The relevance of IFRS, or: strip off the sugar!

Observations on a speech given by IASB Chair Hans Hoogervorst in Washington on December 10, titled IFRS: 2015 and beyond.

Here’s an extract:

  • One of the challenges for the coming years will be to ensure that IFRS further strengthens its relevance in an ever-changing world. The world of financial statements needs to be the anchor of trust for investors, rather than the sugar-coated realm of non-GAAP measures. That means we must improve the communication value of financial reporting. We must make disclosures more effective and discourage boilerplate reporting.
  • We must improve performance reporting, making financial reporting easier to digest, without sacrificing the quality and rigour of our standards.
  • There are other issues to consider. How should financial reporting relate to broader issues of corporate reporting, such as integrated reporting, where sustainability and value creation are central themes? What about the impact of technology and Big Data on financial reporting?
  • These are all issues on which we seek your opinion in our current agenda consultation.”

All good points of course, and for the most part, ones that seem to be perpetually on the agenda. I’ve written more than once in this blog about issues relating to non-GAAP measures, and while I certainly understand the thinking behind their characterization as “sugar-coated,” I see a problem with the apparent underlying metaphor, in which IFRS constitutes the perhaps bitter-tasting pill that can nevertheless be objectively demonstrated to be better for the patient. That problem is, it seems to me, a behavioural one. Many investors aren’t looking for the rigorous long-term health check that might necessitate the bitter pill, but rather for sufficient inputs to take them through their current planning horizon, and a simplified way into engaging with financial performance often seems to them to fit the bill just fine. One can argue that this tactical approach to absorbing financial reporting is limited in the long-run, but for better or worse, if it aligns with the way investors engage with the market (and with the demands on their time and other resources), it’s hard to see how they’re going to be shaken out of it.

If that seems like a narrow and defeatist perspective on the issue, then look no further than two weeks later on the IASB’s website, to the “Summary Report of the EFRAG, EFFAS, AIAF and IASB Joint Investor Outreach Event on profit or loss and the role of other comprehensive income.” Although the report refers to itself as containing “valuable feedback” into the ongoing work on the conceptual framework, most readers will likely perceive it as a largely incoherent mishmash of opinions, the only real value of which, by virtue of that very incoherence, is in providing a reminder (if one were needed) of the folly of glib assertions about investors and their needs. Here’s an extract that seems somewhat relevant to assessing the likely success of any pending battle against non-GAAP sugar-coating:

  • “The panel members replied that to be able to analyze in detail the performance of an entity and make their own adjustments (e.g. normalization), investors needed all the components of the income statement. They also pin pointed the importance of having non-GAAP figures such as EBITDA, especially when the gains and losses in the income statement were classified “by function”. Investors frequently used EBITDA for valuation purposes (e.g. valuation multiples based on EBITDA) and as a measure of the cash that a company generates from its operations. Additionally, panel members referred to the importance of:
  • the information presented in the income statement being “more homogeneous”. That is, for comparability purposes it was important to have a “more consistent breakdown of the accounts”; and
  • having normalized parameters. More specifically, investors want to measure the performance of a company under “normal conditions”. Hence, it would be interesting to have margins and net profit being adjusted for cyclical fluctuations and for items that are not expected to recur frequently or regularly.”

The last point in particular might be taken to go beyond just normal sugar-coating, to the point of throwing away anything but the sugar, and recklessly shoving it into one’s mouth. Again, this is from the “valuable perspective” provided by a high-profile panel and recorded on the IASB’s own website, so it’s hard to take it as some kind of rogue view. Such comments indicate a desire for a form of financial reporting that’s reliable and credible but also malleable, susceptible to multiple forms of easy engagement by users. That’s hardly a surprise – authoritarian, paternal modes of address aren’t really the flavour of the ever-changing world Hoogervorst refers to. But this is awfully hard to reconcile with the way he phrases his remarks. It seems to me users want it all – the IFRS-defined anchor, and a boatful of multi-flavoured sugar tethered to it, which they can dip into or not as they wish. Such an approach doesn’t seem conceptually or technologically implausible, and the IASB’s resistance to it seems to challenge one of the most powerful maxims in all of society. That is – the customer’s always right…

The opinions expressed are solely those of the author

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