IFRS Priorities—An Investor Perspective

Vincent Papa, Director, Financial Reporting Policy, Chartered Financial Analyst Institute | November 11, 2014 |

There have been significant International Financial Reporting Standard (IFRS) developments over the last ten years—most recently with the issuance of a converged revenue recognition standard—but plenty remains to be achieved and investor priorities are a most pertinent consideration. That said, as was evident during the 2011 International Accounting Standards Board (IASB) agenda consultation, there is a long list of specific standards that would be viable candidates for the “topmost priority.”

Even among the investor and user community, there is bound to be diversity of opinion on what the most important projects ought to be. Such differences of opinion among investors tend to arise due to their differences in:

  • Asset class coverage (listed equity, fixed income, private equity)
  • Roles in the investment process (sell-side, buy-side, credit analysts)
  • Sector coverage—for example, utilities sector analysts would consider rate regulated activities to be a topmost priority, as would insurance analysts consider insurance projects
  • Valuation approach—fundamental valuation investor information needs would differ from those who mainly rely on multiples-based valuation
  • Country-specific institutional features, such as the role and prominence of capital markets in financing corporations, and investor information access and concomitant analytical practices

Notwithstanding the inevitable diversity of viewpoints regarding the priority of specific technical standards, there is a core set of characteristics that influence how investors judge the overall quality of financial reporting. For example, the CFA Institute 2007 Comprehensive Business Reporting Model highlighted 12 general principles to generate useful information for investors, including the need for comprehensive disclosures and enhanced presentation of financial statements.

Consequently, rather than pick a narrow list of specific projects, my articulation of investor expectations for IFRS developments revolves around principles and projects that are anticipated to enhance the overall relevance and accessibility of IFRS financial reporting information across the full spectrum of standards. The significant areas that investors would like to see a concerted IFRS standard development focus would include:

Performance Reporting—There remains significant support for the completion of the Financial Statement Presentation (FSP) project, which was suspended in 2010 by both the IASB and Financial Accounting Standards Board (FASB) due to their prioritizing completion of convergence projects. FSP was far reaching in its objectives as it focused on the disaggregation and cohesiveness across the financial statements plus a radical overhaul of the cash flow statement. Enhanced disaggregation principles would potentially have ensured greater coherence between items presented on the statement of other comprehensive income (OCI) and those on the profit-and-loss statement. Furthermore, the articulation of distinguishing economic characteristics of items reported on the OCI statement would help investors pay greater attention to them—especially as OCI items can be material and contain economic information (e.g., changes in value of available for-sale securities held by banks).

It is encouraging that both the IASB and FASB are individually considering pursuing a performance reporting project, however, it is unclear the extent to which the elements of FSP will be carried over into this. Investors would like to see the following three areas addressed: the role of non-GAAP measures; enhanced presentation and disclosure of OCI-related items; and cash flow statement. As highlighted by Mulford from Georgia Tech,[1] a focus on how to make the cash flow statement useful for the banking sector ought to be an important consideration.

Disclosure Effectiveness Initiative that Focuses on Investor Needs—“Disclosure overload” is a commonly applied characterization of the state of financial reporting and often seems to connote the need to cut down disclosures. However, blanket trimming of disclosure requirements would be highly undesirable for investors. Apart from current disclosure requirements being necessary, there are many areas where there isn’t sufficient information to inform investors on underlying risk exposures of reporting companies. The financial crisis was a case in point as it revealed the extent to which investors were blindsided due to limited transparency around structured finance entities. It is also instructive that the Financial Stability Board Enhanced Disclosure Task Force (EDTF), which had significant input from leading institutional investors, proposed 32 recommendations for additional disclosures to enhance risk reporting—revealing that there are existing gaps in risk reporting. It is true that annual reports do have clutter (e.g., boilerplate and unduly lengthy qualitative descriptions of processes) and poorly located disclosures, but the issue ought to be how corporations can shift focus to providing information with a communication, rather than mere compliance, mindset. Hence, any dialogue on disclosure ought to focus on filling the gaps of information and on enhancing communication principles (e.g., signposting and cross-referencing).

Elimination of Avoidable Complexity Due to Avoidable Options—It is understandable that different business models necessitate different accounting approaches. For example, the appropriate choice of how to depreciate assets ought to depend on the pattern of asset consumption across different business models. However, there are cases where IFRS standards allow options that unnecessarily reduce the comparability of similar things. For example, two companies can have similar hedging strategies and be eligible for hedge accounting—one company can elect to apply hedge accounting and the other chooses not to. Another example of avoidable complexity is the presentation of interest paid on the cash flow statement. There is flexibility on whether to present interest paid as an operating or financing cash flow—and this existing flexibility in presentation curtails the ability of investors to make immediate comparisons of cash flow from operations across similar business models.

In conclusion, I would re-emphasize that investors would be best served if IFRS updates focus on broad applicability projects that improve the overall quality of financial reporting. The three areas identified—namely performance reporting, disclosure enhancement, and eliminating unnecessary options—can go a long way toward ensuring that investors have higher-quality and more comparable information. These highlighted areas for improvement are applicable to US and other national Generally accepted accounting principles (GAAP).

Vincent Papa is Director, Financial Reporting Policy, Chartered Financial Analyst Institute in the United States. He will participating in Convergence to IFRS and Global Consistency (Session 1.6) at the World Congress of Accountants 2014 this November 10 – 14 in Rome, Italy. He will be joined by Mark Vaessen, Chair, Corporate Reporting Policy Group, Federation of European Accountants, Netherlands; Hans Hoogervorst, Chair, International Accounting Standards Board, UK; Len Jui, Partner, KPMG, P.R. China; and Patrick Parent,  Member, Committee 1, International Organization of Securities Commissions, France.

[1] Mulford, Dr. Charles W. "Cash Flow Reporting by Financial Companies: A Look at the Commercial Banks." Georgia Tech Financial Analysis Lab (2009): n. pag. Web. http://scheller.gatech.edu/centers-initiatives/financial-analysis-lab/files/2009/ga_tech_cf_bank_2009.pdf.

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