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In the course of its consultations of European constituents, more particularly in the discussions of IFRS requirements for the classification and measurement of financial instruments and insurance contracts, EFRAG had received indications from long-term investors in Europe that their business model was not being appropriately addressed in IFRS proposals. This has been of great concern to EFRAG, as EFRAG, supported by many European stakeholders, affirms that accounting requirements should not impede proper reflection of an entity’s business model.
Role of the business model in performance reporting
Measuring, but also presenting assets, liabilities, income and expenses in such a way that investors can understand how they contribute to the entity’s cash flow generation can in itself be a way of representing the entity’s business model. Segregating assets and liabilities which play a different economic role in the entity, for example helping provide optimum daily cash management versus creating liquidity for acquisitions and capital expenditures would provide users with both a better basis for looking at financial results and forming expectations of future financial results.
EFRAG believes it is important that no standard ends up preventing entities from reflecting their business models. However, measurement cannot be considered in isolation. In order to achieve useful performance reporting, it is essential to consider how the effects of subsequent measurements are presented in the financial statements and how they impact profit or loss.
A more detailed analysis on the role of the business model is provided in the Bulletin The Role of the Business Model in Financial Reporting, which was issued in June 2013 by EFRAG, the ANC, the ASCG, the OIC and the FRC. This paper reflects and well articulates views that have been expressed by EFRAG in past IASB consultations on behalf of Europe. One of IASB’s preliminary views in the revision of the IFRS conceptual framework is that indeed the business model has a role to play in financial reporting.
Insurance
In its continued due process on the IASB’s Insurance Contracts project, EFRAG aims to obtain a better understanding of existing asset-liability management strategies of long-term investors, and how they can serve as objective evidence of the long-term liability-driven business model. Where an entity would rather select the option of reporting all short-term current value changes in other comprehensive income rather than in P/L, there might be certain portfolios of contracts for which reporting through P/L would provide better financial information nevertheless. EFRAG will consider whether such portfolios exist and how their characteristics can be best depicted.
Importance of profit or loss as a main performance indicator
Users from almost all sectors incorporate profit or loss in their analyses, generally as a starting point for analysis. Profit or loss is also acknowledged generally as the main indicator of an entity’s performance in financial communication. EFRAG believes therefore that profit or loss is an essential number that supports users’ needs as it is the primary measure of an entity’s performance. Given that the communication between preparers and users relies heavily on profit or loss, it is crucial that users have a good understanding of what this measure of performance depicts. Nevertheless, acknowledging that profit or loss plays a significant role in financial communication does not mean that it is the only information that should be used.
The IFRS conceptual framework defines income and expenses based on changes in assets and liabilities, and the IASB’s Discussion Paper on the Conceptual Framework confirms this. EFRAG is aware that some believe that this results in the statement(s) of profit or loss and other comprehensive income being secondary to the statement of financial position. EFRAG and standard setters in Europe (for example the standard setters of the UK, Italy and Germany) do not share this view. Defining income and expenses based on changes in assets and liabilities does not conflict with the objective of producing useful performance figures, provided that measurement attributes are selected with the objectives of providing relevant information in both the balance sheet and the income statement, without giving any primacy to one or the other. This is consistent with the preliminary view expressed by the IASB in the revision of the IFRS conceptual framework.