31 January 2012

IASB: 'Performance Reporting: Back to the Future' by Patrick Finnegan

There is one project, however, that respondents to the agenda consultation believe should be a high priority. It cuts across the conceptual framework and many of the existing and, increasingly, new standards (IFRS). The project would define “Other Comprehensive Income” (OCI) and provide expanded guidance on performance presentation. Mr Finnegan believes that such a project is of the utmost importance both to investors and all other stakeholders.

Over the last two decades, the IASB and its predecessor, IASC, have increasingly used current or fair value concepts for the measurement of assets and liabilities in several areas, most notably in the area of financial instruments, but in several other areas too. It is becoming increasingly challenging to understand performance, given the expansion of the use of fair values mixed with the use of historical costs, particularly when the focus is on a single statistic—profit or loss. And, if financial statements are becoming more of an amalgam of mixed attributes, it follows that both cost and fair value should be displayed in one statement or, at least in two consecutive statements, to ensure the highest level of understanding about how performance is measured and communicated.

One of the single biggest challenges the Board has dealt with and continues to face is how to improve recognition and measurement principles, without raising concerns that such improvements will create volatility in reported profit or loss. That concern has been pervasive, for example, during the Board’s deliberations dealing with the accounting for post-retirement benefits, loan impairment, hedge accounting, financial liabilities, insurance contracts, revenue recognition and hybrid financial instruments, to name just a handful.

The concerns above have often slowed down the Board’s progress on several projects and have led the Board to expand the use of OCI to address concerns about volatility and performance masking, but without providing a definition for it. Unfortunately, decisions on which items should be reported as OCI have not had a consistent conceptual basis. Different reasons have been used to support its use. Some of those reasons include an objective of separating income and expenses between elements judged to be recurring vs non-recurring, or controllable vs. non-controllable, or volatile vs non-volatile.

Mr Finnegan therefore recommnds that the Board undertake a project dealing with OCI to achieve the following:

• to provide clarity about what is meant by OCI, when and why it is used and how it helps investors to analyse performance;
• to reduce concerns about potential volatility of profit or loss caused by fair value or current value measurements;
• to enhance the Board’s deliberative process by avoiding, or even eliminating, lengthy debates about what information is more relevant or useful to investors—the cost components or fair value components of income—if presentation guidance is provided for both. Moreover, the development of complex and potentially costly accounting standards to determine when an asset or a liability should be measured using either cost or fair value would be eliminated because income components of both attributes would be displayed;
• to improve the relevance of information used for investment analysis. So much of financial analysis depends on how information is displayed, for example, whether it appears prominently on the face of the financial statements or is in the notes. That is because of limitations on investors’ time, the volume of information to analyse and the complexity of the valuation process.

Full paper

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