Policy Proposals Business Law
Comments on the IASB's Exposure Draft
"General Presentation and Disclosures"
To the International Accounting Standards Board (IASB)
Keidanren is pleased to respond to the Exposure Draft General Presentation and Disclosures (the "ED"). Our comments are as set out below.
As financial statement preparers, we at Keidanren have serious concerns in particular about the following:
1. We are opposed to the proposals for category-based uniform presentation of the statement of profit or loss and for disclosure of management performance measures (MPMs).
The objective of financial reporting is for entities to provide a basis for constructive dialogue with investors by presenting management's view of financial performance and position. Accordingly, in order for entities to better communicate financial performance to investors, it is crucial that entities be allowed to treat the statement of profit or loss flexibly—namely, in a principle-based manner—rather than being required to make uniform presentations, since the realities of business management vary from one entity to another. This approach is consistent with paragraph 85 of the current IAS 1, which requires an entity to present additional subtotals when such presentation is relevant to an understanding of the entity's financial performance.
Nevertheless, the ED proposes requiring entities to present three new subtotals in the statement of profit or loss. We are strongly opposed to this proposal, which would make it difficult for entities to present financial performance in ways that best suit their varied business activities and might thereby hamper dialogue with investors (see Questions 1 to 6 below).
Another problem is that operating profit or loss is characterized as the residual not classified in the other categories, such as the investing category or the financial category. Operating profit or loss, however, is an indicator that has been useful by both entities and investors. Therefore, if the IASB is to introduce the new subtotal in the statement of profit or loss, it should first provide an explicit definition of the term "operating profit or loss" alone, before requiring presentation in the statement of profit or loss (see Question 3).
Furthermore, as implied in paragraph BC165 of the Basis for Conclusions, applying the ED would make it virtually impossible for entities to present MPMs on the face of the statement of profit or loss, where they have hitherto reported these measures to help investors understand their financial performance, and would instead mandate that MPMs be disclosed in the notes. Considering the importance of MPMs as indicators conducive to business management and dialogue with investors alike, however, it is only natural to allow them to be presented on the face of the statement of profit or loss. We are also opposed to the disclosure, in the notes to the financial statements, of the commentary on MPMs that was disclosed in public communications outside financial statements, because that would not only significantly exceed the role of the notes but also cause substantial problems in terms of auditability (see Question 11).
2. We are opposed to the undue enhancement of the notes whose benefits do not justify the costs.
The ED proposes several disclosure requirements that would impose an undue burden on financial statement preparers despite the benefits not justifying the costs. They include requiring an entity that presents an analysis of expenses classified in the operating category using the function of expense method to provide an analysis using the nature of expense method in the notes (see Question 9), and requiring entities to disclose unusual income and expenses (Question 10) and a detailed reconciliation regarding each MPM (Question 11).
These disclosure requirements include ones that were proposed during the IASB's past Financial Statement Presentation projects and other occasions but eventually abandoned due to opposition primarily from financial statement preparers. We request that the costs and benefits of the proposed disclosure requirements be carefully reexamined and the ED thoroughly reviewed.
3. We believe that the ED will in no way obtain consent from corporate managers and financial statement preparers and, therefore, should not be developed into standards in haste.
As stated in 1 and 2 above, the ED includes proposals that would radically change the way the IFRS statement of profit or loss has been presented to date and would impose a heavy disclosure burden on entities. These proposals not only would have a huge impact on existing IFRS adopters but also could significantly discourage Japanese entities, many of whom are expected to consider IFRS adoption in the future, from adopting IFRS. In addition, given that the ED has made no efforts to converge with US GAAP, developing the ED into standards as it is would undermine the international comparability of statements of profit or loss.
In view of the above, the ED should not be developed into standards in haste. Instead, the Board should thoroughly reexamine the ED's impact on business management, business practices, and accounting audits as well as users of financial statements, and, based thereon, should reconsider this project from the ground up, including evaluating the option of suspending it. If the Board chooses to proceed with the project, then it should review the ED by fully taking into account stakeholders' opinions, and carefully address their concerns through such measures as issuing a re-exposure draft.
Below are our responses to the questions raised in the ED.
Question 1: Operating profit or loss
Question 2: The operating category
Question 3: The operating category—income and expenses from investments made in the course of an entity's main business activities
Although we agree with requiring all entities to present a subtotal for operating profit or loss, we do not agree with characterizing operating profit or loss as the residual not classified in the other categories, such as the investing and financing categories.
We agree with presenting operating profit or loss—which has been presented by numerous entities as an important indicator of their sustained earning power—on the face of the statement of profit or loss.
The problem is that the IASB characterizes operating profit or loss as the remaining profit or loss not allocated to the other categories, without defining the meaning and purpose of the term "operating profit or loss" itself. A profit indicator like that cannot have positive significance, nor can it offer meaningful data from the perspectives of business management and of usefulness of information to financial statement users. Therefore, if the Board requires operating profit or loss to be presented, it should explicitly define this term.
Specifically, we propose that operating profit or loss be defined as "profit or loss from activities that the entity identifies as its main business activities." Then, with regard to what main business activities are, the best approach would be for individual entities to determine and explain the definition of this term on their own in line with the realities of their business activities and business management, with minimum guidelines from the IASB. This approach would enable entities to explain on their own what constitutes operating profit or loss, which is the profit or loss from their main business activities, thereby facilitating communication with financial statement users.
Furthermore, an additional subtotal required to be presented pursuant to paragraph 85 of the current IAS 1 should be limited to operating profit or loss alone; then, each entity should be allowed to add subtotals for other items that it considers relevant to an understanding of its financial performance.
Question 4: The operating category—an entity that provides financing to customers as a main business activity
We have no comments.
Question 5: The investing category
We do not agree.
If an additional subtotal is required to be presented pursuant to the current IAS 1, that should be limited to operating profit or loss alone. Creating the investing and financing categories cannot have any positive significance from a business management perspective, and runs counter to the wishes of corporate managers.
Paragraphs 47(a) and B32 of the ED stipulate that income and expenses from investments be classified in the investing category. However, in the case of "minor investments"#1 that are not equity method eligible, if shares of stock are held for business activity purposes such as the maintenance and enhancement of transactional relationships and strategic partnerships, profit or loss from such investments (e.g., dividends received) should be allowed to be presented as operating profit or loss.
Question 6: Profit or loss before financing and income tax and the financing category
We do not agree.
If an additional subtotal is required to be presented pursuant to the current IAS 1, that should be limited to operating profit or loss alone. Creating the investing and financing categories cannot have any positive significance from a business management perspective, and runs counter to the expectations of corporate managers.
Paragraph 49(c) of the ED dictates that interest income and expenses on other liabilities be classified in the financing category. However, items given as examples thereof in paragraph B37, such as net interest expense (income) on a net defined benefit liability (asset) and unwinding of the discount on asset retirement obligations, are ones relating to business management and should thus be allocated to operating profit or loss.
Question 7: Integral and non-integral associates and joint ventures
We do not agree.
There has been no internationally accepted view on the nature of the equity method, as a result of which the IASB plans to launch a research project on this issue. In view of that, we are opposed to the ED creating this new presentation category in advance of clarifying the concept concerning the nature of the equity method.
In investments accounted for using the equity method, significant influence is acquired as a result of the entity's explicit decisions, to begin with; thus, almost all equity-accounted investments are integral to the entity's business activities. The proposed new category goes against the realities of business management and presentation using this category would in no way be useful.
The definitions of integral and non-integral are ambiguous and require judgment, which would likely undermine ensuring comparability that this project ought to aim for. Paragraph BC 211 of the Basis for Conclusions states that Board considered it impossible to "develop an exhaustive list of criteria that could encompass all possible business scenarios" and that "concerns were expressed whether . . . the proposed definitions and indicators would be sufficient to enable an entity to distinguish . . . on a consistent basis." It can hardly be said that the ED has overcome these concerns.
If these ambiguous definitions in the ED were to be relied upon in making decisions in practice, entities with many associates and joint ventures would in particular suffer substantially heavier burdens, including those related to audits, and have to bear greater costs. Nonetheless, as mentioned above, the ED would not ensure comparability between entities, nor does it conform to the realities of business management. Hence, it is fair to say that the benefits would not justify the costs.
As examples of a significant interdependency indicating that the associate or joint venture is integral, the proposed new paragraph 20D of IFRS 12 enumerates three situations: having integrated lines of business; sharing a name or brand; and having a supplier or customer relationship that is difficult to replace. If this stipulation were to be put into effect, many equity-accounted investments might be deemed non-integral. As such, the proposed paragraph goes against the realities of business management and is not appropriate.
Question 8: Roles of the primary financial statements and the notes, aggregation and disaggregation
We do not agree with paragraph 28 of the ED that requires indicating the nature and amount of the largest item of those aggregated under the label of "other."
Whereas items aggregated under the label of "other" were done so due to being deemed immaterial, paragraph 28 still requires disclosure of its largest item simply because of being the largest of the aggregated items. In addition to making no sense, this requirement is inappropriate in that demanding such disclosure might make financial statement users misunderstand management's judgment on materiality.
Whether to classify an item in "other" or present it separately should be a matter of management's discretion and auditing judgment to begin with, and is not appropriate to be dictated by accounting standards.
Question 9: Analysis of operating expenses
- Response 1
We do not agree with paragraph 72 of the ED that states, "An entity presenting an analysis of expenses classified in the operating category using the function of expense method shall also disclose in a single note an analysis of its total operating expenses using the nature of expense method."
- Reasons for Response 1
We believe that the function of expense method and the nature of expense method are equal in standing, and each entity can choose whichever method it considers more faithfully reflective of the realities of management. Therefore, entities using the function of expense method should not be required to provide an analysis using the nature of expense method in the notes.
Many manufacturing entities have opted for the function of expense method for two reasons: firstly, this method faithfully reflects the realities of management; and secondly, on a consolidated basis, disclosure using the nature of expense method is a very complex task and takes enormous man-hours in practice. Entities participating in the IASB's recent field test also noted that disclosure using the nature of expense method incurred huge costs primarily in aggregating information and handling intragroup transactions and rendered it extremely difficult to ensure audit-proof reliability, while providing little benefit for users of financial statements. This means that the proposed disclosure in the notes is not justifiable from a cost-benefit perspective as well. It should be reminded that, during the suspended IASB-FASB joint Financial Statement Presentation project, a proposal similar to this one was made but eventually dropped due to strong opposition from financial statement preparers.
The current IAS 1 requires entities using the function of expense method to disclose breakdowns of certain expenses, including cost of sales, depreciation and amortization expense, and employee benefits expense. Such disclosure should suffice.
- Response 2
We do not agree with paragraph B46 of the ED that states, "An entity shall not provide an analysis of expenses classified in the operating category using a mixture of the nature of expense method and the function of expense method except when required to do so by paragraph B47."
- Reason for Response 2
Presentation using a mixture of the function of expense method and the nature of expense method should also be permitted, because such presentation can sometimes provide more useful information. For instance, it may be useful for entities using the function of expense method to disclose breakdowns of certain items using the nature of expense method.
Question 10: Unusual income and expenses
We do not agree with requiring unusual income and expenses to be disclosed in the notes because the benefits would not justify the costs.
The ED requires that income and expenses be divided into usual and unusual ones. Yet, the definition#2 and application guidance for identifying unusual income and expenses (paragraphs B67 to B75) provided in the ED are insufficient to help entities identify them and would highly likely cause confusion in practice, including accounting audits.
Paragraph 101 of the ED requires an entity not only to disclose the amount, a narrative description, and the line item in the statement of profit or loss, of each item of unusual income or expense, but to an analysis using the nature of expense method if the entity presents an analysis of expenses using the function of expense method. This undue requirement would entail a very heavy practical burden. In addition, Note 2 of the Illustrative Examples, which shows an instance of disclosure that necessitates a calculation of income tax effect on each item of unusual income or expense, appears difficult to put into practice, and is not appropriate as an example due to being too specific.
Question 11: Management performance measures
We do not agree with both the definition of MPMs (paragraph 103 of the ED) and the proposal requiring information about MPMs to be disclosed in the notes (paragraph 106).
Paragraph 103(a) defines MPMs as subtotals of income and expenses that are used in public communications outside financial statements, and requires them to be disclosed in the notes. However, considering that MPMs are also defined in paragraph 103(c) as subtotals of income and expenses that communicate management's view of an aspect of the entity's financial performance, MPMs should instead be presented on the face of the statement of profit or loss, which serves as a starting point for communication with users; then information about the MPMs and their breakdowns should be provided to users in annual reports, investor relations meetings, and other opportunities for public communications outside financial statements.
The ED requires that subtotals defined by IFRS Standards be presented on the face of the statement of profit or loss, but that MPMs be disclosed in the notes. This requirement is inappropriate because it would make users misunderstand that MPMs, which are indicators important to corporate managers, are less useful than subtotals presented in the statement of profit or loss.
Also, disclosing and providing in financial statements the commentary on overall performance indicators that was disclosed in public communications outside financial statements would significantly surpass the role of financial reporting, causing problems in terms of auditability.
In particular, we are strongly opposed to requiring disclosure of the following items: a reconciliation, proposed in paragraph 106(b), between each MPM and the most directly comparable subtotal or total included in paragraph 104; the income tax effect and the effect on non-controlling interests for each item disclosed in said reconciliation, proposed in paragraph 106(c); and a restatement of comparative information in the event of change, addition, or removal of an MPM, proposed in paragraph 108(c). Disclosing these items would impose a considerable burden on preparers despite the benefits not justifying the costs.
Question 12: EBITDA
We agree with the proposal not requiring disclosure of EBITDA.
Given that not all entities use EBITDA, the disclosure thereof should not be mandated.
Question 13: Statement of cash flows
We do not agree with requiring operating profit or loss to be the starting point for the indirect method of reporting cash flows from operating activities.
In spite of operating profit or loss being proposed as the starting point for reporting cash flows from operating activities, the presentation of operating profit or loss is not explicitly given. This might result in the definition of cash flows from operating activities varying from one entity to another, undermining comparability.
We believe that approaches to "operating, investing, and financing" differ between the statement of profit or loss and the statement of cash flows, in the first place. Hence, there is no necessity of making operating profit or loss the starting point for reporting cash flows from operating activities.
Question 14: Other comments
- Presentation of foreign exchange differences (paragraph 56)
We are opposed to paragraph 56 of the ED—which requires foreign exchange differences included in profit or loss applying IAS 21 to be classified in one of the three categories of operating, investing, and financing—because this proposal would greatly exceed the benefits, considering the practical burden imposed by, and cost to comply with the requirement.
- Exemptions of financial institutions from preparing a statement of cash flows
Taking into account the special nature of a business that provides financing to customers, the ED allows entities conducting this business (i.e., financial institutions) to make an accounting policy choice to classify income and expenses from financing activities and from cash and cash equivalents in the operating category. Still, in terms of the special nature of this sector, consideration should also be given to the fact that information disclosed in financial institutions' statements of cash flows diverges from the realities of their cash and liquidity management. As a result, such information is of little value and rarely used by investors. We ask the Board to consider measures such as exempting financial institutions from disclosing a statement of cash flows.
Subcommittee on Corporate Accounting
Committee on Financial and Capital Markets
- These include strategic investments in which shares of stock are held to generate business opportunities or to forge, maintain, and enhance transactional or cooperative relationships; and investments to gain access to resource interests.
- Paragraph 100 of the ED defines unusual income and expenses as income and expenses with limited predictive value, and states, "Income and expenses have limited predictive value when it is reasonable to expect that income or expenses that are similar in type and amount will not arise for several future annual reporting periods." However, terms such as "type" and "several future annual reporting periods" are ambiguous. Also, judgments as to whether "it is reasonable" or not are highly subjective, which would make it impossible to ensure comparability between entities.