The views expressed in this presentation are those of the presenter, not necessarily those of the International Accounting Standards Board (the Board) or IFRS Foundation. Copyright © IFRS Foundation. All rights reserved

IFRS® Foundation

IASB engagement with academics

Anne McGeachin Technical Principal and Academic Relations

October 2016

2 Overview

•  IASB engagement with academics –  standard-setting process –  evidence-informed decision making –  academic research

–  bridging the gap between the academic community and the IASB

•  Case study on operating profit

2

3 3 IFRS Foundation

Standard-setting process

Copyright © IFRS Foundation. All rights reserved

4 The standard-setting process today

4

5 Research programme •  A broad research and development programme

–  low threshold to get onto the programme –  high threshold to progress further

•  Emphasis on defining the problem –  identify whether there is a financial reporting matter that

justifies an effort by the IASB –  evidence-based

•  The programme is designed to shorten the time needed to develop improvements to financial reporting, by:

–  clarifying the problem up front, before a solution is developed –  feeding manageable projects into

the Exposure Draft phase on a timely basis

5

6 Research topics

•  Potential issues come from: –  agenda consultation –  IFRS Interpretations Committee –  on-going outreach

•  These are issues people want us to think about

6

7 Outcomes

•  A recommendation to: –  propose a change to IFRS –  put a project on hold, for the time being

–  resourcing –  other factors

–  stop working on the issue –  develop education or support material

7

8 Current research programme

•  Principles of Disclosure •  Primary Financial Statements •  Business Combinations under Common Control •  Dynamic Risk Management •  Financial Instruments with Characteristics of Equity •  Goodwill and Impairment •  Discount Rates •  Share-based Payment

9 9 IFRS Foundation

Evidence-informed decision making

Copyright © IFRS Foundation. All rights reserved

10 Where evidence is helpful •  Identifying financial reporting problems

–  Financial reporting differences –  Scale –  Evidence of estimation error

•  Assessing solutions –  Surveys –  Decision experiments –  Evidence of how information is incorporated by markets –  Fieldwork

–  Systems testing –  Testing draft words –  Financial statement simulations

•  Implementation –  Evidence of diversity

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11 Sources

•  IASB initiated work –  Fieldwork – Reviews of financial statements – Modelling

•  Independent research – Extant literature –  Fostering new research

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12 Opportunities

•  IASB – Get a broader range of (different) perspectives – Better decision making

–  Better informed decisions –  Ability to defend decisions

•  Academics – Potential for research to have an observable effect

•  Both – Get a better understanding of each others needs – Reduce the expectation gaps

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13

Problem areas in using academic research

•  Timeliness

•  Vast literature

– Only tangentially relevant

– Or very narrow, marginal contribution

– Need synthesis / literature review

•  Not accessible to standard setters

•  Needs interpretation

•  Need to understand limitations

•  Overclaiming results

14 Pitfalls for us to avoid

•  Selectivity bias – We might cite tiny number of papers, only favourable.

•  How to summarise what we have read

•  Biased population

– Non-English

– Non Anglo-Saxon

– Not just empirical capital markets

15 15 IFRS Foundation

Bridging the gap between the academic community

and the IASB

Copyright © IFRS Foundation. All rights reserved

16 Bridging the gap between the academic community and the IASB

•  Research centre on IASB website •  Annual research forum •  External research funding

–  IAAER-KPMG funding –  ICAS calls for research

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17 Research centre on IASB website

•  IASB External Research Website http://www.ifrs.org/IFRS-Research/Pages/IFRS-Research-Centre.aspx

•  Evidence-supported standard-setting – Explanations of when, and how, we use research

•  Research opportunities – Awareness of work programme and specific issues

–  Topics –  Timing

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18 Research centre on IASB website

•  Research impact – When we have used research

•  News and events – Summary of IASB discussions of projects on its research

programme – Events

18

19 Annual Research Forum •  2014 event

–  in conjunction with Accounting and Business Research –  held at SAID Business School, Oxford University, UK –  focused on Conceptual Framework

•  2015 event –  in conjunction with Accounting and Finance, AFAANZ –  held in Hong Kong –  broad range of topics

•  2016 event –  in conjunction with Contemporary Accounting Research –  held at Waterloo, Canada –  broad range of topics

•  2017 event –  in conjunction with European Accounting Review and Accounting in Europe –  held in Brussels, Belgium –  broad range of topics

19

20 20 IFRS Foundation

Case study on operating profit

Copyright © IFRS Foundation. All rights reserved

21 Background: IAS 1 and common practice

•  IAS 1 Presentation of Financial Statements does not require entities to present an operating profit subtotal.

•  However, many entities choose to present an operating profit subtotal.

22 Background: inconsistent structure

•  We observe inconsistencies in structure even within the same industry:

Company A Company B Company C Company D Revenue Revenue Revenue Revenue

Cost of goods sold Cost of goods sold Operating expenses

Distribution cost Selling cost (including marketing costs)

Marketing and administrative costs

General and administrative cost

R&D cost R&D cost

Other cost Other cost

Adjusted operating profit Adjusted operating profit Adjusted operating profit

Non-recurring items Non-recurring items Non-recurring items

Operating profit Operating profit Operating profit Operating profit

Classification and disaggregation of items vary among peer companies

23 Background: lack of comparable subtotals

•  ‘Operating profit’ subtotal is not comparable:

Company E Company F Company G Company H Revenue Revenue Revenue Revenue Operating expenses Operating expenses Operating expenses Operating expenses Interest cost of pension Interest cost of pension

Share of result of associates Operating profit Operating profit Operating profit Operating profit Financial income/ expense Financial income/ expense Financial income/ expense Financial income/ expense

Interest cost of pension Share of result of associates Share of result of associates Tax Tax Tax Tax

Share of result of associates Profit Profit Profit Profit

Entities create their own structure and content ‘to tell their story’

24 Background: performance measures are confusing

•  Even among companies in the same industry, ‘adjusted operating profit’ is not consistent, comparable, or transparent:

Adjustments made to operating profit

Peer companies in the same industry Company I Company J Company K Company L

Acquisition related cost Yes Yes Yes Not clear Amortisation of intangibles Not clear No Not clear Yes Restructuring No Not clear Yes Not clear Impairment of PPE No Yes Not clear Not clear Impairment of intangible No Yes Not clear Not clear Impairment of goodwill Yes Yes Yes Not clear Disposal of PPE No Not clear Not clear Yes Disposal of business Yes Yes Yes Not clear Litigation cost No Not clear Yes Not clear

Yes The company adjusts the item when calculating the adjusted operating profit.

No The company does not adjust the item when calculating the adjusted operating profit.

Not clear The company’s policy was not clear on the footnote disclosure.

25 Background

Hans Hoogervorst recently said:

“We probably need to define more subtotals in the income statement.

We may need to provide a principle-based definition of operating

income which does not allow for obfuscating restructuring or

impairment charges. We may need to create a rigorous definition of

the commonly used non-GAAP metric EBIT. We may have to do all

of the above—and maybe more.”

25

26 Goals •  Users want:

–  comparability between entities –  consistency over time –  a starting point for their analysis that requires relatively few adjustments –  ability for management to tell their story

•  Preparers want: –  flexibility

–  to tell their story –  to meet market expectations

•  IASB wants: –  to respond to needs of users –  to make sub-totals in profit or loss more useful

26

27 Possible principles

•  Objective: –  inclusive performance measure –  business model/ core performance measure –  enhancing predictive value

•  Nature of items: –  operations vs. financing or investing –  core business vs. non-core business –  recurring items vs. non-recurring items –  inside management control vs. outside management control

27

28 The case study

•  Objective –  To provide evidence to the Board about whether it is possible to

define operating profit.

•  Information – You are provided with the consolidated statement of profit or

loss of a manufacturing company London Plc. – You are also provided with information about income and

expenses that needs to be included in London Plc’s consolidated statement of profit or loss.

28

29 The case study •  Tasks

1.  Discuss what you think should be the main principles determining operating profit.

2.  Using the Excel spreadsheet provided insert an operating profit line in London Plc’s consolidated statement of profit or loss.

3.  For each item of income and expense described, decide whether it should be included in arriving at operating profit in London Plc’s consolidated statement of profit or loss. When deciding: –  Avoid discussing measurement and recognition aspects of

existing IFRS Standards and Interpretations. –  Other comprehensive income items are not eligible for being

included in the calculation of operating profit.

29

30 Expected feedback

•  Each group is asked to submit: –  The main characteristics of operating profit. –  London Plc’s revised consolidated statement of profit or loss showing

the calculation of operating profit. –  The reasons why, or why not, each item of income or expense is

included in operating profit.

30

31 London Plc – Incomplete consolidated statement of profit or loss 31

•  The above consolidated statement of profit or loss should be adjusted for the items on slide 32.

32 Income and expenses to be included in London Plc’s Consolidated statement of profit or loss 32

INCOME / EXPENSE No NATURE OF INCOME OR EXPENSE EXAMPLES AMOUNTS IN CU

1 Other income or expense a)  Gains on sales of property, plant and equipment;

and b)  Gains on disposals of intangible assets

a)  1000

b)  500

2

Significant event

An accident occurred at one of London Plc’s factories causing an oil spill.

(300)

3 Impairment charge (non-cash item) a)  Goodwill impairment; b)  Inventory impairment; and c)  Property, plant and equipment impairment

a)  (500) b)  (700) c)  (950)

4 Restructuring Relocation of business activities (300)

5 Post-employment benefits Three components of the pension cost other than actuarial gains.

a)  (450) b)  (10) c)  (50) d)  Any sum of the above 6a), 6b) or/and 6c)

33 Item 1: Other income or expenses •  London Plc sold property, plant and equipment. London Plc is

required to recognise gains on sales of the property, plant and equipment of CU1,000.

•  London Plc disposed of intangible assets. London Plc is required to recognise gains on disposals of intangible assets of CU500.

33

Question 1: a)  Would you include the gains on sales of property, plant and

equipment of CU1,000 in operating profit? Why or why not? b)  Would you include the gains on disposals of intangible assets of

CU500 in operating profit? Why or why not?

34 Item 2: Significant event •  An accident occurred at one of London Plc’s factories

causing an oil spill. London Plc is required to rectify the damage caused by the oil spill.

•  A liability for the costs of rectifying the oil spill of CU300 is required to be recognised.

34

Question 2: Would you include the costs of rectifying the damage caused by the oil spill of CU300 in operating profit? Why or why not?

35 Item 3: Impairment •  Goodwill impairment

London Plc has a wholly-owned subsidiary that is a separate cash-generating unit (CGU).

A sudden and unexpected change in consumer demand occurs and London Plc’s subsidiary cannot respond to it. No restructuring plan is in place yet.

London Plc decided that the carrying amount of the CGU has declined by CU500. London Plc is required to recognise an impairment loss of CU500. 100 per cent of the impairment loss will all be allocated to goodwill.

35

Question 3: a)  Would you include the goodwill impairment loss of CU500 in

operating profit? Why or why not?

36 Item 3: Impairment •  Inventory impairment

London Plc estimates that the net realisable value of its night-vision systems inventory is below cost, due to a decline in selling prices. London Plc is required to recognise an impairment loss of CU700 so that the inventory is carried at its net realisable value.

36

Question 3: b)  Would you include the inventory impairment loss of CU700 in

operating profit? Why or why not?

37 Item 3: Impairment •  Property, plant and equipment impairment (PPE)

London Plc decides that the recoverable amount of an item of plant is lower than its carrying amount. London Plc is required to recognise an impairment loss of CU950

37

Question 3: c)  Would you include the PPE impairment loss of CU950 in operating

profit? Why or why not?

38 Item 4: Restructuring •  Relocation of business activities

London Plc has publicly announced a detailed formal restructuring plan to transfer one of its manufacturing activities to another region where labour costs are lower. London Plc is required to recognise restructuring costs of CU300 associated with this restructuring plan.

38

Question 4: Would you include restructuring costs of CU300 in operating profit? Why or why not?

39 Item 5: Post-employment benefits •  London Plc sponsors a defined benefit pension plan. The components of the pension cost that

are required to be presented in the consolidated statement of profit or loss for the year are: –  Current service cost = CU450 –  Past service cost = CU10 –  Net interest on the net defined benefit liability = CU50 –  Actuarial gains = CU40

•  Actuarial gains should be ignored, since IAS 19 Employee Benefits requires them to be recognised in other comprehensive income (OCI).

•  The past service cost arises from a restructuring plan to transfer its manufacturing activities to another region.

39

Question 5: Which components, other than the actuarial gains, of the pension cost listed above would you include in operating profit? Why or why not?

40 Feedback from case study

•  ????????????????

41 General Question 1 41

Should the Board include consideration of an operating profit and / or similar subtotals? a.  Yes; or b.  No.

42 General Question 2 42

If the Board decides to explore an operating profit subtotal, how do you think an operating profit subtotal might be best described? a.  With a strict definition; or b.  With a principle-based description subject to management judgement

considering the business model and supported by examples; or c.  Free choice for management based on how they wish to communicate

performance to investors.

43 General Question 3 43

If the Board were to require an operating profit subtotal, how should the Board present the non-recurring or other special items with regard to the operating profit subtotal? a.  Include them in the subtotal; b.  Exclude them from it; or c.  Require two subtotals before and after the non-recurring or other special

items.

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