Endorsement of the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income. Introduction, background and conclusions

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1 EUROPEAN COMMISSION Internal Market and Services DG FREE MOVEMENT OF CAPITAL, COMPANY LAW AND CORPORATE GOVERNANCE Accounting Brussels, December 2011 MARKT F3 (2011) Endorsement of the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income Introduction, background and conclusions Attachment 1: Effect study prepared by the European Financial Reporting Advisory Group (EFRAG) Attachment 2: Endorsement advice prepared by EFRAG

2 1. EFFECT STUDY The European Commission has agreed with the European Parliament that effect studies should be prepared for new accounting standards and interpretations up for endorsement in the European Union (EU). The Commission Services together with the European Financial Reporting Advisory Group (EFRAG) prepare these studies containing description of the accounting issues involved, results from stakeholder consultations as well as analysis of effects of using the new accounting rules in the EU. EFRAG has prepared an effect study for amendments to IAS 1 Presentation of Items of Other Comprehensive Income (attached). As the EFRAG effect study refers to the endorsement advice, we also included it in attachments. This cover note contains background information, comments and a conclusion by the Commission Services. 2. BACKGROUND ON THE AMENDMENTS TO IAS 1 PRESENTATION OF ITEMS OF OTHER COMPREHENSIVE INCOME The amendments to IAS 1 Presentation of Items of Other Comprehensive Income IAS 1 prescribes the basis for presentation of financial statements to ensure comparability both with the entity's financial statements of previous periods and with the financial statements of other entities. It sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content. The amendments, issued on 16 June 2011, aim to improve the presentation of the items of other comprehensive income (OCI) in financial statements prepared in accordance with International Financial Reporting Standards (IFRS). The presentation of items of OCI has become more important as the International Accounting Standards Board (IASB) has decided in various projects that entities present particular items of income and expense in OCI. The amendments are the result of the IASB s redeliberations on the Exposure Draft (ED) Presentation of Items of Other Comprehensive Income published in May 2010, and are based on the disclosure requirements proposed in that ED. The document presented by the IASB in June 2011 requires entities: To present separately items of OCI that may be reclassified subsequently to profit or loss (recyclable) separately from those that cannot be reclassified to profit or loss (non-recyclable). To present income tax related to recyclable items of OCI separately from income tax related to non-recyclable items, if OCI is presented before tax. To change the non-mandatory title of the 'statement of comprehensive income' to the 'statement of profit or loss and other comprehensive income'. The amendments to IAS 1 are effective for annual periods beginning on or after 1 July 2012, with earlier application permitted. 2

3 EFRAG consultations EFRAG published its initial draft endorsement advice and effect study report on 28 July 2011 and finalised its advice on 21 October Commentators to EFRAG's consultation agreed with EFRAG s assessment of the benefits of implementing the amendments to IAS 1 and the associated cost involved for preparers and users and supported EFRAG s recommendation that the amendments to IAS 1 should be adopted for use in Europe. 3. EFFECT STUDY Main points identified in the EFRAG effect study Relevance, reliability, comparability and understandability The amendments do not affect the content of OCI (as they do not address the issue of which items should be recognised in OCI or which and when items should be recycled through profit or loss), rather they specify how different types of items should be displayed (how they should be presented). EFRAG notes that the amendments would result in a clear presentation of two types of items of OCI (recyclable vs. non-recyclable items). EFRAG believes that this information is relevant. In addition, EFRAG notes that the amendments satisfy the reliability criterion as they do not involve judgements or estimates. Regarding comparability, EFRAG considers that these presentation requirements would positively affect comparability. Finally, EFRAG believes that the new presentation requirements provide more clarity than those currently in IAS 1 and therefore improve understandability. Costs and benefits for preparers and users EFRAG's analysis provides an overview of the expected incremental costs for preparers and users. With regard to preparers, EFRAG concludes that the first implementation of these amendments is likely to involve an insignificant increase in preparation costs for preparers. This is because the amendments would not require capturing or tracking any new information, rather they would require presenting the existing information in a specified way. EFRAG also concludes that the amendments are likely to reduce users' costs of analysis as they would not need to refer to individual standards in order to determine whether or not an item of OCI can be subsequently reclassified to profit or loss. EFRAG considers that users are likely to benefit from the amendments as the information resulting from them would assist them in their analysis. 4. OVERALL COST-BENEFIT CONSIDERATIONS AND COMMISSION SERVICES CONCLUSIONS On the basis of EFRAG's effect study, the Commission Services have considered the main costs and benefits of endorsing the amendments to IAS 1. The Services conclude that the benefits of the amendments outweigh the costs incurred. The Commission Services believe that the amendments to IAS 1 will have positive costbenefits effects and that it should therefore be endorsed in the EU without delay. 3

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5 Attachment 1: Effect study prepared by the European Financial Reporting Advisory Group (EFRAG) The costs and benefits of implementing the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income Introduction 1 Following discussions between the various parties involved in the EU endorsement process, the European Commission decided in 2007 that more extensive information than hitherto needs to be gathered on the costs and benefits of all new or revised Standards and Interpretations as part of the endorsement process. It has further been agreed that EFRAG will gather that information in the case of the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income (the Amendments). 2 EFRAG first considered how extensive the work would need to be. For some Standards or Interpretations, it might be necessary to carry out some fairly extensive work in order to understand fully the cost and benefit implications of the Standard or Interpretation being assessed. However, in the case of the Amendments, EFRAG s view is that the cost and benefit implications can be assessed by carrying out a more modest amount of work. The results of the consultations that EFRAG has carried out seem to confirm this. Therefore, as explained more fully in the main sections of this report, the approach that EFRAG has adopted has been to carry out detailed initial assessments of the likely costs and benefits of implementing the amendments in the EU, to consult on the results of those initial assessments, and to finalise those assessments in the light of the comments received. EFRAG s endorsement advice 3 EFRAG also carries out a technical assessment of all new and revised Standards and Interpretations issued by the IASB against the so-called endorsement criteria and provides the results of those technical assessments to the European Commission in the form of recommendations as to whether or not the Standard or Interpretation assessed should be endorsed for use in the EU. As part of those technical assessments, EFRAG gives consideration to the costs and benefits that would arise from implementing the new or revised Standard or Interpretation in the EU. EFRAG has therefore taken the conclusion at the end of this report into account in finalising its endorsement advice. A summary of the Amendments Background 4 Items of other comprehensive income include those that can be reclassified subsequently to profit or loss when specific conditions are met, and those that are never reclassified to profit or loss. IFRSs do not contain a principle for determining what can be reclassified subsequently to profit or loss (recycle) and what cannot. These requirements are specified in individual standards. At present, all items of other comprehensive income are presented together regardless of whether they can be subsequently reclassified to profit or loss or not. 5

6 The issue 5 Considering that the number of items being reported in other comprehensive income, particularly items that will not be reclassified subsequently to profit or loss, was likely to increase because of the projects on financial instruments and pensions, the IASB decided that it was necessary to make the presentation of other comprehensive income clearer. What has changed? 6 To achieve greater clarity, the Amendments: (a) (b) (c) Change the non-mandatory title of the statement of comprehensive income to the statement of profit or loss and other comprehensive income (other titles continue to be permitted). Require an entity to present items of other comprehensive income that can be reclassified subsequently to profit or loss (recyclable) separately from those that will never be reclassified to profit or loss (non-recyclable). Require an entity to present income tax related to recyclable items of other comprehensive income separately from income tax related to non-recyclable items, if other comprehensive income is presented before tax. 7 The Amendments do not: (a) (b) Address what is recognised in profit or loss and what is recognised in other comprehensive income; or Address recycling issues, i.e., what can be reclassified (recycled) subsequently to profit or loss and what cannot. The requirements of individual IFRS continue to apply in determining whether an item of income or expense is recognised in profit or loss or in other comprehensive income; and in determining whether or not an item of other comprehensive income can subsequently be reclassified in profit or loss. When do the Amendments become effective? 8 The Amendments become effective for annual periods beginning on or after 1 July Earlier application is permitted. EFRAG s initial analysis of the costs and benefits of the Amendments 9 EFRAG carried out an initial assessment of the costs and benefits expected to arise for preparers and for users from implementing the Amendments, both in year one and in subsequent years. The results of EFRAG s initial assessment can be summarised as follows: (a) Costs for preparers, the Amendments would involve no ongoing incremental costs compared to the existing requirements, but would require some one-off incremental costs to understand and implement the Amendments. These costs are not expected to be significant. For users, the Amendments are not expected to result in any one-off incremental costs, and are likely to result in ongoing cost savings. 6

7 (b) Benefits the Amendments do not affect benefits for preparers in any way, and the users are likely to benefit from the Amendments, as the information resulting from them will assist users in their analysis. 10 EFRAG published its initial assessment and supporting analysis on 28 July It invited comments on the material by 23 September In response, EFRAG received five comment letters. Four respondents agreed with EFRAG s assessment of the benefits of implementing the Amendments and the associated costs involved for users and preparers. The other respondent did not comment specifically on EFRAG s initial assessment of the costs and benefits of implementing the Amendments in the EU, but supported EFRAG s recommendation that the Amendments be adopted for use in Europe. EFRAG s final analysis of the costs and benefits of the amendments 11 Based on its initial analysis and stakeholders views on that analysis, EFRAG s detailed final analysis of the costs and benefits of the Amendments is presented in the paragraphs below. Cost for preparers 12 EFRAG notes that the Amendments do not require capturing or tracking any new information, rather they require presenting the existing information in a specified way. 13 As such, EFRAG s assessment is that the Amendments would involve no ongoing incremental costs compared to the existing requirements. However, some costs would arise as preparers understand and implement the Amendments for the first time, but these costs are not expected to be significant. Costs for users 14 As indicated above, the Amendments do not result in any new information; rather the existing information will be presented in a specified way. 15 At present, users in performing their analysis need to refer to individual standards in order to determine whether or not an item of other comprehensive income can be subsequently reclassified to profit or loss. The Amendments eliminate that necessity, and therefore are likely to reduce the time required for a user to perform an analysis. 16 The Amendments are not expected to result in any incremental costs for users to incorporate the new requirements in their analysis. 17 Overall, EFRAG s assessment is that the Amendments are likely to result in cost savings for users. Benefits for preparers and users 18 The objective of the Amendments is to achieve greater clarity by presenting separately two types of items of other comprehensive income. This would assist users in forecasting future cash flows. 19 The Amendments do not affect benefits for preparers in any way (i.e., benefit neutral). 20 Overall, EFRAG s assessment is that users are likely to benefit from the Amendments, as the information resulting from them will assist users in their analysis. 7

8 Conclusion 21 EFRAG s overall assessment is that the overall benefits of the separate presentation of two types of items of other comprehensive income and associated tax effects are likely to outweigh one-off incremental costs for preparers associated with understanding and implementation of the Amendments. 21 October 2011 Françoise Flores EFRAG, Chairman 8

9 Attachment 2: Endorsement advice prepared by EFRAG Jonathan Faull Director General European Commission Directorate General for the Internal Market 1049 Brussels 21 October 2011 Dear Mr Faull Adoption of the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income Based on the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards we are pleased to provide our opinion on the adoption of the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income (the Amendments), which were issued by the IASB on 16 June The Amendments were issued as an Exposure Draft in May 2010 and EFRAG commented on that draft. The objective of the Amendments is to make the presentation of the increasing number of items of other comprehensive income clearer, and to assist the users of financial statements in distinguishing between the items of other comprehensive income that can be reclassified subsequently to profit or loss, and those that will never be reclassified to profit or loss. The Amendments become effective for annual periods beginning on or after 1 July Earlier application is permitted, however entities shall disclose that fact. EFRAG has carried out an evaluation of the Amendments. As part of that process, EFRAG issued its initial assessment for public comment and, when finalising its advice and the content of this letter, it took the comments received in response into account. EFRAG s evaluation is based on input from standard setters, market participants and other interested parties, and its discussions of technical matters are open to the public. EFRAG supports the Amendments and has concluded that they meet the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards in that they: are not contrary to the principle of true and fair view set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC; and meet the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management. 9

10 For the reasons given above, EFRAG believes that it is in the European interest to adopt the Amendments and, accordingly, EFRAG recommends their adoption. EFRAG's reasoning is explained in the attached 'Appendix - Basis for Conclusions'. On behalf of the members of EFRAG, I should be happy to discuss our advice with you, other officials of the EU Commission or the Accounting Regulatory Committee as you may wish. Yours sincerely Françoise Flores EFRAG, Chairman 10

11 APPENDIX BASIS FOR CONCLUSIONS This appendix sets out the basis for the conclusions reached, and for the recommendation made, by EFRAG on the Amendments to IAS 1 Presentation of Items of Other Comprehensive Income (the Amendments). In its comment letters to the IASB, EFRAG points out that such letters are submitted in EFRAG s capacity of contributing to the IASB s due process. They do not necessarily indicate the conclusions that would be reached by EFRAG in its capacity of advising the European Commission on endorsement of the definitive IFRS in the European Union and European Economic Area. In the latter capacity, EFRAG s role is to make a recommendation about endorsement based on its assessment of the final IFRS or Interpretation against the technical criteria for the European endorsement, as currently defined. These are explicit criteria which have been designed specifically for application in the endorsement process, and therefore the conclusions reached on endorsement may be different from those arrived at by EFRAG in developing its comments on proposed IFRSs or Interpretations. Another reason for a difference is that EFRAG s thinking may evolve. Does the accounting that results from the application of the Amendments meet the criteria for EU endorsement? 1 EFRAG has considered whether the Amendments meet the technical requirements of the European Parliament and of the Council on the application of international accounting standards, as set out in Regulation (EC) No 1606/2002, in other words that the Amendments: (a) (b) are not contrary to the principle of true and fair view set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC; and meet the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management. EFRAG also considered, based only on evidence brought to its attention by constituents, whether it would be not conducive to the European public good to adopt the Amendments. Approach adopted for the technical evaluation of the Amendments 2 The Amendments introduce three changes to IAS 1 Presentation of Financial Statements, which are considered separately below. In particular, the Amendments: (a) (b) Change the non-mandatory title of the statement of comprehensive income to the statement of profit or loss and other comprehensive income (other titles continue to be permitted). Require an entity to present separately items of other comprehensive income that may be reclassified subsequently to profit or loss (recyclable) separately from those that cannot be reclassified to profit or loss (non-recyclable). 11

12 (c) Require an entity to present income tax related to recyclable items of other comprehensive income separately from income tax related to non recyclable items, if other comprehensive income is presented before tax. Amendment A Change to the title 3 The quality of the information provided will not be affected by the change in the nonmandatory title. Amendment C Allocation of income tax to two groups of items of other comprehensive income 4 EFRAG observes that the requirement to allocate income tax to separate groups of other comprehensive income is consistent with the current requirement in paragraph 90 of IAS 1 Presentation of Financial Statements to disclose the amount of income tax relating to each component of other comprehensive income, including reclassification adjustments, either in the statement of comprehensive income or in the notes. Therefore, the overall quality of information provided will not be affected by the requirement to present income tax related to items of other comprehensive income that can be reclassified to profit or loss (recyclable) separately from income tax related to items of other comprehensive income that will never be reclassified, if other comprehensive income is presented before tax. Amendment B Disaggregation of items of other comprehensive income Relevance 5 Information is relevant when it influences the economic decisions of users by helping them evaluate past, present or future events or by confirming or correcting their past evaluations. 6 EFRAG considered whether the Amendments would result in the provision of relevant information in other words, information that has predictive value, confirmatory value or both or whether it would result in the omission of relevant information. 7 The Amendments do not affect the content of other comprehensive income, as they do not address the issue of which items should be recognised in other comprehensive income. Although the Amendments do not change the reclassification requirements set by individual IFRS (i.e., what can be reclassified to profit or loss and what cannot), they would result in a clear presentation of two types of items of other comprehensive income. This will help users to decide which items can potentially affect profit or loss and should be taken into account in projecting future cash flows, without referring to the requirements of each individual IFRS. Thus information resulting from this Amendment will be relevant for the users of financial statements. 8 EFRAG s overall assessment is that the Amendments, on balance, would result in the provision of relevant information; and therefore they satisfy the relevance criterion. Reliability 9 EFRAG also considered the reliability of the information that will be provided by applying the Amendments. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully what it either purports to represent or could reasonably be expected to represent, and is complete within the bounds of materiality and cost. 12

13 10 There are a number of aspects to the notion of reliability: freedom from material error and bias, faithful representation, and completeness. 11 EFRAG notes that the Amendments do not affect the content of other comprehensive income (i.e., what is presented ), rather they specify how different types of items should be displayed (i.e., how it is presented ). 12 As the Amendments do not affect what is presented, the reliability of information from the content perspective is not affected. 13 In respect of how it is presented, entities would follow the requirements of individual IFRS to determine whether an item of other comprehensive income may be subsequently reclassified or not. This exercise does not involve significant judgements or estimates, and would not raise any significant issues concerning freedom from material error and bias, faithful representation or completeness. 14 For the reasons stated above, EFRAG s overall assessment is that the Amendments satisfy the reliability criterion. Comparability 15 The notion of comparability requires that like items and events are accounted for in a consistent way through time and by different entities, and that unlike items and events should be accounted for differently. 16 EFRAG has considered whether the Amendments result in transactions that are: (a) (b) economically similar being accounted for differently; or transactions that are economically different being accounted for as if they are similar. 17 As indicated above, the Amendments do not address accounting requirements; rather they specify presentation requirements for items recognised within other comprehensive income. These presentation requirements will bring more clarity about which items of other comprehensive income can be subsequently reclassified to profit or loss, and which cannot. This will positively affect comparability between entities. 18 For the reasons stated above, EFRAG s overall assessment is that the Amendments satisfy the comparability criterion. Understandability 19 The notion of understandability requires that the financial information provided should be readily understandable by users with a reasonable knowledge of business and economic activity and accounting and the willingness to study the information with reasonable diligence. 20 Although there are a number of aspects to the notion of understandability, EFRAG believes that most of the aspects are covered by the discussion above about relevance, reliability and comparability. For example, information that represents something as similar when it is in fact dissimilar is not comparable, and that lack of comparability will mean it is also not understandable, and vice versa. 13

14 21 As a result, EFRAG believes that the main additional issue it needs to consider, in assessing whether the information resulting from the application of the Amendments is understandable, is whether that information will be unduly complex. 22 EFRAG notes that in applying the Amendments, entities will follow the requirements in the existing standards; therefore the Amendments themselves do not introduce any new complexities that may impair understandability. On the contrary, they would help users to distinguish between items that can potentially affect profit or loss and those that will not, without referring to the requirements of each individual IFRS. This would improve the understandability of information presented in other comprehensive income. 23 For the reasons stated above, EFRAG s overall assessment is that the Amendments satisfy the understandability criterion. True and Fair 24 EFRAG has decided that the information resulting from the application of the Amendments would not be contrary to the principle of true and fair view. European public good 25 EFRAG is not aware of any reason to believe that it is not conducive to the European public good to adopt the Amendments. Conclusion 26 For the reasons set out above, EFRAG s has decided that the Amendments satisfy the technical criteria for EU endorsement and EFRAG should therefore recommend its endorsement. 14