The record of an issue recently discussed by the Canadian IFRS Discussion Group starts off with the following observations:
- “The role of management ability and/or intent in accounting for assets and liabilities under IFRSs is somewhat inconsistent. In some cases, an entity’s plans and expectations may factor into the nature and/or type of asset or liability recorded in the financial statements, as well as its presentation. Other areas of IFRSs are equally clear in describing the extent to which management intent is precluded. Some fundamental accounting concepts focus on an entity’s ability (rather than intent) to do something, while still other standards refer to both notions of ability and intent.
- The ability to avoid costs regardless of intent is a key concept in IAS 37 Provisions, Contingent Liabilities and Contingent Assets and factors into the determination of whether an obligation exists at the reporting date. The same concept appears to affect the determination of whether disclosures of certain contractual terms and commitments are required under IFRSs.”
This leads into a debate about the extent to which the ability to avoid future expenditures is relevant for IFRS disclosure purposes. One view is that unrecognized contractual commitments are disclosed regardless of management’s ability or intent to avoid the commitment, unless a specific standard specifies otherwise. The fact that IAS 17 specifically requires disclosing (among other things) future minimum lease payments under non-cancellable operating leases might suggest that where another standard doesn’t make that specification (as in the IAS 16 reference to “contractual commitments for the acquisition of property, plant and equipment”), it must require disclosing everything, cancellable or not.
Alternatively, you might take the view that an entity’s disclosures about unrecognized contractual commitments should have regard to management’s ability or intent to avoid the commitment, in addition to other entity-specific factors. Among other things, this “appears to analogize to the measurement requirements for onerous contracts in IAS 37. If management is able to cancel the contract for no cost, no provision is required for onerous contracts. It would then follow that where an unrecognized contractual commitment can be cancelled for no cost, no disclosure of such commitment is required (as in substance, it does not exist).”
A key question in this is the intention of IAS 1.114(d) in referring to note disclosure of “other disclosures, including…contingent liabilities (see IAS 37) and unrecognized contractual commitments.” I expect many practitioners have had a discussion at some point about how to interpret that reference. That is, as the group’s discussion sets it out, does it “encompass disclosure of all such contractual commitments over and above specific requirements in the standards, irrespective of the ability and/or intent to cancel,” or is it just a passing reference within “a general discussion pertaining to the structure and ordering of notes to the financial statements rather than their specific content”?
In context, it’s always seemed to me it must be the latter, but if you read it literally, that’s plainly not entirely clear. And the group’s discussion encompasses another very good point that has probably occurred to many of us: “Entities routinely enter into company-wide executory contracts to which they are contractually committed (for example, long-term employee contracts, IT/telecom service provider contracts). Those contracts may be more significant to the ongoing operations of the business than open purchase orders for items of property, plant and equipment. However, they are not disclosed in the notes to the financial statements even if they are non-cancellable.”
A related challenge for Canadian reporting issuers comes in complying with the MD&A Form 51-102F1; this requires a tabular summary of contractual obligations which includes, along with things like debt repayments, a category for “purchase obligations,” defined as “an agreement to purchase goods or services that is enforceable and legally binding on your company that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction,” and another category for “other financial liabilities reflected on your company’s statement of financial position.” Then, the form also requires, as part of an analysis of an entity’s capital resources, “commitments for capital expenditures as of the date of your company’s financial statements, including… expenditures not yet committed but required to maintain your company’s capacity, to meet your company’s planned growth or to fund development activities.” Apart from constituting various interpretation difficulties (for instance, it’s unlikely that most entities interpret “purchase obligations” as requiring disclosure of all existing executory contracts), this has the same logical problem cited above, of shining a spotlight on certain identified future cash flows, while passing over others of equal or much greater significance (although these should be addressed to some degree within the broader disclosure requirements relating to liquidity).
Anyway, back on the IFRS matter, the group didn’t have any clear answer, noting that “the extent of disclosure to meet IAS 1 requirements is based on professional judgment with a view to providing relevant information to users of financial statements,” and listing the following as some factors to consider: “whether the commitment is significant to the entity’s operations; if the commitment is required to maintain key assets of the company; whether it is practical for management to cancel the commitment; and the conditions in the agreement with respect to cancelability.” One might add another factor – whether, in conjunction with what the entity also discloses in its MD&A, the disclosure allows a user to understand future cash flow challenges that are identifiable at the end of the reporting period, based on the anticipated level of general operations and on specific anticipated outflows, whether for investing or other purposes. Despite the mishmash of disclosure requirements that exist in this general area, I’m not sure we can conclude the user always receives such clarity…
The opinions expressed are solely those of the author