The IASB recently posted on its website a summary report on an investor outreach event on profit or loss and the role of other comprehensive income, held on July 1, 2015 in cooperation with the European Financial Reporting Advisory Group (EFRAG), the European Federation of Financial Analysts Societies (EFFAS), and the Association Belge des Analystes Financiers (ABAF).
The broad purpose of the event, chiming with the ongoing work on the conceptual framework, was to “seek the views of users on the role of P&L and what should be the purpose of OCI and its separation from P&L.” Not surprisingly given the topic, the report has little new to say, and not much that’s definitive – there’s a lot of on the one hand/on the other hand; copious uses of “however.” For instance:
- “The members of the panel, formed by users of financial statements (the ‘user panel’) noted that financial information obtained from P&L was key and often the starting point of their analysis. However, members of the panel noted that the sector in which the company operated could influence users’ analysis and that for highly leveraged entities the balance sheet was important.”
Thanks for the insight! Much of the content evokes a kind of “greatest hits” of issues which will no doubt outlast us all:
- “The user panel noted that analysts often make adjustments to P&L and those adjustments are made for a number of different reasons (e.g. to increase comparability or to normalize earnings, etc.), that usually depend on the analysis being made. It was difficult to establish in advance what kind of adjustments should be made.”
Overall, nothing about the report affects my own long-held impression that however eloquently or imaginatively one might dress it up, there’s basically little more to OCI from a standard-setter’s perspective than “you know it when you see it.” (And, I might add, usually little more to it from a user’s perspective than a shrugging “Whatever…”)
Perhaps the following is a bit more interesting: “The user panel and some participants considered that the concept of ‘business model’ is important and that P&L should be closely linked to the entity’s business model and management’s view over the performance of the business.” One user panel mused “that there was a need to separate the activities which were related to the underlying business of the entity and those which were not. He noted that many companies had started to have a lot of derivatives and trading activities which were not related to the underlying business and seemed to be more speculative. He questioned whether these should be considered as performance of the company.”
These thoughts plainly go further than the IASB’s cautious, high-level suggestions in its recent proposals for improving the conceptual framework that the way in which an entity conducts its business activities might occasionally affect the accounting determinations it makes. Of course, it’s only one person’s view, but as it’s recorded on the IFRS website without adverse comment, it seems to carry at least some weight. And it’s not the first time I’ve come across that kind of notion. Superficially, it might sound like a mature, grounded kind of idea. I mean, someone who asserts the opposite, that the business model isn’t important, might come across merely as an abstract, self-absorbed technocrat. And the concept is in vogue now, by virtue of its centrality to IFRS 9, which uses the concept of a business model in determining when a financial asset is measured at amortized cost, or at fair value through other comprehensive income.
IFRS 9, though, seems to provide a cautionary tale to those who detect any conceptual purity in the concept: as I wrote here, it takes an awful lot of somewhat arbitrary rules to define what constitutes one kind of business model versus another, and even the most engaged reader may have trouble keeping track of why the end result is superior to just measuring everything at fair value through profit or loss. The comment cited above seems to sum up its extreme inherent subjectivity. If an entity is loading up on “derivatives and trading activities” which are “more speculative” than its underlying business, shouldn’t the results from those activities be regarded as one of the most crucial aspects of its performance to highlight and explain, rather than, as suggested, regarded as not being part of its performance at all?
For imaginative “business model” advocates, the concept’s potential might be almost limitless. Take advertising costs, as a random example. Currently they’re all expensed, but if “the entity’s business model and management’s view over the performance of the business” regards them as a form of long term investment, as I’m sure many do, then maybe they should be deferred and amortized. I mean, if that’s the business model… Obviously, that’s hardly the most extreme example I could invent.
It reminds me a bit of all the talk about aligning executive compensation with long-term performance and strategy and whatnot, which in practice always just translates into giving the executives more money. Likewise, it might sound as if proponents of a “business model” approach to accounting are beckoning users to a new promised land of rationality and clarity, but if they ever fleshed out the idea in more detail, I suspect it would largely amount to flashy marketing on a jungle of self-serving murkiness….
The opinions expressed are solely those of the author