CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
History of the Performance Reporting Project Staff contact: Jenni Sullivan (
[email protected]) 1-203-956-5279 Farhad Zaman (
[email protected]) 44-20-7246-6456 Richard Barker (
[email protected]) Holly Kispert (
[email protected]) 1-203-956-5310 PURPOSE & SUMMARY 1. Prior to April 2004, the IASB and FASB projects on performance reporting were being conducted independently.
These independent projects were significantly divergent and
independent work was suspended in late 2003 to allow the Boards to determine how to most effectively continue with their projects. At the April 22, 2004 joint Board meeting, the FASB and the IASB (collectively, “the Boards”) agreed that a project of this nature should be conducted jointly to further promote the convergence of accounting standards used internationally. As a joint project, the Boards are sharing staff resources and research and are working to coordinate the issuance of a public discussion document. The Boards also are coordinating the timing of their deliberations of the issues within the joint project, but they are individually deliberating and voting on those issues. Furthermore, the Boards intend to consider the past work of each organization as a useful resource, but will not feel bound by it. 2. Also at the April 22, 2004 joint Board meeting, the Boards directed the staff to form a Joint International Group (JIG) to assist the Boards and staff in identifying issues to be considered in this project and developing proposed solutions. The purpose of this memorandum is to provide the JIG with an update of the progress made and lessons learned by the Boards individually before the project became a joint effort and the Performance Reporting JIG was formed. Please note that this historical background paper is for informational purposes only.
ORGANIZATION OF THIS MEMORANDUM This memorandum is constructed as follows: Part 1:
Project Overview
Part 2:
User Input Received by the FASB
Part 3:
Performance Reporting Models Previously Proposed by the FASB and IASB
Part 4:
Role of the Financial Performance Joint International Group (JIG) 1
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
Part 5:
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
Appendix A – The FASB’s previously proposed statement of comprehensive income for manufacturing and financial institutions Appendix B – The FASB’s previously proposed decision tree for classification of revenues, expenses, gains, and losses within the statement of comprehensive income Appendix C – The IASB’s previously proposed statement of comprehensive income Appendix D – A summary of the differences and similarities between the FASB’s and IASB’s previously proposed models for the statement of comprehensive income
PART 1: PROJECT OVERVIEW Objectives Of The Project 3. The objective of this project is to establish standards for the presentation of information in financial statements that would improve the usefulness of that information in assessing the financial performance of a business enterprise. The project will focus on form and content, classification and aggregation, and display of specified items and summarized amounts on the face of the required financial statements (for both interim and annual periods). That includes determining whether to require the display of certain items determined to be key measures or necessary for the calculation of key measures. 4. The project is not addressing other forms of performance reporting outside of financial statements, such as in management discussion and analysis (MD&A) in regulatory filings or the reporting of so-called pro forma earnings in press releases or other communications. It also does not address disclosures about an entity’s segments or matters of recognition or measurement of items in financial statements. Current Plans 5. At the April 22, 2004 joint Board meeting, the Boards decided to segment the project as follows: 2
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
•
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
Segment A includes: o Whether to require a single statement of comprehensive income that includes a subtotal similar to the existing subtotals “net income from continuing operations” (U.S. GAAP) or “profit and loss” (international accounting standards) o The required primary financial statements (the FASB will consider whether to require a statement of changes in equity as a primary financial statement) o The number of years required to be presented in comparative financial statements and related disclosures in the notes to the financial statements o Whether to require the direct method of presentation in the statement of cash flows
•
Segment B includes: o Considering whether there is value in the notion of “recycling” items between the subtotals of “net income” or “profit and loss” and other comprehensive income and, if so, the basis for the types of transactions and events that should be recycled and when recycling should occur o Developing consistent principles for disaggregating information on each of the required financial statements o Defining the totals and subtotals to be reported on each of the required financial statements (that might include categories such as business activities and financing activities).
6. The staff is working under an assumption that these segments will prescribe the order in which these issues are brought to the Boards, but the project plans and sequencing of the issues are not firmly established. Rather, the staff is seeking to get feedback from members of the JIG regarding the importance of each issue and how these issues are interrelated. The Boards plan to issue a Preliminary Views document in 2005 that will address selected issues from both Segment A and Segment B based on staff and JIG input. PART 2: USER INPUT RECEIVED BY THE FASB Summary Of User Interviews Performed By The FASB 7. As part of its initial research, FASB members and staff interviewed 56 users of financial statements between December 6, 2001 and February 5, 2002. Seven different firms employ those individuals and most of them have broad and extensive experience using financial statements. Based on their current positions, the staff classified them as 32 sell-side equity 3
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
analysts, 7 buy-side analysts/fund managers, 12 credit-rating analysts, 3 credit analysts/lenders, and 2 other users. In all, nine sessions were held: six site visits involving a series of interviews and three telephone conferences. The interview goals were to learn more about: •
The extent to which the required financial statements (balance sheet, income and cash flow statements, and the statement of shareholders’ equity) currently provide sufficient information for analyses and forecasts
•
The key valuation and performance metrics used and the extent to which they can be readily calculated based on information available in the financial statements
•
How to improve the display of information in the financial statements (including additional line items, subtotals, and so on), and
•
The content of note disclosures.
8. Following are the more significant observations gleaned by the FASB staff related to the above goals. Basic Financial Statements – Information For Analyses And Forecasts
a.
Information in financial statements serves as a starting point for analysis and assessments of company performance and prospects but those assessments also utilize and depend on significant information from other sources.
b.
Information useful in forecasting future cash flows is most important to both equity and credit analysts; thus, information with predictive value is highly relevant. Forecast periods sometimes go out to 10 years but the next 2-3 years are critical.
c.
Analysts providing credit ratings have a high interest in information about a company’s financial flexibility, liquidity, and its ability to meet its obligations, including contingent liabilities—guarantees and so-called off-balance sheet obligations. Their interest in balance sheet information is stronger than that of equity analysts, who tend to use selected balance sheet measures (for example, days of inventory and of receivables) as warning signals or checks on earnings quality and revenue recognition concerns.
d.
Distinctions between items of revenues and expenses and of cash inflows and outflows that have different behavioral characteristics—predictive value—are especially important. For example, some users expressed a strong interest in 4
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
greater details about revenues by lines of business that behave differently in different economic cycles or in details about the elements of cost of sales that may be more or less discretionary or variable relative to revenues. Key Valuation And Performance Metrics
a.
Many, if not most, analysts focus primarily on measures such as operating cash flow or free cash flow. However, operating earnings, EBITDA, EBIT, return on investment, and measures of leverage or liquidity and revenue growth or market share also are among the key metrics.
b.
Net income is still an important measure but it is not the focus for most users’ assessments of a company’s performance. It often is a starting point to arrive at “adjusted” earnings or operating earnings measure.
c.
Financial performance cannot be reduced to a single financial metric or a single financial statement. Equity and credit analysts use several financial metrics that are common to both groups in their assessments of a company’s performance as well as nonfinancial metrics, such as unit outputs, unit prices, and other measures that tend to be somewhat more specific to particular industries in which a company operates.
d.
There seems to be little interest among most analysts in comprehensive income as a key performance metric but they do not object to a transparent financial statement that shows all significant items of revenues and expenses and gains and losses, including items of the so-called Other Comprehensive Income (OCI) (for example, foreign currency translation adjustments).
e.
Measures of revenues and margins are important and discerning trends in revenues and margins is especially important in the modeling techniques employed.
f.
In certain industries, nonfinancial measures, which often are obtained through external data providers, are very important in assessing the performance of companies.
Display Of Information In Financial Statements – Suggestions For Improvement
Financial statement display practices are generally perceived as good but there were several rather specific and often repeated frustrations and suggestions for improvement, which follow. a.
More detail, on a quarterly as well as annual basis, for highly aggregated amounts such as revenues, cost of sales or selling, general & administrative expenses (SGA), capital expenditures, and net pension costs. It was suggested that 5
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
elements of such amounts often have different characteristics and the details would provide useful information in forecasting future activities and cash flows. ♦ Better line-of-business disclosures for revenues, including reflecting them with related expenses, and distinctions between different types of revenues (for example, from producing goods, rendering services, trading activities, joint ventures and other investments, and royalties and other fees). ♦ Distinctions between elements of expense (gains and losses) that, for example, are more-or-less (a) variable, (b) discretionary, (c) persistent, or (d) subject to “soft” valuation or unpredictable market measurements. ♦ Distinctions between capital expenditures for “normal” maintenance/replacement and those for expansion or special projects (with forward-looking management discussion and explanations about the prospects from such expansion expenditures and project related financing). b.
Consistent classification of revenues and expenses is of high importance. Many, if not most, expressed a preference for classifying items as operating/nonoperating but a consensus on the definition or underlying notion of operating is not clear. Some users acknowledged difficulties in defining operations and the potential costs that may arise to allocate certain items (for example, income taxes), adding that consistency and adequate disclosures often are more important than precise classifications.
c.
Presentation of operating cash flows using the direct method. It was noted that the reporting of amounts of “net” changes suppresses relevant information and should be avoided.
d.
Some users cited consolidating statements1 as a preference, particularly credit analysts seeking more detail about potential limits on cash and others seeking more details about lines of businesses.
Content Of Note Disclosures
a.
High on the wish list of many users, particularly credit analysts, is greater disclosures surrounding so-called “event risks” or “triggering events” that might result from a company’s commitments, guarantees, debt covenants, and other arrangements, including exposure to events affecting a company’s relationships with off-balance partnerships, joint ventures, and other vehicles. Paramount
1
The term “consolidating statements” refers to the worksheet that is utilized and the process that is used to get to the numbers on the consolidated statements. Consolidating statements have columns for each company, for eliminating entries, and for the final consolidated numbers. Therefore, consolidating statements show much greater detail than consolidated statements in which only the consolidated numbers are shown.
6
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
among their concerns is the potential for a liquidity crisis and adequacy of a company's “liquidity risk insurance.” Several users suggested disclosures surrounding such events in the form of stress tests. b.
Several users requested more information about segments.
c.
Several users desire more timely disclosures of quarterly financial information; that is, at the same time as (or very soon after) a company’s quarterly press release announcing its earnings. They said those announcements must be reconciled with the SEC’s Form 10-Q. Some added, for example, that very significant information often is not revealed about a company’s assets, liabilities, or revenue recognition practices until the filing of its 10-Q.
d.
Better and more consistent information about revenues (and expenses) through joint ventures, equity method investees, and other “off-balance sheet” alliances and special purpose vehicles.
e.
Insurance company analysts suggested better disclosures about the factors causing changes (positive and negative) in the measurement of various reserves, including quarterly information on underwriting layers.
Summary Of Comments From The FASB’s User Advisory Council 9. On February 13, 2003, the FASB held a public meeting with its User Advisory Council (UAC). As preparation for that meeting, UAC members were asked to provide their views about the objectives and priorities for the financial performance reporting project. Based upon survey results and the discussion at the UAC meeting, UAC members generally stated the following points: a. The financial statements are used for many purposes including: • Making projections (predictive) • Judging performance (feedback) • Evaluating/adjusting projections (feedback/predictive) • Determining enterprise valuations. Users indicated that the major use of the income statement is to evaluate management performance. b. Users require more information about the type of transactions and events aggregated within financial statement line items. The UAC members used the term “granularity” to describe this disaggregation. Granularity will assist users in identifying transactions and events that are “nonrecurring” which is critical for forecasting (to the
7
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
extent the financial statements are used for this) and for evaluating the quality of earnings. c. A number of users indicated that they begin their analysis with net income, but adjust that amount for nonrecurring and other items (some of which include the items in OCI). There was no consensus on the definition of “nonrecurring” that would be appropriate in all situations. The users indicated that a particular transaction or event may or may not be considered nonrecurring depending on the entity, industry and economic trends. Several users indicated that disaggregation/granularity along the lines of “multiples” they use in their work, may be helpful. For example, if a user was to give a particular transaction, event or line item a multiple of “0” or “1” there is the indication that the amount is not particularly useful to the users work. d. All users showed support for the concept of segregating remeasurements from transactions unrelated to remeasurements. However, this appeared to be more related to increased granularity that would assist in evaluating quality of earnings, rather than specifically needing remeasurement information based on its characteristics alone. e. A number of users stated that, in their opinion, transactions and events currently excluded from net income (OCI items) are appropriately excluded from net income. They referred to these items as “squishy,” but were unable to clearly express what characteristics made these items “squishy.” Some members indicated that these items should be segregated because they are volatile, unpredictable, irrelevant, or sometimes, nonrecurring. The staff raises concerns that the discussion indicated that some users do not clearly understand that other comprehensive income is not defined and therefore, may give those amounts less relevance based on their placement within the statement. f. The term net income should be retained. Although some users indicated that they use items in other comprehensive income in their work, most users indicated that eliminating net income would not be helpful. One user noted that this would be especially true for the general public who look to net income and EPS as a measurement of performance. The staff is unclear whether users want net income as it is defined today or, if they simply want to distinguish some measure of performance that is a subtotal within comprehensive income. PART 3: PERFORMANCE REPORTING MODELS PREVIOUSLY PROPOSED BY THE FASB AND IASB 10. Early in their respective separate projects on financial performance, the FASB and IASB both concluded that a business enterprise should report all items of revenues, expenses, gains, and losses in a single statement of comprehensive income. In 2003, the FASB and IASB both individually proposed a statement of comprehensive income model and performed field testing to get feedback. Below is a description of each model as well as comments received 8
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
from the field test participants. Appendix D provides a summary of the differences and similarities of the FASB and IASB proposed models for the statement of comprehensive income. Previously Proposed FASB Model Overview
11. The FASB, as well as the IASB, concluded that the classification and aggregation of transactions and events into several categories would enhance the understandability of the information for users. In its model, the FASB had the following categories: •
Business
•
Financing
•
Nonbusiness/Nonfinancing
•
Income Taxes
•
Discontinued Operations (which would be presented on a net of tax basis)
•
Other Comprehensive Income.
An example of the FASB’s previously proposed model is included in Appendix A and Appendix B provides a decision tree to help prepares classify items into the categories presented on the statement of comprehensive income. Approach To The Classification Of Revenues, Expenses, Gains, And Losses Within Categories
12. Under the FASB model, the business, financing, income tax, discontinued operations, and other comprehensive income categories would be defined by the proposed Statement. The residual category in the FASB model would be the nonbusiness/nonfinancing category. This approach differs from the approach under consideration by IASB in which the business category is the residual or default category. 13. The FASB was advised by users that the information most important in predicting an enterprise’s future earnings is information about the enterprise’s core or business operations. Members of the FASB’s User Advisory Council (UAC) stated that transactions and events 9
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
associated with the operations of an entity provide valuable information with regard to the financial health of the ongoing business. Those transactions and events also allow users to collect information on trends that are useful in making predictions about the entity’s ability to generate future cash flows. Based on that input, the Board decided to consider an approach that would attempt to define the business category directly rather than as a residual. The Business Category
14. The FASB decided to define the business category using a management approach. The key to this approach is that management would be required to provide a description of what they believe their business activities to be and the reason why certain revenues, expenses, gains, and losses are either considered related to or unrelated to their business activities. Under this approach, a bright line definition of business activities would not be provided, but rather some guidance would be provided on what types of transactions and events might or might not be considered business activities. Additionally, there would be a requirement that once a transaction or event is considered a business activity, it can not be classified in any other category, except if it meets the definition of a discontinued operation. 15. In order to facilitate feedback from the field test participants, the following working definition was used for the business category: The business category of the statement of comprehensive income should include all revenues, expenses, gains, and losses associated with business activities. Business Activities are: (a) Activities undertaken by a business enterprise as part of its objective to provide goods or services in an attempt to make a profit, or (b) Activities that are not directly related to providing goods and services but are essential to the enterprises’ ability to achieve the objectives in (a)2, or
2
For example, revenues, expenses, gains, and losses related to providing insurance, security, and defense of assets used in business activities, environmental clean-up if related to sites where business activities occurred, research and development activities related to new and current product development, and general and administrative activities.
10
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
(c) Activities in which the enterprise engages to pursue its strategic objectives, that result in either or both the impairment and disposal of assets used in either (a) or (b) above. Note—Transactions and events that meet the definition of discontinued operations in Statement 144 or are accounted for under Statement 109 shall be displayed as required under those Statements. In addition, once a transaction or event has been classified in the business category similar transactions and events may not be presented in any other category unless they are required to be accounted for as a discontinued operation under Statement 144. The Financing Category
16. The FASB tentatively concluded that there is a need for separate presentation of information relating to an entity’s financing activities. This perceived need stems from the desire of users to analyze the performance of the entity independent of its capital structure. According to the UAC, financing transactions and events provide information with regard to how well the entity manages its cost of capital and whether that cost can be covered by its ongoing operations. The FASB also tentatively decided to define financing based on a concept of net debt which requires the offsetting of liabilities with certain assets.
This approach is
consistent with ratios used in financial analysis such as net-debt-to-equity ratio, net-debt-tocapital ratio, and the calculation of return on equity. Two of the key performance drivers of an entity for forecasting purposes include ratios such as after-tax net interest expense to net debt and net debt to net capital. Underlying the net debt concept is the view that liquid assets (such as cash, cash equivalents and marketable securities) can be used to pay off debt and, therefore, the net position should be that which is considered outstanding debt. 17. The following definition was used for the financing category: The financing category of the statement of comprehensive income should include: (a) Expenses that arise from the passage of time for all liabilities, other than those that are deemed to be part of the enterprise’s business activities (b) Income that arises from the passage of time, relating to all cash and cash equivalents, and
11
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
(c) Gains and losses associated with the issuance, restructuring, and extinguishment of debt, except that which is deemed to be part of the enterprise’s business activities. The Nonbusiness/Nonfinancing Category
18. Because this category is to represent the nonbusiness and nonfinancing type of transactions and events, the FASB determined that this should be the residual category resulting from revenues, expenses, gains, and losses not meeting the definitions of the business and financing categories. The items included in this category would be dependent on how management defines their business and what types of revenues, expenses, gains, and losses fall outside that definition. In the limited field tests that were completed by the FASB, the most common items that participants’ included in this category include holding gains/losses on securities held for nonbusiness purposes, income loss from companies carried under the equity method of accounting unrelated to business activities, gains, and losses from sale of nonbusiness equipment, interest income on other than cash and cash equivalents, and dividend income. Field Testing Results
19. During August and September 2003, the FASB conducted a field test of its model with five preparers.
Three participants were manufacturing enterprises and two were financial
institutions. Each preparer was given a package describing the project, the categories, and example financial statements. While all five enterprises were able to prepare financial statements in accordance with the definitions given, all expressed concerns over the elimination of net income, the operationality of the definitions for the business and financing category, and whether this new presentation would enhance or improve current reporting. Some of the general comments received from the participants are as follows: a. General Comments •
A few participants suggested that the current model is not broken and that the proposed model will reduce comparability.
•
Others would prefer the project’s focus be on defining key metrics such as free cash flows.
12
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
•
One suggested that for public companies the model requires much of the information found in the MD&A Section.
•
One participant suggested that the new format will require additional disclosures be made.
•
A few suggested that the proposed model will require additional education on the part of users and analysts and that it will not reduce the use of pro forma statements.
•
At least two participants argued that it will decrease comparability or create diversity in practice.
•
Participants that represented financial institutions suggested that the distinction between financing and business would be useless because of the nature of their business.
•
At least one participant noted that: o Categorization should be based on theory, but practicality should also be considered o Resulting data may be used to second guess management o Categorization has the potential to change how management manages its business negatively o Categorization may limit management’s flexibility o The statement of comprehensive income should consider the purpose/strategic objective of investments and dividend income in categorizing those items o The statement of comprehensive income should include investing activities within the finance section and be consistent with the statement of cash flows.
b. Implementation Issues •
Participants questioned the categorization of the following items: o Charitable contributions o Depreciation o Derivatives o Investment and dividend income o Minority interest o Capitalized interest o Foreign currency translation adjustments o Split of treasury activities between financing and nonfinancing.
c. Other Issues •
Whether regulators would accept the new format 13
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
•
How much dissagregation is necessary to make the information useful
•
Whether recycling in any form should continue
•
Whether a subtotal called net income should be retained
•
Whether the changes to the system required by the new statement are too costly and provide enough benefit.
20. Based on this feedback, the staff believes the model needs to reconsidered. However, the staff believes that the field tests were very helpful because participants brought up issues that need to be taken into account when the staff further explores a statement of comprehensive income model.
Previously Proposed IASB Model Overview
21. The IASB’s previously proposed model of a statement of comprehensive income was intended to enhance financial analysis. The introduction of consistent categorizations of data was designed to appeal to the analyst’s need to compare companies against one another. 22. There are two related aspects of the IASB’s model: the use of remeasurements as a basis of classification and the use of columnar/matrix method of presentation. First, remeasurements are regarded as a relatively objective basis for partitioning income statement data, leading, for example, to the separation of fair value changes from other income and expenses. Remeasurements are defined as revisions of prices or estimates that change the carrying value of assets and liabilities.
They include items such as: fixed asset revaluations,
impairments and disposal gains and losses, pension actuarial gains and losses, fair value changes in financial instruments, and impairments of goodwill. 23. The partition was designed to give a classification of data that is consistent with the objectives of enhancing predictive value and feedback value.
Second, the columnar
presentation was designed to avoid a sharp distinction that pushes some items “below-theline.” The total column is all-inclusive, and the columns simply disaggregate the total amounts on a line-by-line basis.
14
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
24. In its model, the IASB had the following categories: •
Business with three subcategories
•
Financing
•
Income Taxes
•
Discontinued Operations
•
Category for special case of cash flow hedges, which are taken directly to equity under IAS 39.
An example of the IASB’s previously proposed model is provided in Appendix C. The Business Category
25. Unlike the FASB’s proposed model, the IASB’s model used a subcategory in the business category as a residual category that comprises all items not to be included in one of the other categories.
The IASB model categorized the business section into the following three
subcategories: (a) Operating profit – the remaining transactions and events that do not meet the criteria to be considered in either the other business profit income or financial income subcategories defined below, or that meet the criteria to be considered a financing activity. (b) Other business profit income – a group of transactions and events specified by the statement on Reporting Financial Performance. At this point in the project, the IASB has not yet developed the qualitative characteristics of the items in this category, nor have they finalized the list of likely candidates for inclusion. (c) Financial income – With the exception of certain designated hedging instruments, this category represents income from financial assets. Certain financial instruments may switch during or between periods from being an asset or a liability. Unless contrary to the requirements of other IFRS, income and expenses arising on financial assets only should be reported in the business category, and income and expenses arising on financial liabilities only should be reported in the financing.3
3
The reporting of financial instruments that “switch” has yet to be discussed by the Boards.
15
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
26. As business profit excludes financing expenses, it is a measure of the total return generated by a company that is independent of its capital structure. Alternatively stated, business profit is a metric directly relevant to enterprise value, while financing expenses and comprehensive income relate, respectively, to debt value and shareholder value. These distinctions are common to corporate finance and equity valuation theory though they have not in the past been incorporated into accounting standards. Specifically, the term ‘financing’ has been used in accounting standards but without clear definition on whether it includes income from financial assets or interest expenses recognized on the unwinding of discount rates. 27. The financial income category was proposed by the IASB for two reasons. First, there is often a close relationship between income from financial assets and financing expenses—for example, treasury management will often include both assets and liabilities—such that the clear and proximate presentation of the financial and financing categories is helpful.4 Second, valuations often make a distinction between operating and financial activity. Operating activities are typically treated as the source of value creation and analyzed by means of projecting and discounting future cash flows, whereas financial activities can be treated as independent of operating activities and valued directly on the basis of current market values. The separate presentation of financial income facilitates analysis of this type. The Financing Category
28. As mentioned above, the FASB used the concept of net debt to define its financing category. The IASB rejected the notion of net debt because the IASB concluded that an objective of the performance statement is to allow users to distinguish between the return on total capital employed from the return on equity. However, the IASB did not discuss at length whether gains or losses associated with the issuance, restructuring, and extinguishment of debt (which might not be considered returns to providers to debt capital) would be included or excluded from the financing category.
4
Entities would be allowed to exclude the business profit subtotal if this is perceived to assist users regarding the relationship between financial and financing.
16
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
Field Testing Results
29. In early 2003, the IASB performed field tests utilizing preparers and users spanning a wide variety of industries and geographic locations.
Significant comments received by
participants can be segmented into the following topics: a. Net Income and Recycling •
In several field visits, the single most important issue was a desire to preserve the present notion of net income.
•
Participants argued that items reported in equity are not managed by the entity in the sense that operating activities are, and that they are unrelated to business performance.
•
It was argued that items reported in equity are not a part “realized performance” in a variety of aspects: their value is uncertain until realized; they are not distributable; they are not held with the aim of realization.
b. Inventory Impairments •
Several participants disagreed with the proposal to report inventory impairments as remeasurements.
•
Some argued that inventory impairments are not remeasurements because they are an ongoing, normal component of business performance, and unlike other items reported as remeasurements.
•
The distinction between inventory impairments and other costs of sales can be based upon realization and not upon economic substance. An entity can choose to sell inventory at a loss, as opposed to first recognizing an impairment charge. This means that there would be, in effect, a management choice between the columns.
c. Writedowns of Accounts Receivable •
Similarly to inventory impairments, there was considerable disagreement with the proposal to report write-downs of accounts receivable as remeasurements. There were also strongly-held views that write-downs of accounts receivable should not be reported as “financial.”
d. Pensions •
There were numerous objections to the proposed display of income and expenses relating to pensions.
e. Provisions 17
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
•
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
Concerns were raised over the proposal to require a distinction between initial recognition and remeasurements of provisions. For the most part, these concerns related to difficulties with measurement.
f. Other Business Profit •
In general, there was support for an “other business profit” category and little disagreement over most of the items proposed for inclusion.
•
To the extent that the category was opposed, this was because of the option to take out items and report them within operating profit. This option was perceived by some to reduce comparability and add complexity.
•
The most contentious item included in “other business profit” is foreign exchange gains/losses on net investment. Those who opposed this offered the following objections: o Management has little or no effective control over foreign exchange gains/losses on net investment. They are an inevitable consequence of operating an international business. o The gain/loss is of no consequence for managing the business, and neither do investors ever seem to take any interest in it. o The gain/loss can be large and volatile, which increases the potential confusion if it is reported in a misleading location.
g. Income from Associates •
There were mixed views on whether income recognized under the equity method should be reported as operating or financial. The source of the variation in views was that associated companies are used in different ways by different entities, i.e. some are arm’s length while others are integral to an entity’s major operating activities.
•
There were no strong supporters of reporting income from associates within financial. There were several who had no objection or else some preference for this approach, but also several who objected strongly, arguing that this item is much closer to operating and unlike other items classified within financial.
h. Financial and Financing •
The field visits did not suggest practical difficulties in reporting financing separately from financial.
•
Some field visit participants regarded the definition of financing as too broad in so far as it includes the unwinding of discount rates (e.g. on pension obligations and asset
18
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
retirement obligations). In other words, it was argued that certain liabilities are “operating in nature” and should be excluded from financing. •
The items that are proposed for inclusion in financing are not, in any event, as contentious as the proposed separation of financing from financial. A commonlyheld view is that the financing category is too narrowly defined because it does not capture fully an entity’s treasury operations. This is the net debt issue.
i. Earnings and EPS •
There were frequent discussions of ‘earnings’ (i.e. a single, primary, summary measure of performance). Users and preparers alike wanted to know where the earnings figure was in the statement. Both groups tended to look to the profit before remeasurements column for the earnings figure (hence, the reactions noted above to write-downs of accounts receivable and inventory impairments, both of which would be expected to fall within earnings).
•
The use of earnings is somewhat more subtle than it might at first appear. Field visit participants described the earnings number as central to the process of communication between companies and analysts. It serves as a common reference point before and after the announcement of financial results. It is a benchmark against which investor relations managers guide the market, analysts form expectations, and share prices react on earnings announcements. It serves as a starting point for analysis, rather than as a definitive measure of financial performance. It is more narrowly defined than comprehensive income in order to better measure current trading performance. It is a company-specific measure and need not be defined consistently between entities.
j. Function vs. Nature Classification •
Several analysts have expressed a strong view that presentation by nature should be required. This is for three reasons: o Functional presentations tend to be at such a high level of aggregation as to be of limited use. o Functional classifications are subjective, opaque, and inconsistent between entities. o Natural classifications aid analysis by showing more clearly the links between the financial statements (e.g., the effects of PPE on the accounts could be tracked through the income statement, cash flow statement, and balance sheet).
19
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
•
On the other hand, a number of analysts expressed a need for gross margin data and strong support for maintaining existing functional classifications.
•
Preparers stressed the need for classifications to be consistent with internal and segmental reporting.
k. Banking Activities •
The banks had strong objections to several aspects of the proposed formats. A common plea was that banks’ income statements are not broken and do not need to be fixed. Equally common was a concern not to be constrained by a nonfinancial general format and to be enabled to report through the eyes of management. There was also a general view that remeasurements are less relevant to banks than to other organizations.
•
Specific objections were focused on the following issues: o Held-for-trading/dealing profits o Net interest income o Loan loss impairments o The “operating profit” category o Recycling and net income, especially in the context of available-for-sale and cash flow hedges.
30. Overall, the comments received from the field tests helped determine the functionality of the matrix model. The comments brought forth issues that have not yet been considered but will be taken into account as the IASB and FASB move forward together with this project. Some of these issues include property, plant, and equipment, pensions, financial instruments, and financial institutions. PART 4: ROLE OF THE FINANCIAL PERFORMANCE JOINT INTERNATIONAL GROUP (JIG) 31. At the April 22, 2004 joint Board meeting, the Boards directed the staff to form a joint international group to assist the Boards and staff in identifying issues to be considered in the Financial Performance Reporting project and developing proposed solutions. The period for nominating individuals for the Performance Reporting Joint International Group (JIG) closed 20
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
on June 25, 2004. Originally, the group was intended to be composed of 20 individuals. However, as over 120 nominations were received and due to the large number of high quality nominations received, as well as the staff's goal of including individuals with diverse geographic backgrounds and work experience, the group now consists of 24 individuals and as many as six official observers. 32. Members of the Performance Reporting JIG will assist the Boards and their project teams by acting as a resource throughout the life of the project. Members will be expected to provide information and practical insights from their perspectives and also serve as a sounding board as reporting alternatives are being considered by the staff and deliberated by the Boards. 33. As the project has progressed from its earlier stages, it has undergone a few name changes to better communicate the objective of the project. Formerly, the project was called “Reporting Comprehensive Income” by the IASB. However, as the project is now analyzing the income statement, balance sheet, statement of cash flows, and statement of stockholders’ equity, that name no longer seemed to appropriately capture the scope of the project. Likewise, the FASB has historically called the project “Financial Performance Reporting for Business Enterprises.”
For simplicity, the project is now being referred to as “Performance
Reporting,” but the staff and Boards expect this to change after receiving feedback at the first JIG meeting. Since the project is looking at the presentation and display of all of the required financial statements (described above) and the notes to the financial statements of business enterprises, this project no longer deals solely with reporting performance.
21
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
APPENDIX A Illustrative Example of the Previously Proposed FASB Model Example Statement of Comprehensive Income Manufacturing Company Business: Revenues Cost of sales Research & development Selling & marketing (including service cost of pension) Administrative (including service cost of pension) Depreciation Restructuring Charge Gain (loss) on sale of business equipment Equity earnings from companies carried under the equity method of accounting Income (loss) from business Financing: Interest expense Interest income from cash and cash equivalents Unwinding of discount rate Change in pension obligation discount rate Gain (loss) associated with extinguishment of debt Income (loss) from financing Nonbusiness/Nonfinancing: Gain (loss) on sale of nonbusiness equipment Interest income on investments other than cash and cash equivalents Dividend income Gain (loss) on sale of available-for-sale and trading securities Change in unrealized gain (loss) on trading securities Equity in earnings from companies carried under equity method accounting Income (loss) from nonbusiness/nonfinancing
Income tax expense (benefit)
Income (loss) from continuing operations
Discontinued operations, net of tax Foreign currency translation adjustment, net of tax Changes(s) in minimum pension liability, net of tax Change in unrealized gain (loss) on available-for-sale securities, net of tax Cash flow hedges, net of tax Cumulative effect of change in accounting principle, net of tax Comprehensive Income 22
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
APPENDIX A Illustrative Example of the Previously Proposed FASB Model Example Statement of Comprehensive Income Financial Institution Business: Interest income Interest expense Dividend income Gain (loss) on sale of available-for-sale and trading securities Change in unrealized gain (loss) on trading securities Selling & marketing (including service cost of pension) Administrative (including service cost of pension) Depreciation Restructuring Charge Gain (loss) on sale of business equipment Equity in earnings from companies carried under the equity method of accounting Income (loss) from business Financing: Unwinding of discount rate Change pension obligation discount rate Gain (loss) associated with extinguishment of debt Income (loss) from financing Nonbusiness/Nonfinancing: Gain (loss) on sale of nonbusiness equipment Equity in earnings from companies carried under equity method of accounting Income (loss) from nonbusiness/nonfinancing
Income tax expense (benefit)
Income (loss) from continuing operations
Discontinued operations, net of tax Foreign currency translation adjustment, net of tax Change(s) in minimum pension liability, net of tax Change in unrealized gain (loss) on available-for-sale securities, net of tax Cash flow hedges, net of tax Cumulative effect of change in accounting principle, net of tax Comprehensive Income
23
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
APPENDIX B FASB’s Previously Proposed Decision Tree Does the transaction or event relate to a discontinued operation as defined in paragraphs 41-44 of Statement 144?
YES
Report the transaction or event in the Discontinued Operations category
YES
Report the transaction or event in the Income Tax Expense/Benefit category
YES
Report the transaction or event in the Business Category
NO Does the transaction or event meet the criteria in Statement 109 to be classified as income tax expense/benefit?
NO Does the transaction or event qualify as a business as defined using the “management approach” described in the entity’s footnotes (linked to MD&A where applicable)?
NO Does the transaction or event meet the definition of a financing as defined herein?
NO Report the transaction or event in the Nonbusiness/Nonfinancing Category 24
YES
Report the transaction or event in the Financing Category
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
APPENDIX C Illustrative Example of the Previously Proposed IASB Model Total
Revenue Write-down of accounts receivable Cost of sales Selling, general, admin Operating Profit Disposal gain/loss PPE revaluation Investment property Goodwill FX gain/loss on net investment Other Business Profit
Remeasurements
1000 (10)
1000 -
(10)
(400) (250)
(340) (200)
(60) (50)
-
100 150 (100) (50)
50
(60) 15 (150)
340 100 150 (100) (50)
100
Income from associates Equity investments Debt investments Pension assets
50 (60) 20 (150)
Financial Income
(140)
Business Profit
Before Remeasurements
5
300
Interest on liabilities Pension financing expenses
(80) (120)
Financing expense
(200)
(120) (200)
40 80
Tax
(30)
-
-
Discontinued operations
(10)
(5)
(5)
-
50
Cash flow hedges Comprehensive Income
50 110
25
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
APPENDIX D A Summary of the Differences and Similarities Between the FASB’s and IASB’s Previously Proposed Models for the Statement of Comprehensive Income
Overall Objective
Business
FASB
IASB
Single statement. Aim to provide classifications of data that are decision-relevant to users. Does not support a continued separation between an income statement and other recognized gains and losses (in the form of either a Statement of Other Comprehensive Income or a direct-to-equity approach).
Single statement. Aim to provide classifications of data that are decision-relevant to users. Does not support a continued separation between an income statement and other recognized gains and losses (in the form of either a Statement of Other Comprehensive Income or a direct-to-equity approach).
The primary objectives of the project are: (1) to improve the quality of information displayed in financial statements so that investors, creditors, and others can better evaluate an enterprise’s financial performance and (2) to ascertain that sufficient information is contained in the financial statements to permit calculation of key financial measures used by investors and creditors.
The main focus of the project is the development of a single statement of comprehensive income – i.e., a statement that reports all recognized income and expenses. The project will specify the format of the statement of comprehensive income and the basis on which items of income and expense are categorized and ordered. It is expected that there will be consequential changes to the statement of changes in equity and the cash flow statement.
Business - defined category using ‘management approach’ • Operating Profit – no subtotal • Other Business Profit – no subtotal
Operating - residual category
•
Financing Expenses
Financial Income – no subtotal.
Defined to include: • Incurred expenses related to the passage of time for all types of liabilities • Income related to the passage of time from cash and cash equivalents • Gain or loss on the extinguishment, restructuring, or issuance of liabilities.
26
• •
•
Operating Profit – default Other Business Profit – defined as list, includes disposal gain/loss, PPE revaluation, investment property, goodwill, FX gain/loss on net investment Financial Income – conceptually defined to include income from financial assets which may include income from associates, equity investments, debt investments, and pension assets.
Defined to include: • Incurred expenses related to the passage of time for all types of liabilities.
CONFIDENTIAL --- NOT TO BE DISTRIBUTED TO UNAPPROVED PARTIES, THE PRESS OR THE PUBLIC
PERFORMANCE REPORTING JOINT INTERNATIONAL GROUP (JIG) LONDON, JANUARY 2005 AGENDA PAPER 2
FASB
IASB
Discontinued Operations
Same proposal, retain as separate line item.
Same proposal, retain as separate line item.
Tax
Same proposal, retain as separate line item.
Same proposal, retain as separate line item.
Net Income and Recycling
Accepted the notion of other comprehensive income and recycling. Requires the subtotal Income (loss) from continuing operations.
Rejected a notion of net income that is based upon recycling (partial exception for cash flow hedges).
Use of the term ‘Comprehensive Income’
Comprehensive Income is consistent with the conceptual framework.
Adopted Comprehensive Income as a working title, but term is not defined in IASB framework.
The Board has not yet deliberated this issue.
Does not favor a standard definition of EPS; allows entities to generate own EPS, but it cannot be displayed with greater prominence than comprehensive income per share and must be transparently reconciled to comprehensive income per share.
The Board has not yet deliberated this presentation. Some Board Members have expressed a preference for including these types of transactions and events in the notes to the financial statements.
Use remeasurements as a basis of classification consistent with objective of enhancing predicative and feedback value. Use columnar presentation to avoid a sharp distinction that pushes some items “below-the-line.” Columns disaggregate total amounts on a line-by-line basis. No grand total to columns.
Earnings Per Share
Remeasurements and Columnar Presentation
27