepared in accordance with IFRS. more meaningful.3 As set out in the previous issue of this publication4, inappropriate application of the concept of materiality is often pointed at as a key contributor to excessive disclosure of immaterial information that can obscure useful information and make financial statements cluttered and less understandable. It can also lead to useful information being left out. Materiality plays a key role when preparing IFRS financial statements, as it impacts which information is considered relevant – in particular, from the users’ point of view – and should therefore be presented in the financial statements. However, the application of the concept of materiality requires significant judgement, which is inherently subjective. There is a widely acknowledged uncertainty about how the concept of materiality should be applied, resulting in a somewhat overly cautious approach to disclosure, preparers being reluctant to ‘filter out’ information which is not relevant and auditors and regulators being reluctant to accept omissions. Also, the drafting of some Standards could be read to suggest the specific requirements of those Standards override the general statement in IAS 1 Presentation of Financial Statements that an entity need not provide information that is not material. This article, in five simple Q&As, aims at reflecting on the factors that might be helpful in applying materiality to IFRS financial statements, in particular to the explanatory notes in such reports. 1. What is materiality and why is it difficult to apply the concept? On average, financial reports are not as concise and/or as useful as they could be, for many reasons. For example: information is sometimes repeated within a report rather than incorporated by cross reference; regulatory and financial reporting requirements sometimes overlap; some IFRS Standards use prescriptive and inflexible language; preparers might think that auditors and regulators feel more reassured by including information than by filtering out immaterial information; the consequences of over disclosing are perceived as being better than under disclosing; the concept of materiality can be difficult to apply to information that supports the primary financial statements etc. Something is material to a person if it influences the decisions they make. In the case of financial reporting, the issue is the influence that a particular piece of information would have on a decision being made, when included or omitted from the financial statements. IFRS gives the following definition of materiality: ‘Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements.
Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.’ In other words, information is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. Most importantly, materiality is an entity-specific aspect of relevance based on the nature and/or magnitude of the items to which the information relates in the context of an entity’s financial report. The concept of materiality acts as a filter, helping management to ensure that financial statements include all material information (i.e. the financial information that could influence users’ investment decisions) and exclude information that is not material, in order to present material information in a clear and effective manner. Whether information is material is a matter of judgement based on a range of factors and entity-specific circumstances. Currently, there is a lack of guidance to help management understand how to apply the concept of materiality when preparing financial statements, and in particular, in the notes.
See RSM’s comment letter on the Draft Practice Statement in this issue. Since improving the quality and quantity of disclosures requires joint efforts by auditors, regulators, companies and standard-setters, the IASB has consulted with the International Auditing and Assurance Standards Board (IAASB) and the International Organization of Securities Commissions (IOSCO) during the development of the Draft Practice Statement.
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See the role of materiality in “An overview of the IASB’s Disclosure Initiative in ten questions-and-answers”
Exercising that judgement requires that preparers of financial statements (preparers) understand the characteristics of the primary users of the financial statements (users) and the decisions they make, and the information that is relevant to particular types of activities of the business. The different characteristics of materiality need to be considered when applying it: the pervasiveness of the concept in IFRS; the importance of management’s use of judgement; who the primary users of the financial statements are and what decisions they make based on those financial statements; the need for a quantitative and qualitative assessment when applying the concept; and the need to assess whether information is material both individually and collectively. In plain language, applying materiality involves assessing the likelihood that including or excluding information, or changing how it is presented, will affect the decisions being made by the users, which sometimes proves not to be a straightforward task. 2. How do you identify who the primary users of the entity’s financial statements are, and the information those users need to find in the financial statements? The definition of materiality focuses on the users of the financial statements, and the need for preparers to decide what information will be important to their users. General purpose financial reports are intended to help a broad range of users, including investors (existing and potential), lenders, creditors, employees, regulators, tax authorities, etc. It is essential that management know the main characteristics of their primary users, including whether those users include any groups with particular interests, and the types of decisions they are making. Users are assumed to be well informed, have a reasonable knowledge of business and economic activities and review and analyse the information diligently, although sometimes with the help of an adviser. Management should also know what type of information their primary users want, and expect, to be included in the financial report. Meeting users’ needs requires management to identify the information that is likely to be relevant to those users and, from this information set, work out what is material to them (i.e. what to include or exclude), and to present the information in a meaningful way that emphasises those matters that are likely to be of most interest to the users. Understanding what the primary user groups of a particular entity consider to be important is an essential element of applying materiality. The mix of users might reflect some different preferences, i.e. some information might be material to some primary users but not to others.
Investors, lenders and other creditors are likely to want information to help them make decisions related to providing resources to the entity. Those decisions include whether to buy, sell or hold equity and debt instruments, whether to provide or settle loans and other forms of credit, and voting as equity holders. Some shareholders could be more interested in corporate governance information, because their main decisions might relate to exercising their voting rights, rather than making buy, hold or sell decisions. Accordingly, some information such as director remuneration might be material to how they will vote on that matter but not material to an assessment of the value of the entity. Hence, a business could have different types of primary users with a range of different interests. Management need to use their judgement as to whether the mix of current and potential investors and creditors means that they should provide more information to a particular type of primary user. There are various ways to identify the types of decisions and information likely to be important to the primary users of an entity, including: analyst reports, listening to what key stakeholders have said is important to them, questions from shareholder meetings and investor calls, review of the information included in financial reports of others in the same industry, etc. 3. What factors should be considered in deciding whether information is material? Whether information is material or not is a matter of judgement, and depends on a range of factors including entityspecific circumstances: Type of information (qualitative factors) and the amounts involved (quantitative factors) – Qualitative characteristics relate to the quality or nature of the matter being assessed, rather than the amounts involved. The nature of the activity or item informs preparers as to whether they should assign a higher or lower threshold in terms of the amounts involved. While information about individual ordinary/basic activities is likely to be of less interest to the users, those users are likely to be interested in knowing about remuneration of key personnel, related parties, one-off transactions and less usual matters, even if the amounts are smaller. Entity’s environment – Preparers need to be sensitive to how materiality is defined and applied in a particular jurisdiction (e.g. if an entity is filing its IFRS financial statements in the USA). Local enforcement and laws can help preparers identify information needs that are particularly important to the primary users in that jurisdiction. Some information will be of interest to some users even though the amounts involved are small. Unusual information – Entities need to have a system in place to ensure that they identify information that
is unusual or sensitive and might therefore need to be disclosed. IAS 1 gives examples of circumstances that could warrant the separate disclosure of items of income and expense, because they are ‘unusual’, such as write downs or reversals of write downs, the effect of restructurings, disposals of items of property, plant and equipment or investments, discontinued operations, litigation settlements, reversals of provisions, etc. Trends – Entities also need to be aware of the trends affecting their business that could make smaller amounts more sensitive to their primary users. Focusing on information that is specific to the entity and its business can help filter out generic disclosures and reduce clutter. For example, the accounting policy information presented in the financial statements should focus on how the policies are relevant to the business and how management applies them. Hot topics – There might also be some hot topics that increase the materiality profile of particular issues, such as exposure to a particular sector or economy (e.g. the global financial crisis), and sometimes securities or banking regulators highlight such matters. In such cases, disclosing the fact that the entity does not have any exposure to a particular sector or risk could itself be material (i.e. a nil balance can be material by nature). Management need to think about whether all the following could be material to their users: relationships (information about related parties, key management personnel, key suppliers or customers), circumstances of the entity (e.g. a major business combination during the year), nature of the entity (e.g. banks would be expected to include more disclosure around financial risks), trends in the industry or market, adequacy (i.e. whether more information is required to enable users to understand how judgements or estimates were made, or to understand a complex scenario). Also, materiality assessments should not be made in isolation. For example, an item might not appear to be material now in terms of the amounts involved in the current period, but it could be clear that it will affect the long-term strategy of the entity or its ability to create value. 4. How can the amount of immaterial information in the financial statements be reduced, ensuring that material information is not obscured? The fact that the IASB’s current definition of materiality focuses on omissions and misstatements has often been interpreted as implying that materiality is only about making sure that information is not omitted. In practice, many preparers tend to err on the side of caution and leave information in the financial statements because the consequences of omitting information are perceived as being greater than including it. Although Standards are an important source for identifying information that might need to be disclosed, there is no requirement to disclose every item specified in an IFRS.5
Materiality assessment also involves making sure that information that is important to the users is not obscured by immaterial information, thus undermining the usefulness of the financial statements. However, it is also not appropriate to assume that only disclosing items specified in an IFRS is sufficient. One needs to step back and ensure that the information provides a faithful and balanced summary of a particular matter, such that information beyond the items specified by an IFRS might be necessary to give a more faithful and complete picture. 5. How is presentation (e.g. aggregation/disaggregation) of information influenced by materiality (and vice versa)? The way information is presented is part of the materiality assessment, because presentation can affect the information’s usefulness and perception by the users. In other words, presentation matters if it can influence or affect the decisions taken by the primary users. It is not sufficient to argue that the information is included in the financial statements if it is difficult to find. Nor is it appropriate for information that should be considered together to provide a more complete picture of an aspect of the business to be presented as if it is not related. Part of the materiality decision therefore relates to identifying which matters should be given particular emphasis and which matters should be presented together, or at least related to each other by way of crossreference. Assessing disclosure requirements on a Standard by Standard basis can lead to a false sense that because the items are included in the financial statements, then the report is fair, balanced and understandable. Simply disclosing items specified in IFRS could lead to important information being omitted, and including all specified items could obscure material information. The most common examples include use of the disclosure requirements as a checklist, and describing accounting policies in financial statements using words directly from IFRS, or copying note disclosures from illustrative financial statements without making the information entity‑specific (i.e. boilerplate disclosures). On the contrary, preparers should consider whether there is any information that could be removed, or summarised further, to reduce clutter or to make sure the information known to be important to the primary users is more accessible. They should also consider whether there are any gaps in the information that need to be remedied, whether the report is structured in a way that gives appropriate emphasis to the matters they know were important to the entity during the period, etc. Financial statements are meant to be a means of communication, and should not be viewed as a mere compliance exercise. Management needs to take a step back and consider whether they are providing the right level of information in the financial statements and whether it is useful.
Although it has always been the case that if the information is not material it needs not be disclosed, the IASB amended IAS 1 Presentation of Financial Statements in 2014 to remove any doubt. The amended IAS 1 now clearly states that an entity needs not provide a specific disclosure required by an IFRS if the information resulting from that disclosure is not material. This is the case even if the IFRS contains a list of specific requirements or describes them as minimum requirements.
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We commented on IASB’s recent proposals for: Ifrs foundation trustees’ review of structure and effectiveness
What is the current status of the project? The Request for Views Trustees’ Review of Structure and Effectiveness: Issues for the Review (the RFV), issued on 7 July 2015, aims at further enhancing the structure and effectiveness of the organisation to respond to an everchanging reporting landscape, with focus on three main areas: maintenance of the relevance of IFRS, consistency of the application of IFRS, and governance and financing. Comments on the RFV were requested by 30 November 2015.
What did RSM say on the RFV? In our opinion, the IASB should not extend the scope of its standard-setting activities by developing standards for the public sector or the private not-for-profit sector; such activities would require substantial additional resources, as well as specific knowledge, expertise, skills and competencies that are different from the currently available ones within the IASB. We agreed with the Trustees that it is very important for the IASB to play an active role in developments in wider corporate reporting, but only through co-operation (as outlined in the RFV) instead of considering broadening the scope of the IASB’s work into areas outside the boundaries of reporting of financial information that should remain the IASB’s primary focus. We agreed also with the Foundation’s focused goal on ‘having the IFRS Taxonomy recognised as the globally agreed standard to tag and intelligently structure IFRS financial information within a digital report’, thus supporting regulators in their efforts to improve digital access to general purpose financial reports to investors and other users.
View the full comment letter here
Concerning the consistent application of IFRS, we believe that Standards should articulate clear principles and be written in a way that makes them capable of being applied in practice without the need for extensive further interpretations or guidance or excessive additional work by preparers, auditors and regulators. To this effect, we recommended field testing and impact analyses before finalisation of a Standard as essential steps resulting in Standards that are stable and less open to interpretations and divergence in practice. As to governance and financing, we agreed with the proposals to increase the number of ‘at large’ Trustee appointments from two to five, to reduce the size of the IASB from 16 members to 13, and to continue operating the three-pillar system of funding.
We commented on IASB’s recent proposals for: iasb’s agenda consultation
What is the current status of the project? The Request for Views 2015 Agenda Consultation (the RFV), issued on 11 August 2015, aims at seeking feedback on the IASB’s work plan (research projects, standardsetting projects, maintenance and implementation projects) and priorities until 2020, in particular on whether it has correctly identified the most important issues in its research programme and whether any adjustment is needed in how its Standards-level programme is prioritised. Comments on the RFV were requested by 31 December 2015.
What did RSM say on the FRV? Overall, we believe that the IASB has correctly identified the relevant issues, and has struck an appropriate balance between fundamental improvements to IFRS versus fine-tuning the Standards to keep them fit for purpose. In particular: We agreed with the factors identified by the IASB in prioritising individual projects on its work plan and allocating resources to them as set out in the RFV. Completing the Conceptual Framework, the Disclosure Initiative, and the Insurance Contracts projects should be a priority of the Board. In view of consistency in implementation, maintaining existing IFRSs should be given the highest priority from the point of view of addressing practical issues of application as they arise. Although research activities are certainly critical to help identify the needs for developing financial reporting, we do not believe that the IASB should dedicate too many resources to this effect, but could instead use the work of national and regional standard setters around the world. The research projects on foreign currency translation and high inflation should be given the lowest priority, because they do not seem to be widespread enough.
View the full comment letter here
The categorisation of research projects into assessment and development stages is helpful in highlighting the progress on a project. However, we recommended that the process for moving a project from the assessment stage to its development stage be clarified. We believe the highest priority should be given to progressing the work on the following research projects, as they all are both important and urgent: Disclosure Initiative – Principles of Disclosure; Financial Instruments with Characteristics of Equity; Definition of a Business; and Primary Financial Statements. Our strong preference would be for major projects to progress more quickly; more time invested in the research development phase on assessing the practical operability of proposals could save time overall. In order to reduce the need for subsequent amendments and clarifications, the Board should envisage strengthening its system of quality control in finalising Standards before issuing them (e.g. field testing, public reviews, etc). We are of the opinion that the IASB should retain the three-year interval between Agenda Consultations.
We commented on IASB’s recent proposals for: Foreign Currency Transactions and Advance Consideration
What is the current status of the project? The draft interpretation of IAS 21 DI/2015/2 Foreign Currency Transactions and Advance Consideration (the DI), issued on 21 October 2015, aims at providing guidance on which exchange rate should be used to report foreign currency transactions when payment is made or received in advance. Comments on the DI were requested by 19 January 2016.
What did RSM say on the DI? We welcomed the guidance and agreed with the consensus proposed in the DI, provided that the final Interpretation is sufficiently clear about the distinction between ‘monetary’ and ‘non-monetary’ prepayment assets and deferred income liabilities. Otherwise, diversity in practice when accounting for foreign currency transactions in which consideration is received or paid in advance of the recognition of the related asset, expense or income would most likely continue to exist. Concerning the proposed transition requirements, we recommended that entities are given the choice between a retrospective application and a prospective application only from the beginning of the reporting period in which the final Interpretation is first applied (i.e. we disagreed with providing the choice of dates for a prospective application).
View the full comment letter here
We commented on IASB’s recent proposals for: Uncertainty over Income Tax Treatments
What is the current status of the project? The draft interpretation of IAS 12 DI/2015/1 Uncertainty over Income Tax Treatments (the DI), issued on 21 October 2015, aims at providing guidance on how uncertainty over income tax treatments should affect the accounting for income taxes. Comments on the DI were requested by 19 January 2016.
What did RSM say on the DI? We welcomed the guidance and agreed with the DI’s scope and proposals on: when and how the effect of uncertainty should be included in the determination of taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates; the assumptions for taxation authorities’ examinations, as well as on changes in facts and circumstances; and the disclosure and the transition requirements. Also, we agreed that entities should use judgement to determine whether each uncertain tax treatment should be considered independently, or whether some uncertain tax treatments should be considered on a collective basis. However, in a situation where the resolution of uncertainty over an uncertain tax treatment is expected to affect, or be affected by, another uncertain tax treatment, we believe there should be a presumption that the uncertain tax treatments are considered collectively due to the interdependence of the resolution of such uncertain tax treatments.
View the full comment letteR HERE
We commented on IASB’s recent proposals for: annual improvements to ifrs’s 2014-2016 cycle
What is the current status of the project? The exposure draft ED/2015/10 Annual Improvements to IFRSs 2014–2016 Cycle (the ED), issued on 19 November 2015, covers narrow-scope amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards, IFRS 12 Disclosure of Interest in Other Entities, and IAS 28 Investments in Associates and Joint Ventures. Comments on the ED were requested by 17 February 2016.
What did RSM say on the ED? Overall, we supported the IASB’s continuing efforts to deal with non-urgent amendments to IFRS in an efficient and effective manner via the Annual Improvements Project, as well as the proposals in the ED as they provide greater clarity and promote consistent application of the concerned Standards. In particular: We agreed with the proposed deletion of short-term exemptions in IFRS 1 that provided relief that is no longer available. We recommended that the IASB considers the introduction of ‘sunset clauses’ when future short-term exemptions are added to IFRS 1 so that it will be possible to remove them as editorial amendments rather than following extensive due process. We agreed with the proposed clarifying amendments to IFRS 12, but we indicated to the Board an inconsistency in the wording that might cause some confusion. For IAS 28, we simply agreed with the proposed clarifying amendments.
View the full comment letter here
We commented on iasb’s recent proposals for: application of materiality to financial statements
What is the current status of the project? The exposure draft ED/2015/8 IFRS Practice Statement: Application of Materiality to Financial Statements (the ED), issued on 28 October 2015, aims at providing explanations and examples to help management apply the concept of materiality, in particular to ensure that financial statements include all the financial information that could influence users’ investment decisions, present material information in a clear and effective way, and exclude information that is not material. Comments on the ED were requested by 26 February 2016.
What did RSM say on the ED? We welcomed the IASB’s initiative to provide non-mandatory guidance, in the form of a Practice Statement (‘PS’), with the aim of assisting management to use judgement in applying the concept of materiality when preparing financial statements. We consider that such guidance could be helpful, in particular in the context of disclosures, without waiting for the completion of the IASB’s Principles of Disclosure project. In our view, guidance in the PS should focus on areas where existing difficulties in using an appropriate level of judgement in applying the concept of materiality have been identified (e.g. the qualitative aspect of materiality, the application of materiality to disclosures, the application of materiality in determining the prominence to be given to information, applying materiality in interim financial reporting, applying materiality in relation to the disclosure requirements on judgement, assumptions and uncertainties contained in IAS 1). Also, the inclusion of illustrative examples may be useful if they illustrate both decisions to include and to leave out information. We consider that the guidance should be drafted in a more concise and practical way. As we noted that many paragraphs of the ED merely quote or reproduce in full guidance that is already contained in existing IFRS literature, we believe that such quotes and references could be moved into an appendix and referred to by cross-references.
We focused on: seperate financial statements vs standalone financial statements
What is the issue? Company XYZ prepares its financial statements in accordance with IFRS. XYZ is not a subsidiary of any other entity, and itself has no subsidiaries (i.e. it controls none of its investees). It determined that it has significant influence over investee ABC and is seeking advice as to the appropriate accounting
for this associate. In particular, could the investment in ABC be accounted for at cost in accordance with IAS 27 or should it be accounted for under the equity method in accordance with IAS 28?
What is the proposed solution? In the case of XYZ, ABC should be accounted for applying the equity method as per IAS 28 Investments in Associates and Joint Ventures, while IAS 27 Separate Financial Statements does not apply. In fact, an entity that does not have any subsidiaries uses the equity method to account for its investments in associates (or joint ventures) in its financial statements, even though those are not described as consolidated financial statements. The only financial statements to which an entity does not apply the equity method are separate financial statements it presents in accordance with IAS 27. Based on the fact that XYZ has no subsidiary (i.e. it does not control any of its investments according to IFRS 10 Consolidated Financial Statements), it does not prepare consolidated financial statements. Since XYZ has determined that it has significant influence on ABC, the entity must apply the equity method to account for its investment in the associate (unless XYZ were a venture capital organisation, or a mutual fund, unit trust or a similar entity; it could then choose to measure its investments in associates at fair value through profit or loss under IAS 39 / IFRS 9, in accordance with the exemption offered by IAS 28.18-19). Also, as XYZ is a standalone entity (i.e. not a subsidiary of another entity), the exemption from applying the equity method in IAS 28.17 does not apply.
XYZ proposes to account for its investment in the associate ABC at cost, in accordance with IAS 27.10. However, XYZ is incorrect. IAS 28.44 cross-references to IAS 28.10 but in respect of separate financial statements. Separate financial statements are defined (IAS 27.6) as additional to consolidated financial statements or to financial statements in which investments in associates are accounted for using the equity method; thus, an entity that does not prepare consolidated financial statements because it has no subsidiary, prepares a unique set of standalone financial statements â&#x20AC;&#x201C; that are not separate financial statements â&#x20AC;&#x201C; in which associates must be accounted for under the equity method of IAS 28. In accordance with IAS 27.8, XYZ could present separate financial statements as its only financial statements (in which ABC would be accounted for at cost) if XYZ were exempted from applying the equity method under IAS 28.17, which is not the case (XYZ being neither a parent nor a subsidiary).
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Editor Dr Marco Mongiello ACA Deputy Head of School Executive Director MBA and MSc Programmes Surrey Business School T +44 01483 683995 E m.mongiello@surrey.ac.uk
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