Friday, April 06, 2012

Disclosure and Other Comprehensive Income Are Items on IASB’s Future Agenda Says Chairman Hoogervorst

Issues around disclosure and other comprehensive income are on the upcoming agenda of the IASB, according to Board Chair Hans Hoogervorst. In remarks at the KASB/Korea Accounting Seminar in Seoul, he said that many companies and others are complaining of disclosure overload. This is not entirely due to financial reporting, said the Chair, noting that businesses have become more complex and financial reporting must describe this complexity, not mask it. He also said that not all disclosures provide useful information to investors, citing standard boilerplate disclosure that the Chair called box ticking that does not help investors really understand what is going on. This is an issue that preparers, auditors, regulators and standard-setters will have to tackle together.

The Chair pledged that the IASB would ensure that disclosure requirements are appropriate. While each individual disclosure requirement may have made sense when the standard was first introduced, he noted, the Board will ask if disclosures in totality improve the clarity of financial reporting, or do they make it more difficult to really see what is going on. This will not be an easy exercise, said the Chair, adding that one investor’s disclosure clutter is another investor’s golden nugget of information. Moreover, taking information away is never easy. Nevertheless, feedback from the IASB’s agenda consultation indicates that this is an important area for many respondents, particularly smaller listed companies, many of whom believe that the disclosure overload falls disproportionately on their shoulders.

Separately, the IASB must decide what to do with Other Comprehensive Income (OCI). Everybody is asking the Board to shed more light on it. There are questions about the meaning of OCI and what should be in it, as well as how does it relate to profit or loss. There is also the question of whether the Board should allow recycling.

In June of 2011, the IASB and FASB have aligned the presentation of items of other comprehensive income in financial statements using IFRS and US GAAP. Companies preparing financial statements in accordance with IFRSs must group together items within OCI that may be reclassified to the profit or loss section of the income statement. Items in OCI and profit or loss should be presented as either a single statement or two consecutive statements. FASB has brought US GAAP into alignment with IFRSs for the presentation of OCI.

The changes did not address which items should be presented in OCI or which and when items should be recycled through profit or loss. However, requiring OCI to be presented as part of, or in close proximity to, the profit or loss (income) statement will make it easier for users of financial statements to assess the impact of OCI items on the overall performance of an entity and improve comparability between IFRSs and US GAAP.

Chairman Hoogervorst observed that the biggest fans of the P&L often want to put as much as possible in OCI, so long as it can be recycled to earnings in due time. While it is impossible to anticipate at this time what the outcome of these deliberations will be, the IASB Chair said that the juxtaposition of the P&L and OCI often seems counterproductive. He does not believe that OCI should be regarded as a largely irrelevant number that should preferably be buried in the notes. Other comprehensive income is often of a less certain nature than Profit or Loss, he conceded, but that does not make OCI meaningless. For financial institutions with large balance sheets, he said, OCI can contain very important information. It can give indications of the quality of the balance sheet.

The Chair emphasized the importance of investors knowing what gains or losses are sitting in the balance sheet, even if they have not been realized. OCI can give information on duration mismatches between assets and liabilities; he said, and it can signal sensitivity to interest rate fluctuations. Moreover, since controlling the volatility of the balance sheet is a core task of the management of financial institutions, OCI can be a very important performance indicator.

In addition to providing a clearer conceptual definition of OCI, the Board will also have to tackle the thorny issue of recycling. Globally, there are many supporters of recycling. The main argument for recycling of OCI is that it ensures that the total amount of profit or loss will ultimately be equal to the total amount of cash flows, which the Chair described as a pretty powerful argument. Still, the IASB has never been very enthusiastic about recycling. One of the main reasons for this reluctance is the scope for earnings management in the timing of realizing gains and losses. That is why investors often demand to see profit or loss before recycling where recycling is permitted. They know recycling has the potential of clouding a company’s true performance.