The discussion paper noted the following problem:
- The Board has received…feedback that some users of financial statements analyze the information in the statements listed in paragraph 3.3(a) (i.e. the balance sheet, income statement, statement of changes in equity and cash flow statement) more closely than they do with information in the notes. This feedback indicates that users’ decisions could be affected by whether entities present particular information separately in those statements, rather than disclosing it solely in the notes. This is supported by some academic research that provides evidence that some users of financial statements appear to react in different ways depending on how and where information is presented or disclosed in the financial statements.
- The Board has also received feedback that entities find it difficult to exercise judgement about what information should be presented in the statements listed in paragraph 3.3(a) instead of being disclosed in the notes. In some cases, IFRS Standards allow an entity to choose whether to provide information either in those statements or in the notes…
The discussion paper went on to cite various examples of terminology in IFRS standards that perhaps contributes to difficulty in exercising judgment. The discussion paper suggested that the term “primary financial statements” might be defined to include the following statements: (i) statement of financial position; (ii) statement(s) of profit or loss and other comprehensive income; (iii) statement of changes in equity; and (iv) statement of cash flows, and that language be developed to clarify the roles of these primary statements versus those of the accompanying notes (other possibilities considered by the IASB to define those four items included “face of the financial statements,” “statements,” “set of statements,” “main financial statements,” and “summary statements”).
The IASB staff paper suggests that these ideas received broad support, although with plenty of individual caveats and reservations. Not surprisingly, these often touch on the concern that the notes not be somehow coloured as being “inferior” to or “less important” than the “primary” statements. A recent IASB update indicates that the Board is going to keep considering this, within its “primary financial statements” project.
This might be an area where there’s something of a tension between theory and practice. You could easily argue that the “primary” statements should be significantly less important than the notes, given their extreme degree of summarization. For example, the fact that (say) a balance sheet amount for accounts receivable increased by X% between 2017 and 2016 provides no meaningful information in isolation; even everyone’s favourite exercise of taking income statement sales and computing a ratio only provides the broadest possible indication of relative movement. To feel safe in reaching (say) a conclusion that the increase in receivables is a good thing, you’d likely want to know something about the aging within the balance, about concentrations and bad debts, about how it breaks down across (to the extent relevant) the various divisions and segments and foreign currency jurisdictions, and about the factors that caused fluctuations in revenue during the year, among other things that you’d only get from the notes, and perhaps only from the MD&A. Looked at that way, one can imagine a different philosophy whereby the “primary” statements are more akin to a table of contents or index that leads the reader into the story, without ever being likely to be taken for the story in itself.
But in practice, I expect we’ve all had conversations that supported the perceived supremacy of the “primary” statements. In addition to the various observations cited in the staff paper, one could cite how the term “notes” is somewhat similar to “footnotes” (the SEC actually uses that term sometimes), carrying the connotation of something provided mainly for academics. If one looks to established resources like the SEC’s Staff Accounting Bulletin No. 99 on materiality, the flavour is overwhelmingly of a focus on the “primary” statements (although not exclusively – it does discuss, for instance, a misstatement involving “a segment of the registrant’s operations”). Basically, the collective belief by now in the notes being over-long and over-everything is so widely established that many practitioners may hardly consider it worth questioning.
As we’ve established in previous posts, all these roads lead back to the overriding issue of technology, and the IASB’s failure to take that adequately into account in developing the discussion paper. If there’s a need to sort out the relative importance of different parts of the statements, it’s more of a function of limited human capacity and flexibility than anything else: to an AI-generated reader, it doesn’t matter if a valuable piece of information is in one place or another. Of course, there’s still the problem that a lot of the information in the notes couldn’t possibly be of much use to anyone or anything, whether human or machine, but the IASB already seems to be tuned into that issue…
The opinions expressed are solely those of the author