EFRAG TEG Discussion on Consistency in Financial Reporting: Causes and Solutions | Lecture notes Accounting

EFRAG TEG meeting

26 – 27 July 2017

Paper 08-01

EFRAG Secretariat: Patricia McBride

EFRAG TEG meeting 26 – 27 July 2017

Paper 08-01, Page 1 of 3

This paper has been prepared by the EFRAG Secretariat for discussion at a public meeting of EFRAG

TEG. The paper forms part of an early stage of the development of a potential EFRAG position.

Consequently, the paper does not represent the official views of EFRAG or any individual member of the

EFRAG Board or EFRAG TEG. The paper is made available to enable the public to follow the discussions

in the meeting. Tentative decisions are made in public and reported in the EFRAG Update. EFRAG

positions, as approved by the EFRAG Board, are published as comment letters, discussion or position

papers, or in any other form considered appropriate in the circumstances.

Consistency in financial reporting

Objective

1 The EFRAG Board plans to discuss consistency in financial reporting at its meeting

in September. The EFRAG Board’s discussion may include an exchange of views

on the effectiveness of the IFRS Interpretations Committee’s (IFRS IC’s) activities

in enhancing consistency. The objective of today’s session is to seek input from

EFRAG TEG on possible causes of inconsistency in financial reporting and ways to

address those causes.

Issues for consideration

2 Consistency is described in the 2015 Conceptual Framework Exposure Draft as “the

use of the same methods for the same items”. Consistency is related to, but not the

same as comparability. The Conceptual Framework does not include consistency

among the qualitative characteristics of financial reporting, but instead as one of the

factors that contributes to comparability.

3 It is interesting to note that consistency is described in terms of the same methods,

not the same outcomes. Presumably the same method can result in different

outcomes due to the use of different assumptions and estimates. Estimation

uncertainty can be considered as an inherent and, at least to some extent,

unavoidable feature of financial reporting.

4 Comparability is “the qualitative characteristic that enables users to identify and

understand similarities in, and differences among, items”. Comparability is one of

the enhancing qualitative characteristics of financial reporting in the Conceptual

Framework and is also one of the technical endorsement criteria in the IAS

Regulation. It is widely accepted that comparability does not require absolute

uniformity of accounting for the same transactions and events: such an outcome is

clearly impossible to achieve (e.g. due to unavoidable factors such as estimation

uncertainty). Also, pursuing absolute uniformity is likely to undermine the principle-

based nature of IFRS.

5 It follows from the above characterisation that efforts to achieve consistency should

be pursued as far as necessary and/or practical in order to reach a desired level of

comparability, but not as a goal in itself.

6 Putting aside any issues with misrepresentation or other misuse of IFRS Standards,

what factors might lead to inconsistent financial reporting? The preliminary list that

EFRAG Secretariat considers might lead to inconsistency in financial reporting

arising from IFRS Standards is (the list is in no particular order and includes issues

that overlap):

(a) Different interpretations of IFRS Standards. This root cause – which might be

termed ‘interpretive inconsistency’ – is the main focus of the IFRS IC and also

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EFRAG TEG meeting 26 – 27 July 2017 Paper 08- 01 EFRAG Secretariat: Patricia McBride

This paper has been prepared by the EFRAG Secretariat for discussion at a public meeting of EFRAG TEG. The paper forms part of an early stage of the development of a potential EFRAG position. Consequently, the paper does not represent the official views of EFRAG or any individual member of the EFRAG Board or EFRAG TEG. The paper is made available to enable the public to follow the discussions in the meeting. Tentative decisions are made in public and reported in the EFRAG Update. EFRAG positions, as approved by the EFRAG Board, are published as comment letters, discussion or position papers, or in any other form considered appropriate in the circumstances.

Consistency in financial reporting

Objective

1 The EFRAG Board plans to discuss consistency in financial reporting at its meeting in September. The EFRAG Board’s discussion may include an exchange of views on the effectiveness of the IFRS Interpretations Committee’s (IFRS IC’s) activities in enhancing consistency. The objective of today’s session is to seek input from EFRAG TEG on possible causes of inconsistency in financial reporting and ways to address those causes.

Issues for consideration

2 Consistency is described in the 2015 Conceptual Framework Exposure Draft as “the use of the same methods for the same items”. Consistency is related to, but not the same as comparability. The Conceptual Framework does not include consistency among the qualitative characteristics of financial reporting, but instead as one of the factors that contributes to comparability.

3 It is interesting to note that consistency is described in terms of the same methods, not the same outcomes. Presumably the same method can result in different outcomes due to the use of different assumptions and estimates. Estimation uncertainty can be considered as an inherent and, at least to some extent, unavoidable feature of financial reporting.

4 Comparability is “the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items”. Comparability is one of the enhancing qualitative characteristics of financial reporting in the Conceptual Framework and is also one of the technical endorsement criteria in the IAS Regulation. It is widely accepted that comparability does not require absolute uniformity of accounting for the same transactions and events: such an outcome is clearly impossible to achieve (e.g. due to unavoidable factors such as estimation uncertainty). Also, pursuing absolute uniformity is likely to undermine the principle- based nature of IFRS.

5 It follows from the above characterisation that efforts to achieve consistency should be pursued as far as necessary and/or practical in order to reach a desired level of comparability, but not as a goal in itself.

6 Putting aside any issues with misrepresentation or other misuse of IFRS Standards, what factors might lead to inconsistent financial reporting? The preliminary list that EFRAG Secretariat considers might lead to inconsistency in financial reporting arising from IFRS Standards is (the list is in no particular order and includes issues that overlap): (a) Different interpretations of IFRS Standards. This root cause – which might be termed ‘interpretive inconsistency’ – is the main focus of the IFRS IC and also

Consistency in financial reporting

a major focus of Transition Resource Groups for recent major standards. Constituents might arrive at different interpretations for several reasons, ranging from ambiguities or inconsistencies in the Standards, which might require interpretive guidance or standard-setting response, to education needs (see (b) – (d) below). (b) Background and experience. With standards that require the application of judgement, it is very difficult to apply standards to specific transactions without being affected by past experience and education. (c) Rules are easier than principles. It is easier to look for rules and procedures to avoid dealing with uncertainty. It may be that participants in the preparation of financial statements (preparers, auditors, regulators) prefer to apply a rule that seems to be near the issue than to apply judgement to the economics of the transaction or event. (d) Top-down or bottom up. That is, in applying IFRS Standards, some preparers may take a holistic view – analyse the substance of a transaction in the light of the principles in IFRS Standards before moving to the Standards that are relevant to the transaction. Alternatively, the transaction could be approached from the bottom up and each element of the transaction accounted for under the relevant standard without consideration of the overall result. (e) Format of IFRS Standards. Complex transactions often require complex standards, but, in some cases, it is difficult to find the requirements for relatively simple transactions. If accounting for simple transactions is unnecessarily difficult, people will not be encouraged to look for the way to approach complex transactions. (f) Explicit flexibility in IFRS Standards. IFRS Standards provide many explicit accounting policy choices, practical expedients, transition options and other areas of explicit flexibility. A topical example is IAS 1’s flexibility in the precise formats for the primary financial statements. Some argue that fixed formats for the primary financial statements may reduce inconsistency. Fixed formats clearly have a role to play in making information in the financial statements more accessible. It is not clear whether fixed formats would make the information more consistent. (g) Implicit flexibility in IFRS Standards. As well as explicit or stated flexibility in IFRS Standards, some degree of flexibility is implied by broader ‘gaps’ in the Standards (e.g. business combinations under common control) or narrower topics on which the IASB has, deliberately or otherwise, provided limited or no guidance (e.g. how to account for a change in an interest in an associate in accordance with IAS 28).

Question for EFRAG TEG 7 Can EFRAG TEG identify other possible causes of inconsistency in financial reporting?

And the solution is?

8 Issue (a) relates in part to the IFRS IC’s process and the IASB’s wider initiatives aimed at implementation. While some constituents have questioned whether the IFRS IC is sufficiently active to drive the degree of consistency they consider to be necessary or desirable, EFRAG has expressed caution over suggestions to increase the output of interpretive material. For example, in our response to the 2015 IFRS Foundation Review of Strategy and Effectiveness, we stated: “EFRAG is of the opinion that standards should articulate clear principles and be written in a

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Consistency in financial reporting