Let’s take a look at the ongoing discussions relating to presenting unusual or frequent items, taking place as part of the primary financial statements project.
The staff paper prepared for the September 2018 IASB meeting sums up the issues and some possible ways ahead. The underlying premise, of course, is:
- Non–persistent items do not enhance users’ ability to forecast an entity’s future performance as those items may arise unexpectedly (such as natural disasters) or may arise from phenomena that are difficult to forecast so users would often exclude non–persistent items from their analysis to avoid distortions. Separate presentation or disclosure of such items is therefore helpful.
However, the “the way entities present information about unusual or infrequent items varies significantly and…it is often not clear how or why items have been identified as unusual or infrequent.” Among other familiar issues “transactions or events are classified as ‘infrequent’ by some entities when in the view of many investors they occur on a regular basis.” In its Principles of Disclosure discussion paper, the Board set out the following possible definitions as a basis for further consideration:
- Unusual: Highly abnormal and only incidentally related to the ordinary and typical activities of an entity, given the environment in which an entity operates;
- Infrequently occurring: Not reasonably expected to recur in the foreseeable future given the environment in which an entity operates
Not surprisingly, the Board received a wide range of comments on these definitions, often identifying problems of one kind or another, and foreseeing difficulty in implementing them. In the staff paper, the staff doesn’t recommend trying to develop these definitions further. Instead, it recommends that the IASB “develop principle-based guidance to help entities identify items that are ‘unusual or ‘infrequent’.” The staff recommends that additional disclosure be required of such items, and that this be provided in the notes rather than in the statement of financial performance itself: “as long as the information presented in the notes is comprehensive, appropriately labelled and presented fairly users would obtain the information they need. Disclosing the information in a note would also mean that users can have easy access in a single location to the information about the items and how they relate to the complete income statement/line items within the statement of financial performance.” Of course, the staff paper notes various objections and difficulties that attach to all of its recommendations.
I think there’s often a danger with this area of tending to focus on trees at the expense of the forest behind them. An incremental change within the business (say for example a slippage in a retailer’s same store sales due to aging products) may have a greater financial impact than a restructuring charge or comparable discrete item, and certainly one of greater ongoing consequence. But no one suggests that the effect of such a change should be quantified (not that the cause and effect could ever be quantified with precision of course) and shown separately in the income statement. Instead, we understand that this is the kind of thing to address in an MD&A or similar document. Still, there’s an inherent contradiction there. That is: why should an item of perhaps little or no predictive consequence be subject to prominence in the financial statements, when something of potentially much greater impact may not be illustrated there at all?
Of course, the answer has something to do with the ease of describing and measuring a tree, compared to the forest around it (although all unusual items aren’t created equal in this respect – a restructuring charge may be capable of precise quantification, but the impact of a natural disaster, to take an example from above, isn’t as likely to be). But at the risk of pushing this comparison beyond its breaking point, this may only lead the observer to spend too much time studying the tree.
One of the recurring issues with this area, as the staff paper acknowledges, is that: “transactions or events are classified as ‘infrequent’ by some entities when in the view of many investors they occur on a regular basis. For example, acquisitive entities or diversified multinational corporations that experience costs on a regular basis nevertheless identify some of those costs as one–off or non–recurring in nature to provide an improved picture of their financial performance.” There may sometimes be a somewhat ideological element to these debates too. To take the same example, our political culture still tends to regard natural disasters such as forest fires and hurricanes as individually notable catastrophes, deserving of limitless “emergency” reaction but of little if any subsequent strategic response, no matter the scientific evidence that links their increased frequency and severity to climate change and related policy failures. Of course such events remain “unusual” from the perspective of the individuals affected, but perhaps not so much from any broader one. However, to spend time arguing over the definitional issue of whether a particular kind of natural disaster is “unusual” is as likely to delay an effective policy response as to inform it. Maybe there’s some kind of analogy in there for financial reporting too…
The opinions expressed are solely those of the author