By Jane Fuller, former financial editor of the Financial Times and co-director of the Centre for the Study of Financial Innovation think-tank
The proposal that the same asset should be measured at amortised cost in the P&L but at fair value in the OCI is inconsistent at best, and raises fundamental issues about performance reporting.
When I see the words ‘limited amendments’ on a proposal from the International Accounting Standards Board (IASB), my gut reaction is relief that there will be no need to respond. Voluntary representatives of users of accounts, like myself at CFA Society of the UK, welcome invitations to drop things from the priority list.
But the dismissive description of ED/2012/4, which proposes a new category for financial assets, is misleading. This is not just because of the revived emphasis on convergence with US GAAP, but, crucially, because it raises fundamental issues about performance reporting and expands the use of the other comprehensive income (OCI) statement.
This timing is unfortunate since a debate on the purpose of OCI is part of the IASB’s revisiting of the conceptual framework. Many users hope this will provide a back-door route into tackling our biggest concern about International Financial Reporting Standards (IFRS): financial statement presentation.
The IASB’s ‘limited’ proposal is to create a new category of financial asset that is measured at amortised cost (complete with impairment testing) in the profit and loss account, but at fair value on the balance sheet. The difference between the two would run through the OCI, hence the FVOCI label. This waters down the plan for IFRS 9 on financial instruments, which was to replace the four asset categories of IAS 39 with just two – a welcome simplification. One of those scheduled for the dustbin was ‘available for sale’ which this proposal revives but with a new P&L treatment.
Questions raised by the draft include:
– if the difficulty lies in the definition of ‘hold to collect’ (for amortised cost accounting) because even a ‘simple’ debt instrument might be sold, then why was that not a key point in the consultation?
– If insurers complain of an ‘accounting mismatch’ because assets are put in a different section to linked liabilities, why is the OCI the best place to marry these things up?
– Why is the OCI being expanded when users of accounts suspect it gives preparers an opportunity to smooth ‘P&L’ earnings, and describe it as a ‘dumping ground’?
The logical inconsistency in measuring an asset one way in the P&L and another in the balance sheet is criticised by IASB board members Steve Cooper and Jan Engstrom in their alternative view, which says: ‘Where amortised cost is judged to be the most appropriate basis for reporting, this should be applied consistently throughout the financial statements.’ In that case, changes in fair value would be disclosed in the notes.
An underlying cause of unease is the sensitivity of the debate about ‘fair value’ accounting. The FVOCI proposal ducks the issue. It tries to satisfy both those who think performance reporting should be balance sheet driven and those more interested in inflows and outflows in the P&L.
In non-financial sectors the balance-sheet may be a poor reflection of assets because internally generated goodwill is ignored, but for banks and insurers this matters deeply – the balance-sheet is where it’s at for valuation and risk assessment purposes.
This is just the beginning of the debate on what to do about the OCI, including whether to abolish it. Could it be replaced with a single income statement with different sections, or columns, that distinguish between different types of income/expense and balance-sheet gains/losses? On the timing issue, the long-established tools of accrual accounting and cashflow reporting also come into it.
The proposed ‘limited amendments’ looks like a fait accompli. But the IASB must not let this FVOCI patch predetermine the outcome of a wider debate on performance reporting.
This post first appeared in Accounting and Business magazine, May 2013