PAAB SUBMISSION ON ED 2015/7- CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

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1 20 November 2015 IFRS Foundation 30 Cannon Street London EC4M 6XH United Kingdom Dear Sir/Madam PAAB SUBMISSION ON ED 2015/07 CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING In response to your request for comments on ED/2015/7- PAAB SUBMISSION ON ED 2015/7- CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING, attached is the comment letter prepared by the Zimbabwe Accounting Practices Board (ZAPB) of Public Accountants and Auditors Board (PAAB). This comment letter is a result of deliberations of the ZAPB, which comprises members from reporting organisations, regulators, auditors, IFRS specialists and academics in Zimbabwe. We are grateful for the opportunity to provide our comments on this project. Please do not hesitate to contact us should you wish to discuss any of our comments. Yours faithfully, Brian Njikizana CA(Z) Chairperson of the ZAPB Anesu Daka CA(Z) Project Director Prepared by PAAB Technical Page 1

2 PAAB SUBMISSION ON ED 2014/7- CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING SPECIFIC COMMENTS Question 1 Proposed changes to Chapters 1 and 2 Do you support the proposals: (a) to give more prominence, within the objective of financial reporting, to the importance of providing information needed to assess management s stewardship of the entity s resources; (b) to reintroduce an explicit reference to the notion of prudence (described as caution when making judgements under conditions of uncertainty) and to state that prudence is important in achieving neutrality; (c) to state explicitly that a faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form; (d) to clarify that measurement uncertainty is one factor that can make financial information less relevant, and that there is a trade-off between the level of measurement uncertainty and other factors that make information relevant; and (e) to continue to identify relevance and faithful representation as the two fundamental qualitative characteristics of useful financial information? Why or why not? Comments to Question 1 (a) Management s Stewardship We strongly support the proposal to give prominence to information needed to assess management s stewardship. This will result in management taking responsibility and being accountable to the entity s stakeholders on the use of entity s resources. Management stewardship is inherent in financial reporting as all financial statements provide information that is directly linked to management stewardship, e.g. the profit and loss shows the returns of assets employed by management, the statement of financial position shows how management has managed to grow the shareholders wealth, whereas the statement of cash-flow shows how effective management managed the cash resources of the entity. Thus, silence on management stewardship will not completely achieve the objective of general-purpose financial statements. Respondents felt that standards should deliberately include certain disclosures related to providing relevant information to assess management stewardship. There was a Prepared by PAAB Technical Page 2

3 strong feeling that the conceptual framework should at least provide guiding principles on what management stewardship is to avoid varying interpretations as they felt that defining it may not be not be quite possible as it seems a very broad concept. By not providing proper guidance on what management stewardship is, preparers may overly focus on the positive aspects of it in the financial statements only at the expense of negative aspects. Some respondents also felt that general-purpose financial statements would not be able to provide all relevant information to assess management stewardship but rather users you also consider other relevant sources, e.g. sustainability report, corporate governance reports that may or may not accompany general purpose financial statements. (b) Prudence We support the proposal to reintroduction an explicit notion of prudence. We believe that prudence supports faith representation and neutrality. Thus, the position of the entity is not over stated but rather conservative especially where there are conditions of uncertainty. A prudent position will not be biased towards any of the preparer s favoured outcomes, especially, where significant judgements calls have to be made, thus achieving faithful representation and neutrality. However, faithful representation and neutrality are too subtle to explicitly bring out the notion of prudence. Thus, the clarification of prudence is therefore justified as it enhances faithful representation and neutrality. A few respondents were indifferent of whether the an explicit notion of prudence should be reintroduced as they felt that even though it was not specifically mentioned in IFRS there were numerous places that represented the notion clearly, e.g. IAS 36 impairment of assets, measurement of inventory in IAS 2, asset ceiling in IAS 19 just to mention a few. They felt the concept is already embedded in faithful representation. This notion may also be specifically abused especially by understating assets and overstating provision on to release them in specific periods thereby smoothening earnings. (c) Substance over form We support the proposal to state explicitly that faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form. This helps clarify the need to properly assess the economic essence of transactions and Prepared by PAAB Technical Page 3

4 events reported. Respondents felt that the lake of explicit mention of it may provide crafty preparers to misstate when convenient. The respondents also noted that the principle was clear in IFRS where applicable, e.g. paragraph 15 of IAS 32 classification of financial instruments contracts in the books of the issuer, classification of the an arrangement as lease arrangement as per IFRIC4 paragraph 6, and classification of lease agreements as per IAS17.10, etc. However, the explicit mention of it as part of faithful representation does removes any doubts on its importance. (d) Measurement Uncertainty We support the proposal to clarify that measurement uncertainty is one factor that can make financial information less relevant, and that there is a trade-off between the level of measurement uncertainty and other factors that make information relevant. Because of the use of estimates in preparing the financial statements there is support in clarifying measurement uncertainty. We also believe that clarification on measurement uncertainty does complement faithful representation and relevance. (e) Fundamental qualitative characteristics We support the proposal to continue to identify relevance and faithful representation as the two fundamental qualitative characteristics of useful financial information. The two qualitative characteristics would ensure more useful financial information is availed to users. Question 2- Do you agree with: (a) the proposed description of a reporting entity in paragraphs ; and (b) the discussion of the boundary of a reporting entity in paragraphs ? Why or why not? a) Whilst we agree in the description of a reporting entity as one that chooses or required, there is need to provide more clarity in the description of a reporting entity. We suggest that the board should consider needs of user of financial statements in defining the reporting entity e.g. individual reporting entities be identified by reference to the existence of users who are dependent on general purpose financial reports for Prepared by PAAB Technical Page 4

5 information for making and evaluating resource allocation decisions. This means that a class of entity may include some entities which should be identified as reporting entities, by virtue of the existence of users dependent on general purpose financial reports prepared by the entity, and other entities which should not be so identified. b) Whilst in giving clarity on the boundary of a reporting entity, much focus has been spent on when a parent controls a subsidiary, there is need to clarify the position where there is joint control or significant influence. We understand that the boundary is focusing on the underlying assets, liabilities and equity, income and expenses directly and indirectly controlled by the reporting entity the boundary should has not shed light with regards to control of the same in entities which it has joint control or significant influence. Question 3 Do you agree with the proposed definitions of elements (excluding issues relating to the distinction between liabilities and equity): (a) an asset, and the related definition of an economic resource; (b) a liability; (c) equity; (d) income; and (e) expenses? Why or why not? If you disagree with the proposed definitions, what alternative definitions do you suggest and why? a. The use of the word potential may be misconstrued and may lead to recognition of assets that ordinarily would not be recognized maybe capable would be a better word or ability or expected. Use of the word past event is redundant as there is word present. More clarification that control is on the right not the asset Classification of assets may be misleading as entity would just have rights in the assets Economic Benefits Certain assets do not directly generate cash and are bought for their service potential on cash generating assets or activities. Individually they do not generate cash flows and they would not increase cash flows for the cash generating unit they belong to. There are therefore no direct economic benefits expected to flow to the entity. Examples could be a bus bought to transport staff to and from work, head office invests in a consolidation accounting package. We suggest that addition of directly or indirectly. The definition would read An economic resource is a right that has the potential to produce economic resource directly or indirectly. Prepared by PAAB Technical Page 5

6 b. Yes c. There is need to define equity separately rather than treating it as a residue There is need to provide more guidance in the difference between equity and liability Distinguishing them will deal with differences and inconsistences in the application of the principle in difference standards e.g IAS32 and IFRS 2 d. Yes e. Yes Question 4 Do you agree with the proposed description of a present obligation and the proposed guidance to support that description? Why or why not? Whilst we agree with the proposed description of a present obligation we are of the opinion that Para 4.31a Practical ability would leave room to excise management discretion. Would suggest we use the word right. It would read the entity has no right or practical ability to avoid the transfer. This is in spirit with the proposed amendments to IAS 1 on classification of assets and liabilities. Para 4:37 On the insurer example make it clear what is the past event that gives rise to a present obligation i.e is it underwriting insurance or is it the occurrence of the insured event. As it is it is not clear. Question 5 Do you have any comments on the proposed guidance? Do you believe that additional guidance is needed? If so, please specify what that guidance should include. No we do not have any other comments and we believe guidance provided is sufficient. Question 6 Do you agree with the proposed approach to recognition? We agree with the proposed approach to recognition. Relevance and faithful representation should be considered when deciding on recognition of assets and liabilities. This entails that an item that would meet the definition of an asset or a liability should not automatically be recognised. Entities need not, recognise an asset or a liability if recognising the asset (or the liability) would provide users of financial statements with information that is not relevant, or not sufficiently relevant to justify the cost; or if no measure of the asset (or the liability) would result in a faithful representation of the asset (or the liability) and of changes in the asset (or the liability), even if all necessary descriptions and explanations are disclosed. Prepared by PAAB Technical Page 6

7 Clarity should be given on the issue of low probability. Should the same levels of probability be used in determining whether or not to recognise an asset and a liability or should liabilities be recognised at a lower probability in line with the prudence concept? Question 7 Do you agree with the proposed discussion of derecognition? We agree with the proposed discussion of derecognition. An entity should discontinue recognition when it ceases to control an asset or no longer has an obligation to deliver economic benefits. Derecognition allows for faithful representation of retained assets and liabilities and changes in assets and liabilities. Guidance has been clearly provided on the difference between a modification of an asset or liability and derecognition of an asset or liability and recognition of another, this has made this addition of derecognition, clear and understandable to users. Question 8 Has the IASB: (a) correctly identified the measurement bases that should be described in the Conceptual Framework? (b) properly described the information provided by each of the measurement bases, and their advantages and disadvantages? We agree that the IASB has correctly identified the measurement bases that should be described in the Conceptual Framework. Limiting the number of measurement bases could assist in more uniformity among financial statements of different entities thereby increasing comparability of financial information. We agree that the IASB has properly described the information provided by each of the measurement bases and provided a comprehensive discussion of the measurement bases available. The Framework should also articulate clearly the measurement objective of cash flow-based measurement: is it to determine an entry price, and exit price, a settlement value, fulfilment value, or something else? Question 9 Has the IASB correctly identified the factors to consider when selecting a measurement basis? We agree that the IASB correctly identified the factors to consider when selecting a measurement basis. Prepared by PAAB Technical Page 7

8 The objective of general purpose financial reporting is to provide useful financial information. For information provided by a particular measurement basis to be useful, it must be understandable, relevant and faithfully presented within the cost constraints. We feel it is also necessary that the Framework should address unit of account explicitly in the context of measurement. Unit of account issues are particularly relevant to measurement and the selection of a measurement basis thereof. Question 10 Do you agree with the approach discussed in paragraphs and BC6.68? We agree with the IASB s view that, a single measurement basis for all assets and liabilities may not provide the most relevant information for users of financial statements. In our view, one role of the Framework is to identify the circumstances in which a particular measurement basis would provide the most relevant information for users. Therefore, we think that the Framework having provided a more comprehensive discussion of the measurement bases available, when it would be appropriate to use them, we feel a discussion is also necessary on the circumstances when it might be appropriate to change a measurement basis,. Question 11-Do you have any comments on the discussion of the objective and scope of financial statements, and on the use of presentation and disclosure as communication tools. We support having disclosure principles in the framework. We think that the fundamental principle for disclosure should be relevance of the information to users of the entity s financial statements and that any disclosure should be clear, concise, balanced and understandable. This implies that disclosures are entity-specific (reducing the likelihood of boiler plate). We would also like the board to provide clarity on who can use the financial statements. We believe that financial statements are primarily prepared for profit oriented entities. Although other entities can use financial statements they should be aware of this limitation. Question12-Do you support the proposed description of the statement of profit or loss? Why or why not? If you think that the Conceptual Framework should provide a definition of profit or loss, please explain why it is necessary and provide your suggestion for that definition. We agree with the board that the purpose of the statement of profit or loss is to: (a)depict the return that an entity has made on its economic resources during the period; and (b)provide information that is helpful in assessing prospects for future cash flows and in assessing management s stewardship of the entity s resources. Prepared by PAAB Technical Page 8

9 We also agrees that income and expenses included in the statement of profit or loss are the primary source of information about an entity s performance for the period However we have note that people will likely have different interpretations of what return that an entity has made on its economic resources would mean. Some may consider that it refers to a return on investment measure therefore we feel that it is necessary to provide further clarity on what is meant. Question 13-Do you agree with the proposals on the use of other comprehensive income? Do you think that they provide useful guidance to the IASB for future decisions about the use of other comprehensive income? Why or why not? If you disagree, what alternative do you suggest and why? There has to be guidance on what helps preparers decide what goes into the OCI and preparers should be able to decide themselves and make their own judgements. Also consider a different name of other comprehensive income. The split between items that goes into P&L and OCI should: 1. Not be based on whether it is realised or unrealised but rather on the nature of the item for example non-trading gains and losses should be taken to the OCI regardless of whether they have be realised or not realised. 2. With this view on number 1, there should therefore not recycle of items from OCI to P&L as this creates unnecessary inconsistencies. 3. OCI should be reflective of performance of assets or liabilities which are non-operating. We believe that if profit or loss excludes some items of income and expense resulting from changes of current measures of assets and liabilities (remeasurements), the profit or loss total has more predictive value than total comprehensive income. While we acknowledge the work done by the board by identifying items that would qualify for recognition in other comprehensive income, we encourage the IASB to give more clarification on relevance since this might give more discretion to the management and result in consistent decisions about whether the effects of a transaction or change in an asset or a liability should be reported initially in profit or loss or other comprehensive income. Question 14-Do you agree that the Conceptual Framework should include the rebuttable presumption described above? Why or why not? If you disagree, what do you propose instead and why? View 1 Prepared by PAAB Technical Page 9

10 If the OCI is clarified on what should be taken to OCI and that it is not based on whether it is realised or not, there would not be need to reclycle items from OCI to P&L. View 2 We agree with the rebuttable presumption described above. We think that when an item of income and expense is presented in OCI, it should automatically qualify for the recycling, unless recycling would not result in relevant information in profit or loss which is the primary measure of an entity s performance. We find a lot of appeal in the principle that items initially presented outside of profit or loss need to be recycled into it when the reason for initial exclusion no longer applies- if this is not practical then the income or expense should be recognised straight in profit or loss and not OCI. Question 16-Do you agree with the proposed approach to business activities? Why or why not? We agree that the business activities should affect the selection of a measurement basis, the unit of account, what items should be reported in profit or loss and presentation and disclosure. However, we believe that the relationship between the business activities and the decisions made in relation to these topics should be developed into guidance in the Conceptual Framework since the exposure draft merely state that when making decisions related to those topics, business activities should be considered. In addition to playing a role in relation to measurement, the unit of account, the distinction between profit or loss and OCI, and presentation and disclosure, we think that the business model plays a role in relation to recognition. In current standards some executory contracts are recognised while others are not. For example, a contract to buy or sell a nonfinancial item that can be settled net in cash should be recognised except if it is entered into and continues to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity s expected purchase, sale or usage requirements. Question 18-Do you have comments on any other aspect of the Exposure Draft? Please indicate the specific paragraphs or group of paragraphs to which your comments relate (if applicable). As previously noted, the IASB is not requesting comments on all parts of Chapters 1 and 2, on how to distinguish liabilities from equity claims (see Chapter 4) or on Chapter8 Prepared by PAAB Technical Page 10

11 Other Comments Extend the list of primary users to include customers we believe in identifying users customers are very key and should be identified as primary users. Going concern considerations whilst the conceptual framework and IFRS only is applicable when an entity is a going concern there is need to provide an alternative basis if the entity is not a going concern. This is particularly important especially in a group situation where one or the subsidiaries is not a going concern the subsidiary would not be best accounted under IFRS 5 as the sale is not under normal circumstances but rather under forced liquidation. Prepared by PAAB Technical Page 11