Changes to the Income Statement Changes to the Income Statement Changes to the Income Statement

One important area of discussion among investors and preparers at present focuses on the International Accounting Standards Board’s (the Board) proposals to re-shape the way financial statements are presented under IFRS® Standards, particularly the income statement. 

These proposals, which aim to improve the usefulness of financial statements to investment decision makers, were issued in December 2019 and remained open for stakeholder comment until the end of September 2020. If the proposals are adopted, a new IFRS Standard would be issued to replace IAS®1 ‘Presentation of Financial Statements’.

Shortly before the close of the comment period we discussed the key points in the Board’s exposure draft (ED) with investors and analysts to better understand the views of its target audience.

The discussion centred on four key proposals in the ED.

·   Defined subtotals in the income statement

·   Analysis of operating expenses by nature and function

·   Management performance measures

·   Disclosure of unusual items

The proposed changes are explained in detail in this article by KPMG’s International Standards Group. Here, we’ll outline the range of views expressed by the investors and analysts present at our discussion.

Defined subtotals in the income statement

The Board’s proposals in this area aim to add consistency to income statement presentation. At present, there is no consistent definition of any profit measures above the ‘profit before tax’ line. As a result, the structure and content of income statements varies from one company to another, which hinders comparison.

Consistent definitions: Participants generally welcomed the proposal to introduce consistent definitions to three profit measures between the ‘revenue’ and ‘profit before tax’ lines in the income statement – two of which are operating profit and profit before financing and income tax.

‘Integral’ vs ‘non-integral’: The third new defined subtotal – ‘operating profit and income and expenses from integral associates and joint ventures (JVs)’ – received a much cooler welcome from attendees.

As the name suggests, it would require preparers of financial statements to analyse JVs and associates according to whether they were ‘integral’ or ‘non-integral’ from the preparer’s perspectives. This would be a new judgement area which ‘adds little value’ according to participants in our discussion, noting its potential to generate inconsistencies in accounting treatment.

Labelling of categories: Some participants noted that the proposed new categories used to classify items in the income statement (i.e. operating, investing and financing) are identical to those used in the cash flow statement; however, the categories themselves are not aligned. This may be confusing for financial statement users.

Analysis of operating expenses by nature and function

The Board proposes new requirements for disaggregating information in the income statement: companies would present an analysis of operating expenses, either by nature (e.g. ‘raw materials used’, ‘employee benefits’) or by function (e.g. cost of goods sold, general and administrative expenses), using whichever of these methods provides the most useful information to financial statement users. An analysis of operating expenses by nature would always be given, either in the income statement or in the notes.

Some participants expressed that they would benefit from having income statement information presented both by function and by nature – i.e. by function on the face of the income statement, and by nature in the notes.

However, some reservations were expressed about the current proposals, well-intentioned though they are.

Rigidity: Some noted that the proposals would impose a rigid structure which could prevent material items from being presented on the face of the income statement, reducing its usefulness.

No more columns: Preparers in several jurisdictions (including the UK) use a multi-column income statement format to reconcile GAAP and non-GAAP financial measures. Under the proposals this would no longer be permitted, yet several of our participants consider this format to be a useful income statement presentation method that does not distort the underlying economic reality.

Restructuring costs: Participants identified a need for further clarification, as restructuring costs often straddle both by-nature and by-function disclosure.

Management performance measures

The proposals introduce a new definition of management performance measures (MPMs), which are subtotals of income and expenses that:

·   Are used in public communications outside financial statements;

·   Complement totals or subtotals specified by IFRS Standards; and

·   Communicate to users of financial statements management’s view of an aspect of an entity’s financial performance.

Transparency: MPMs are an important means of presenting financial information but investors and analysts often bemoan a perceived lack of transparency, which participants believe would be addressed by the ED’s call for disclosure of MPMs in the notes to the financial statements along with a new requirement to reconcile  to the most directly comparable total or subtotal specified by IFRS Standards.

Scope: Some participants questioned whether the scope of the proposals is too narrow, indicating that many commonly-used performance measures would not be covered – particularly ratios and margins, or cash-flow performance measures. 

Disclosure of unusual items

The Board proposes introducing a new definition of ‘unusual items’ to improve consistency and transparency in financial statement disclosures. Items of ‘limited predictive value’ – i.e. those for which it is ‘reasonable to expect that income or expenses that are similar in type or amount will not arise for several future annual reporting periods’ – can be classified as unusual under the proposals.

Participants generally concluded that although the new definition is well-intentioned, a new label might not be necessary – consistent disclosure of lumpy or potentially unusual items could be more valuable than a new prescriptive definition of unusual. Other potential issues identified covered how to:

·   Add precision to the meaning of ‘similar in type’ and ‘several periods’;

·   Account for unusual items that span more than one accounting period; and

·   Avoid inconsistencies as what it is ‘reasonable to expect’ changes from one period to another. 

Next steps

Overall, we get the impression that users of financial statements consider the proposals in the ED to be a step in the right direction, but that there are also several areas in which additional clarity and further consideration by the Board would be welcome. At the time of writing, the Board intends to consider the feedback on the proposals. We look forward to seeing how this important project progresses in the coming year.