This column has focused recently on the disclosures within the financial statements, examining the moves that the International Accounting Standards Board (IASB) is making to further improve and clarify the items communicated by entities.
In addition to the targeted review of disclosures within IFRS 13, Fair Value Measurement, and IAS 19, Employee Benefits, this column has considered proposals for a new international sustainability standards board. This current emphasis on disclosures has been further increased with the proposed framework for companies preparing management commentaries.
Management commentary refers to reports complementing a company’s financial statements. While these are not required by IFRS Standards, regulators may require companies to provide them or companies may voluntarily choose to do so. Currently the IASB has a practice statement in place, IFRS Practice Statement 1, Management Commentary. The proposed framework would represent an overhaul of this.
The IASB has issued an exposure draft that outlines the proposed management commentary framework. Investors often say they need more company-specific information, so the proposed framework does not offer a checklist of information to include. Instead, it takes what the IASB refers to as ‘an objectives-based approach’, which aims to give companies the flexibility to tell their story while allowing regulators to assess compliance with the revised practice statement.
This objectives-based approach has been applied to six areas of interrelated content identified as central to management commentary. These are:
- the entity’s business model – how the entity creates value and generates cashflows
- strategy – the entity’s strategy for sustaining and developing its business model
- resources and relationships – the resources and relationships the entity relies on for its business model and strategy (including assets not recognised in the financial statements)
- risks – the risks that could disrupt the business model or strategy, resources or relationships
- external environment – how this has affected, or could affect, the entity’s business model, strategy, resources/relationships and risks
- financial performance/position – information on the performance and position included within the financial statements
Material information will relate to matters that are fundamental in creating value and generating cashflows
This objectives-based approach identifies three types of objective, applying each across the six areas identified above.
The first is headline objectives, which target the information that gives users an overall understanding of an area.
The second refers to something called assessment objectives, where there is sufficient information about an area to allow the investor to make an assessment about the entity based on the disclosure. This means that a preparer of management commentary should be thinking of more than providing the simple information that explains each area.
To illustrate how entities would produce information that satisfies the assessment objectives, consider the information provided about the entity’s business model and the resources and relationships. To meet the headline objectives of the information, the entity would need to explain the overall business model and discuss key resources and relationships in meeting those. To satisfy the assessment objectives, the preparer should look at the business model information provided and ask whether it allows a user to assess how effective the entity has been or how scalable the business model is. Sufficient information should be provided for users to assess the extent to which the entity relies on key resources or relationships, and possibly to judge the entity’s ability to maintain these.
The final objective type outlined by the proposal are specific objectives, which cover the more detailed needs of investors and creditors. Information that satisfies these objectives could cover such items as factors regarding financial resources, social and environmental factors, and progress towards target.
The six areas are interrelated and won’t necessarily be produced under those headings. The major guidance from the IASB comes back to the concept of materiality – that information is material if its omission or misstatement would affect the economic decisions of the user. The IASB believes that material information in the context of management commentary will relate to matters that are fundamental in creating value and generating cashflows.
The proposed new framework would remain guidance and not be compulsory. Similar to the existing practice statement, the framework would be used as a basis for businesses that are required by regulators to produce such information or voluntarily choose to do so.
There is clearly plenty of scope for judgment in what information could be included under this proposed framework, but the hope is that the revised practice statement will give a more detailed framework for preparers to refer to when producing management commentary.
The deadline for comments on the exposure draft is 23 November 2021.
Watch Adam Deller’s short video on IAS 36, Impairment of Assets