From the IFRS Institute – December 4, 2020
In December 2019, the International Accounting Standards Board (the IASB® Board) issued an Exposure Draft1 to revisit the structure and content of financial statements, focusing on the income statement. Among other things, companies would be required to present new performance subtotals (allocating income and expenses between new major categories) and analyze operating expenses on the face of the income statement. The Exposure Draft also acknowledges the importance of management performance measures, and seeks to improve transparency and discipline around them. In this article, we look at the proposals and stakeholders’ feedback.
Exposure Draft key proposals
The IASB Board’s proposals come from its efforts to improve financial communication and comparability across companies. They have the potential to introduce significant changes for many companies and across industries. The key proposals are:
- a new income statement structure with three new subtotals;
- changes to operating expense analyses on the face of the income statement, and disclosure requirements for ‘unusual’ items; and
- disclosure of certain management performance measures (MPMs)2 in a note to the financial statements and their reconciliation to a defined subtotal or total specified by IFRS Standards.
While the primary focus of the Exposure Draft is on the income statement, the balance sheet and statement of cash flows would also be affected, with fewer presentation options. If finalized, the proposals would result in a new standard replacing IAS 13.
Proposed new income statement structure
Current IFRS Standards allow flexibility in the format of the income statement, which may cause difficulty for users when comparing performance across companies (e.g. self-defined subtotals presented in the income statement, share of the profit or loss of associates and joint ventures included or excluded from operating profit).
The Exposure Draft proposes a defined structure organized around four major categories and three new subtotals, as illustrated below.
|Example income statement|
|20XX||Proposed category||What is included|
Information about income and expenses from a company’s main business activities
All income and expenses recognized in profit or loss unless they are classified in other categories
(analyzed by nature or by function as appropriate)
|Share of profit or loss of integral associates and joint ventures||X||‘Integral’ associates and JVs||Share of profit or loss and related income and expenses of associates and joint ventures. Integral associates and joint ventures are equity-accounted associates and joint ventures that are integral to the main business activities of the company and hence do not generate a return individually and largely independently of the other assets of the company|
|Operating profit and income and expenses from integral associates and joint ventures||X|
|Share of profit or loss of non-integral associates and joint ventures||X||Investing||Information about returns from investments that are generated individually and largely independently of other resources held by a company|
|Income from investments||X|
|Profit or loss before financing and income tax||X|
|Interest revenue from cash and cash equivalents||X||Financing||Information about income and expenses from assets and liabilities related to a company’s financing|
|Expenses from financing activities||(X)|
|Profit before tax||X|
|Profit for the year||X|
Although certain of the new proposed income statement categories (e.g. operating, investing and financing) are familiar from the statement of cash flows, the definitions do not align across the two statements. For example, while purchases of property, plant and equipment are investing cash outflows in the statement of cash flows, depreciation of property, plant and equipment would be presented in the operating category in the income statement.
Also, when classifying income and expenses into each of the three categories, companies would need to consider the nature of their main business activities. Some type of income or expenses could be classified differently across companies due to differing main business activities – e.g. interest expense on borrowings would typically be considered financing activities for a manufacturer, but an operating expense for a bank.
Significant judgment may be required to implement the proposed income statement structure, including determining those associates and joint ventures that are ‘integral’ to the company, as well as allocating income and expenses between categories.
Analysis of operating expenses and ‘unusual’ items disclosures
The Exposure Draft proposes that companies analyze operating expenses on the face of the income statement, either by nature (e.g. cost of materials, labor, amortization and depreciation) or function (e.g. cost of goods sold, selling and administration). Companies would select the approach that provides the most useful information to investors. A ‘mixed presentation’ would be prohibited. For example, presenting goodwill impairment as a separate line in a presentation by function would not be allowed.
In an effort to improve disaggregation, the Exposure Draft defines ‘unusual’ items of income or expense. Such items would be disclosed in a single note to the financial statements that describes the item and references the relevant line item in the income statement that includes it.
MPM disclosures to provide transparency
The proposals define MPMs as subtotals of income and expenses used in public communications outside the financial statements to complement totals or subtotals specified by IFRS Standards, and communicate management’s view of the company’s financial performance. These MPMs would be disclosed in a single note to the financial statements explaining why each MPM provides useful information to investors and how it is calculated. Companies would also be required to reconcile each MPM to the most directly comparable subtotal or total as specified by IFRS Standards.
Non-GAAP measures that are not performance measurement-based (e.g. free cash flows) would be excluded from the MPM definition and not subject to these disclosure requirements.
In addition, the Exposure Draft would require a company to present goodwill separately in the balance sheet from other intangible assets, which aligns with the IASB Board’s initiative to improve disclosures around goodwill and impairment.
In the statement of cash flows, nonfinancial companies would be required to classify interest and dividends paid as financing activities, and interest and dividends received as investing activities. The current accounting policy election would be eliminated.
For more detail on each of the key proposals, see KPMG publication New on the Horizon - Presentation and disclosures.
Status of the proposals and stakeholders’ feedback
Given the potential scale of the changes to the financial statements, it’s no surprise that the IASB Board has received over 200 comment letters on its proposals. Many respondents expressed support for the Board’s aim to enhance the comparability and transparency of financial statements and improve the structure of the income statement.
Generally, respondents indicated the following:
- presentation of additional defined subtotals and requirements for determining what income and expenses are included within those subtotals would improve consistency and comparability across companies;
- disaggregation requirements and unusual income and expense disclosures would improve decision-usefulness of profit and loss information; and
- disclosures of MPMs would help users better understand how management assesses performance and provide valuable insight to investors.
Respondents also identified areas for improvement, expressed concerns and requested additional clarification on aspects of the proposals, such as:
- the proposed classifications of income and expenses on the face of the income statement, and whether these classifications would be understood by preparers and users, including suggestions for different labels to avoid confusion;
- the need for further guidance on the term ‘main business activities’ and how that term interacts with other IFRS Standards, such as IFRS 84, because this concept is key to determining what is presented in the operating category;
- the prohibition of mixed presentation for analyzing operating expenses, on the basis that a mixed presentation may provide relevant information in certain instances;
- the proposed definition of unusual income and expenses because the proposed classification is solely based on expectations about the future – which may lead companies to classify items as unusual for a number of consecutive periods;
- the proposed definition of MPMs, and why it is limited to subtotals of income and expenses only; and
- whether the reference to subtotals ‘used in public communications outside financial statements’ is too broad and may not be operational.
Comparison to US GAAP
US GAAP provides baseline presentation guidelines for the primary financial statements that are often less prescriptive than those of IFRS Standards. However, SEC domestic registrants must follow specific presentation and disclosures requirements that can be stricter than those of IFRS Standards. Read the KPMG article Income statement presentation: IFRS compared to US GAAP for more detail.
SEC registrants are prohibited from presenting non-GAAP financial measures within the financial statements, although such measures are permissible outside the financial statements (e.g. in MD&A or investor materials). SEC registrants usually present non-GAAP measures in an earnings release, often coupled with a press conference call to provide financial statement users with a picture of the company’s financial position and performance.
Nevertheless, non-GAAP financial measures continue to be a hot financial accounting and reporting topic. The SEC believes that GAAP financial measures, supplemented with non-GAAP measures, can provide good information for investors. In 2016 the SEC staff issued updated Compliance & Disclosure Interpretations (C&DIs) with additional guidance about how companies are allowed to use non-GAAP financial measures5. The SEC staff continues to actively comment to companies about their use of non-GAAP financial measures. In March 2020 the SEC staff issued CF Disclosure Guidance: Topic No. 9, which expressed the staff’s views on disclosure obligations, including non-GAAP financial measures. Our article summarizes the SEC staff’s views regarding disclosure and other obligations if affected by COVID-19.
Further, our article, IFRS Perspectives: Non-GAAP financial measures are thriving highlights already existing implications of non-GAAP financial measures for foreign private issuers using IFRS Standards.
The FASB added a technical project in 2017 focused on the disaggregation of performance information either through presentation in the income statement or disclosure in the notes. The project is currently focused on the disaggregation of line items that represent the cost of revenue and selling, general and administrative expenses using a principles-based approach. As of November 2020, the FASB has put the project on hold while it monitors progress of the IASB Board’s primary financial statements project.
This project once finalized is likely to impact all companies that prepare financial statements under IFRS Standards. It could present implementation challenges and require companies to rethink their approach to financial communication. The IASB Board has started analyzing the feedback received and will further deliberate initial proposals in view of stakeholders’ concerns. Although new requirements are not yet in place, companies should continue to monitor both Boards’ activities in the area of communication in financial statements and improvements to performance reporting.
- Exposure Draft (ED), ED/2019/7 General Presentation and Disclosures
- The ED defines management performance measures; these measures are a subset of what is commonly known as non-GAAP measures, alternative performance measures (APMs), or key performance indicators (KPIs).
- IAS 1, Presentation of Financial Statements.
- IFRS 8, Operating Segments
- See KPMG Issues In-Depth, Non-GAAP financial measures