DISCLOSURES - IASB TAKES ON THE CHALLENGE

There is a remarkable consensus in the IFRS world that we have a problem with disclosure but there is no consensus on what the problem is. John Hitchins, PwC Global Chief Accountant, provides his stance on the debate.

It is evident that there is a problem with disclosure but there are different views on what the problem is and how to resolve it. The IASB hosted a public forum in January with both users and preparers. The discussion confirmed the consensus and tackled the issue of how to improve the usefulness and clarity of disclosures.

Too little or too much?

Preparers complain about disclosure overload pushing up the cost of financial reporting. Some regulators and users argue that there is too much irrelevant disclosure – 'clutter' – such that important disclosure gets lost amongst the trivial. Others say there is not actually enough disclosure on critical issues. Some feel that the amount of disclosure isn't the problem, it is the way it is organised and explained.

Finding a solution

Without agreement on what the problem is, it is no surprise that there is no obvious solution on the table. A cottage industry has developed in the last couple of years around producing discussion papers on the subject. The only common theme emerging from these is that we should all be braver in applying the materiality concept to disclosures. Even here, there are differences of view as to whether existing materiality guidance is sufficiently clear.

Materiality alone does not solve all the perceived problems – preparers still have to collect the data to decide whether something is material, and just reducing clutter does not necessarily make what is left any more readable or useful.

A more 'radical' idea

The debate needs to be expanded to consider more radical ideas. There has been much talk about establishing a single principle for disclosure but, so far, there has been little research into what that principle might be.

Two ideas that come to mind are:

  • to disclose information that has direct predictive value for cash flows; or
  • to disclose information that allows users to have an in-depth understanding of the quality of assets and claims as well as the expected timing of payments and the ultimate amount of liabilities.

Applying either would probably eliminate some disclosures; equally, it could highlight the need to expand other disclosures or introduce new ones. There is no guarantee that the amount of disclosure would reduce, but at least following a principle should help to present a more coherent set of information rather than a compliance checklist of data.

Interestingly, the first option above did come up at the IASB Discussion Forum but, apart from a disagreement among participants about how much disclosure it might eliminate, it was not really explored. This option should be explored, although we should not underestimate the difficulty in both agreeing a single principle and then agreeing how to apply it. But a more radical debate might well help in bringing closer together the different views on what the real problem is.

What is next?

The IASB Disclosure Forum concluded there are no quick fixes. This might be true but we can make short-term progress. We can establish a principle that every piece of disclosure be accompanied by an explanation of its significance to the business. This could have two benefits:

  • first, where that significance is difficult to find, it could embolden us to leave the disclosure out as not material, thus getting rid of clutter; and
  • second, additional explanation would help the reader to navigate the financial statements – the 'story' behind the financial statements would be clearer.

The board will continue outreach on disclosures. The output from the disclosure forum will inform the IASB's work on its Conceptual Framework. A discussion paper on the Conceptual Framework project is expected later this year. It is time to get involved in the debate.

IMPROVING IFRS – A POINT OF VIEW

Amidst the current, rather stagnant, debate on the merits and flaws of IFRS, Claude Lopater, PwC partner and member of the Board of the French accounting standards authority (ANC), suggests ten concrete measures for improving IFRS and increasing Europe's influence over the IASB.

There are those in favour and those against IFRSs, the enthusiasts and the weary, the disheartened and the convinced. There is no question about it – rebellion is stirring among the ranks of users who find these standards hopelessly complex and far too prone to change. As for the standard setters, they ardently defend the principles. The stand-off between these two camps is about to turn ugly.

"France wants its voice to be heard, not for the sake of criticising IFRS standards, but to improve them", says Claude Lopater. He stresses the need for a rapid change of mindset, by both the IASB, who should set up an 'after-sales service' for existing standards, and their European users, who must not only show their willingness to continue with IFRS, but also "fight for more freedom in order to make their voices heard". Claude offers the following ten suggestions to improve IFRS and increase Europe's influence over the IASB.

Ten measures to improve IFRS

1. Make the standards drafting process more stable

This is priority number one and is the best way to improve the standards. It will let the standards 'live', thereby giving the IASB time to improve them other than by preparing new exposure drafts. This will ensure that the IASB finally has the time to provide a real after-sales service for existing standards, for example, by implementing measures 2 to 8 suggested below.

2. Put an end to the drafting of complex new standards with no real added value

IFRS 10 and 11, which were reluctantly adopted by the EU in December, replaced previous IFRS standards which had not been called into question by those who applied them on an everyday basis. This concerns, first and foremost, the exposure drafts on revenue recognition and leases, both of which go against companies' business models.

The revenue exposure draft could lead to the recognition of revenue well before the receivable itself arises, particularly in the case of handset sales and subscriptions in the Telecoms sector. The exposure draft on leasing focuses on the liability relating to firm or quasi-firm lease commitments, which is to be recognised with an adjusting entry made to intangible assets (despite the fact that it is already disclosed in the notes), suggesting that all service agreements should be capitalised.

3. Make IFRS more realistic and easier to Understand

The main counter-intuitive impacts of IFRS should be listed and examined. Certain concepts could be adjusted slightly to inspire a positive rather than hostile attitude among users. For example, who can understand:

  • why a capital gain will never be recognised in income on the sale of 20% of a wholly-owned subsidiary?
  • why should a liability relating to a put option on a non-controlling interest be recognised at fair value?
  • why should a liability be recognised immediately on the dividends a company undertakes to pay to its shareholders before future earnings are generated?
  • why must an expense be recognised on the cancellation of a stock option plan?

4. Ensure consistency between IFRS

In order for IFRS to be credible, it is essential that the same treatment be prescribed for identical situations. At present, the costs of acquiring a subsidiary must be expensed, whereas the costs of acquiring any other assets must be capitalised (including short-term assets).

5. Create protective measures

Some of the current methods increase the temptation to 'break the rules'. For example, the requirement to recognise contingent consideration or provisions after a 12- month period in the income statement encourages companies to record significant goodwill at the outset that will ultimately be converted into revenues.

6. Be clearer

In order to help companies and auditors properly account for transactions, the IASB should clearly explain whether the economic substance (economic compulsion), the legal substance (the actual consequences of contractual clauses) or the legal form of an agreement prevails. The IASB and IC have not consistently applied economic compulsion, for example, in the recognition of liabilities.

7. React to current events and interpret the Standards

Current events have significant consequences for companies' annual financial statements. The IASB must take a stance on the accounting before the financial year-end in order to ensure a meaningful comparison of financial statements. They should certainly not criticise the positions taken by companies after the fact, as was the case in 2011 during the Greek crisis or, in 2012, as regards the discount rate for pension obligations.

In fact, the IASB rather than the IC would to be the best placed to interpret 'its' standards. That would also eliminate unproductive exchanges with the IC and irrational decisions, which was the case recently with put options on non-controlling interests and contingent consideration.

8. Revise the conceptual framework

Trying to please investors at all costs is not the right approach when it comes to establishing effective standards. Regardless of what is said, executive managers are the main users of financial statements. Creating an internal accounting system is costly, which is a good thing for IFRS as these managers can play a double role. It is certainly more positive than seeing businesses communicate with ever decreasing links with IFRS (more non- GAAP measures).

9. Amend European regulations and particularly rules on the right of veto

The right of veto must enable the EU to approve only part of IFRS. As it stands, the right of veto on IFRS enshrined in European law frightens no one, especially not the IASB given that the EU has approved every standard since 2005 with one exception.

If a more flexible right of veto were granted, EU members would feel not only freer but stronger, because the threat to the IASB of the EU not approving a new standard would be more real. This would prove an effective weapon for increasing European influence.

10. Reform EFRAG governance

It is necessary to reform the European Financial Reporting Advisory Group (EFRAG), which filters the standards at the European level, in order to provide European standard setters with real powers of decision and representation.

This is particularly important at a time when the IFRS Foundation is planning to improve IASB governance by creating an Accounting Standards Advisory Forum, which will allow national standard setters to be more closely involved with the work of the IASB, under highly questionable conditions.

IASB PROFILE: MARY TOKAR

Mary Tokar has returned to standard setting, replacing Paul Pacter on the IASB from 1 January.

It is undoubtedly an interesting and perhaps daunting time to join the board. There are a number of new projects just kicking off and the IASB is refocusing on the fundamentals of IFRS in the Conceptual Framework project.

That said, there is a long tail of legacy projects. Mary faces the challenge of balloting decisions taken by fellow board members and predecessors on some significant projects, including revenue recognition, leases, financial instruments and insurance. About this Mary said "I might be unnaturally quiet as we wrap up the existing sweep issues and rack up an unprecedented number of abstentions."

The quiet noticeably fades when the board debates new topics as it did with the Conceptual Framework in the February. It then becomes clear that, although Mary may be the 'new kid on the block', she is no stranger to the IASB and standard setting. Mary is highly experienced in both standard setting and the implementation of IFRS. She served on the Interpretation Committee from 2001 – 2007. Before that she was with the U.S. Securities and Exchange Commission and most recently headed up KPMG's Global IFRS Group.

Mary emphasises that IFRSs are 'real and in use around the world'. She hopes to bring a sense of practicality to the IASB which is under pressure to develop new guidance and maintain existing IFRSs while balancing the cost of change to users.

Hans Hoogervorst, Chairman of the IASB, described Mary by reference to "her straight-talking, no-nonsense approach". When asked about this portrayal, Mary commented, "I still need to think about whether I want to live up to it, or disprove it." We will all have to wait and see.

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