Dean Ardern, Accounting Technical Director, Pitcher Partners September c) the IASB, to improve disclosure requirements.

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1 The Disclosure Initiative Principles of Disclosure Discussion paper the latest instalment in the IASB's march towards 'Better Communication in Financial Reporting' Dean Ardern, Accounting Technical Director, Pitcher Partners September 2017 In March this year, the International Accounting Standards Board (IASB) published for public comment its Discussion Paper DP/2017/1 Disclosure Initiative Principles of Disclosure. The DP represents the IASB s response to feedback received in 2013 at its public Discussion Forum on Financial Reporting Disclosure and through its 2015 Agenda Consultation that financial statements are increasingly perceived as burdensome to prepare and fail to meet the needs of existing and potential investors, lenders and other creditors ("primary users"). The main objectives of the DP are to identify disclosure issues and (ultimately) develop new, or clarify existing, disclosure principles in IFRS to address those issues, as well as to assist: a) entities, to apply better judgement and communicate more effectively b) users, by improving the effectiveness of disclosures and c) the IASB, to improve disclosure requirements. While the objectives of the DP suggest it could potentially cover a wide range of issues, the IASB has limited the scope of the DP to those issues constituents identified during the aforementioned consultation forums. The DP also confirms that any changes arising from the DP would take the form of either amendments to parts of IAS 1: Presentation of Financial Statements or else the publication of a new Standard that would replace parts of IAS 1. The DP might also result in the development of some non-mandatory guidance. What is the disclosure problem? The DP identifies the following three main constituent concerns about information disclosed in general purpose financial statements:

2 a) insufficient relevant information is being provided to facilitate appropriate investing and lending decisions b) too much irrelevant information is being provided, which obscures relevant information and imposes unnecessary costs on preparers and c) information is not being communicated in an effective manner. The DP identifies a number of causes for these concerns, including: a) the tendency to treat financial statements primarily as compliance documents, rather than as a means of communication with users b) a general lack of guidance in Standards on the content and structure of financial statements c) the absence of clear disclosure objectives in some Standards and d) the predominance in some Standards of long lists of prescriptive disclosure requirements. Consequently, rather than being subject to professional judgement and the resulting information being tailored to reflect the sui generis nature of the entity, disclosure requirements are treated by some entities, auditors and regulators as checklists to be applied mechanically. In light of these concerns, the IASB acknowledges that disclosure principles could help to address the disclosure problem, but significant improvements in the effectiveness of financial statements will only be achieved with a change in the mindset of those parties that currently treat financial statements primarily as compliance documents. What disclosure issues does the DP specifically address? The DP covers a number of topic areas related to the disclosure problem, including: a) principles of effective communication b) the respective roles of primary financial statements and notes c) the location of information and the provision of non-ifrs information d) the presentation of performance measures and e) the development of centralised disclosure objectives. Two areas of consideration in the DP that have the potential to both significantly and immediately impact on the length of, and detail provided in, financial statements are the provision of IFRS information outside the financial statements and the disclosure of accounting policies, which are discussed further below. Providing IFRS information outside the financial statements Providing IFRS information outside the financial statements is a direct way of reducing the preparation burden as well as enhancing the effectiveness of financial statements, particularly where regulatory requirements overlap with IFRS disclosure requirements. For

3 Australian listed entities, a prime example of such an overlap is where the legislative requirements applicable to remuneration reports meets the disclosure requirements in AASB 124: Related Party Disclosures. As a number of IFRS currently permit entities to provide specific IFRS information outside the financial statements, the debate has clearly moved beyond "should any IFRS information be available outside the financial statements?" to "when?", "where?" and "how?". The DP notes that the views among constituents differ as to when entities are permitted to incorporate IFRS disclosures in financial statements by way of cross-reference, ranging from only in the current limited exceptions specified in IFRS right through to any circumstance where IFRS information is provided outside the financial statements but within an accompanying or associated document (such as a directors report or management commentary). This diversity of views is unsurprising given the increasingly electronic (and potentially enduring) nature of our public communications. As outlined in the DP, the IASB s preliminary view is that a general disclosure Standard should include a principle that information necessary to comply with IFRS can be provided outside the financial statements so long as such information: a) is provided within the entity s annual report b) its location outside the financial statements makes the annual report as a whole more understandable, the financial statements remain understandable, and the information is faithfully represented and c) is clearly identified and incorporated in the financial statements by means of a cross-reference. While such proposals have the capacity to improve the effectiveness of financial statements, they do raise some issues, as outlined in the DP, including: a) excessive use of cross-referencing, rendering financial statements both fragmented and difficult to understand b) discerning which information has been subject to audit c) locating and accessing cross-referenced information, particularly if the information is located outside of a single reporting package d) specifying the boundaries of an annual report, including whether it encompasses documents accompanying but not part of the document including the financial statements and e) dealing with similar but not identical legislative/regulatory and IFRS disclosure requirements. Disclosing accounting policies IAS 1 currently requires entities to disclose the accounting policies used if disclosure would assist the users in understanding how transactions, other events and conditions are reflected in the financial statements. IAS 1 also requires the disclosure of accounting policies that are significant because of the nature of the entity s operations, notwithstanding

4 that the resulting reported amounts may not be material. Unsurprisingly, constituents view these requirements as generally diminishing the effectiveness of financial statements because they do not facilitate entities distinguishing: a) significant accounting policies from all other policies, including descriptions of mandatory requirements in IFRS and b) policies that involve management choices, significant judgements and/or estimates from those that don t. Disappointingly, the IASB s response to these concerns is to focus on developing additional requirements in a general disclosure standard rather than contemplating alternative solutions. One such alternative solution would be to require entities to disclose, in addition to an explicit and unreserved statement of compliance with IFRS, all accounting policies that involve management choices, significant judgements and/or estimates. Another solution, as suggested by the Joint Working Group of the Institute of Chartered Accountants of Scotland and (as it was then) the New Zealand Institute of Chartered Accountants (Losing the Excess Baggage), would be to permit entities to disclose their accounting policies outside the financial statements, such as on the entity s website. While either approach could dramatically reduce the average length of financial statements, both would require a significant shift in the IASB s conception of a primary user as well as its conception of a complete set of financial statements. The IASB s focus on developing additional requirements stems from its presumption that the primary users of financial statements are not IFRS experts. Accordingly, the IASB s preliminary view is that accounting policies should be considered significant, and therefore disclosed, if their disclosure is necessary for primary users to understand the information in financial statements. Consequently, few, if any, accounting policies are rendered insignificant under this conception. The IASB s presumption that primary users are essentially unsophisticated is arguably at odds with both the length of time IFRS have been in existence and the breadth and depth of consultation and outreach activities the IASB has undertaken since Moreover, this presumption is arguably unsophisticated in itself. While some retail investors might (as the DP notes) consider the disclosure of all accounting policies used in preparing the financial statements as beneficial, it s unlikely they would expect an equivalent level of disclosure in other economic exchanges. For instance, would primary users expect their builder to provide a detailed description of the construction techniques used to build their new home?

5 What pieces of the disclosure puzzle are missing from the DP? The capacity of the DP to elicit meaningful solutions for the disclosure problem is constrained by the absence of any meaningful guidance on the application of materiality in the context of disclosures. The DP notes that the IASB is currently undertaking two separate projects on materiality as part of its wider Disclosure Initiative project. Nevertheless, the DP s questions can only be addressed by respondents in the context of the current definition of material, which fails to provide a meaningful basis for distinguishing between: a) information to be included in the primary financial statements from information to be included in the notes or b) information to be included in the notes from information to be excluded from the financial statements altogether. While the compliance/checklist mentality might be a significant driver of many reporting behaviours, the DP fails to acknowledge the role information asymmetries and other similar risks (both real and perceived) play in the interpretation and application of disclosure requirements, and how the absence of meaningful guidance on materiality to resolve the include/exclude question might lead many entities, auditors and regulators to favour inclusion (leading to clutter and overload) over exclusion (leading to transparent and useful). Written comments on the DP are due to the IASB by 2 October A copy of the DP is available from ifrs.org