At a glance
- Debate surrounds what should be in the hard numbers of financial statements and what should be in the surrounding commentary.
- Due to the way new standards are being written, accountants require a solid understanding of risk management issues.
- Issues such as accounting for climate change and cryptocurrencies remain a challenge for standard-setters.
Accounting standards are designed to make the principles and requirements clearer for financial report preparers and investors alike. International-based financial reporting (IFRS) continues to evolve as standard-setters seek to address the demand for more and better information in financial statements.
Debate continues around what should be in the hard numbers and what should be in the commentary accompanying financial statements. Corporate value associated with intangibles remains a challenging area for capture in financial statements. What is the effect of climate change on corporate bottom lines, and should cryptocurrencies be included as assets?
Sue Lloyd, vice-chair of the London-based International Accounting Standards Board (IASB), and Kris Peach FCPA, chair and CEO of the Australian Accounting Standards Board (AASB) have overseen some major changes in accounting standards in recent years, and they can see new challenges on the horizon for the profession.
Lloyd says that because of the way the new standards are written, being a good accountant requires enhanced skills, such as a better understanding of risk management – expected credit losses for example.
“Accounting used to be very rules-based, but to account for loan-loss provisions [under IFRS 9 Financial Instruments], you need to understand risk management and know how the business is run. It’s far more interesting than it was in the past.”
Lloyd and Peach believe accountants are becoming more important and more involved with the front office.
Peach notes that companies such as Wesfarmers are asking how they can improve documents, so they are not just ticking the boxes and submitting a stock annual report as required by the Australian Securities and Investments Commission (ASIC).
“They’re creating a document that talks to investors, and that requires a different mindset. With the standards we’re writing, it means you have to apply judgement far better than under a rules-based regime. Softer skills are becoming important.”
Lloyd says disclosure of management performance measures (MPMs) in financial statements is now on the standard-setter’s radar.
“It is very valid for management to have a perspective on core performance – typically they’ll come out with some sort of operating profit metric, such as EBITDA or core performance-type metrics emphasising underlying earnings. However, you have to be careful they’re not just stripping out all the bad news and focusing on the good.”
Ultimately, investors must decide whether the numbers presented (as MPMs) are the correct ones for valuing the company now and further out.
Peach says it can be difficult for investors to separate the non-IFRS MPMs from IFRS-based measures.
“Financial reporting is trying to address two areas,” she says. “How do we make you accountable for decisions you made last year, and the look-forward approach – what’s in here that has some ongoing importance? These two concepts are blended, and it’s very hard for an investor to split out and say, ‘Here’s the piece where you’re telling me about accountability, and here’s the piece where you’re telling me what’s going forward’.”
However, Peach says bringing MPMs of what the future may look like into the IFRS-based financial statements meets the changing expectations of investors. “It will now be audited and have more credibility.”
Accounting for climate change
In terms of looking forward, few topics would be as controversial and challenging as accounting for the effects of climate change. The IASB’s project on management commentary guidance is seeking to address such challenges. It seeks to make sure that when climate risk may affect the future value of a company, this information is provided to investors.
Lloyd says that there could be a risk that a coal miner, for example, may have to shut operations in 10 years, and the management commentary needs to inform investors of the risk. However, it’s less clear how to calculate a financial number for a potential loss in value, even though that is what financial markets will be seeking.
“Some of the valuation experts are beginning to flag climate risk, but it’s probably in the discount rate,” Peach says.
However, she notes that this is not necessarily simple. “It’s not always that easy to pull out and say, ‘This is the impact’. Reporting is not at the point where we can say ‘x per cent’ of the discount rate is that [climate change related risk]’.”
Peach notes the Commonwealth Bank of Australia included a note on climate change in its 2018/2019 annual report, saying it didn’t believe there was any material impact on loan portfolios.
“We now have a bank making mention of how the climate might affect loans – for the first time.”
Cryptocurrencies are another puzzle for the standard-setters, with Facebook the latest in line with an announcement to launch its Libra currency in the coming year.
The IASB has considered requests for accounting direction on how to account for crypto assets and currencies, but has decided to monitor it rather than to include this on its standard-setting program for the moment.
“However, there have been some agenda decisions from our Interpretations Committee that provide some guidance on how to account for cryptocurrencies,” Lloyd says.
“Usually, you have to apply the intangible standard [IAS 38], unless it is inventory.
“There are also questions on cloud computing arrangements, so we’re getting more questions on digital related accountancy questions. Do cryptos meet the definition of cash? At the moment – according to the IASB – they don’t because they’re not used in an exchange transaction frequently enough.
Lloyd acknowledges, however, that over time this could change. Peach says there is a gap in the accounting standards for intangible assets held as investments.
While accounting standards deal with intangible assets, they don’t let you recognise or revalue them so they are fully reflected on the balance sheet. If they are revalued, it is through a revaluation reserve, and many don’t think that is the right answer. It’s not just cryptos; it relates to things like emissions trading and carbon credits. Many believe it would be better if some of these valuations went through the profit and loss statement.
To date, the IASB has rejected this suggestion. Lloyd says it has to choose the number of projects it can work on at any time. There are questions about whether cryptocurrencies will survive and develop, and whether a crypto project is a good use of resources when you can’t work on everything.
Globally, a standards jamboree
Work continues to develop and maintain a set of IFRS standards for all 144 IFRS jurisdictions that require their use for all or most domestic publicly accountable entities.
Lloyd acknowledges that it’s a complicated business.
“We have a diverse audience and we hope that the feedback we get while we develop standards works in different environments. We’re answering questions through the Interpretations Committee and we have an emerging economies group – the EEG – which meets a twice a year with standard-setters from emerging economies to deal with their specific questions.
“There is a world standard-setters’ meeting once a year, where all the standard-setters come [together] and it gives everybody an opportunity for input,” she says.
“It’s a jamboree of accounting!”
Is it a problem that China is not one of the 144 adherents to IFRS? Lloyd says that China is “substantially converged” with the standards, with the Chinese version of the standards very similar to IFRS.
“The Chinese are very close to our standards, but because they don’t use the same words, we don’t include them in the official count of 144 jurisdictions. We’re hoping they’ll take that final step.”
Lloyd says Japan is interesting in allowing listed companies to choose whether they want to apply Japanese GAAP (generally accepted accounting principles), IFRS, US GAAP or the Japanese version of IFRS – JMAS.
An increasing number of listed companies in Japan are using IFRS – more than one-third of the total market value capitalisation.
Maintaining standards for various jurisdictions is just one of the challenges facing IFRS. Accounting for climate change and cryptocurrencies continues to be a topic of debate and an understanding of risk management will be a vital skill for accountants in the future.
Sue Lloyd and Kris Peach have overseen the introduction of new IFRS standards on revenue, financial instruments, leases and insurance contracts. How do they feel the implementation has progressed?
Sue Lloyd: It’s a big change in accounting and in systems, and the extent of change has differed by company. The financial instruments standard brought in a new approach for impairment for loans – that was a big change for banks. The revenue standard was a big change for corporations, particularly those with long-term contracts. The leasing standard, which now brings operating leases onto the balance sheet, is not difficult accounting, but there are lots of requirements to capture lots of data, so it’s systems-intensive.
Kris Peach: For the revenue and the leases standards, companies have benefited because they found there were a lot of things in their contracts that they actually didn’t know.
SL: We’ve heard of people who continued to make payments on leases that expired – they had to catch the information from the systems, and also people have found in their revenue contracts terms that have been agreed to by sales people that were news to head office – it’s given many a better understanding of their businesses.
What has been the preparers’ response?
SL: The banks have been very positive about this. Because we’ve added in the new impairment accounting for loans – which a number of banks wouldn’t have done if they had a choice – they’re now saying that the risk experts are working more closely with the financial reporting people, with an overall better understanding of credit risk throughout the organisation and at board level. They’re now talking about future credit losses, and that’s [good] news.
KP: You only manage what you measure. When it’s off the balance sheet and not accounted for, it’s easy to ignore, but when it’s front and centre, on the balance sheet or in your profit and loss statement, suddenly you need to understand what’s going on.