IFRS 18 Implementation Issues: Operating Profit is too Important to be Defined as a Residual Category
In line with statements that preceded the publication of the IFRS 18 and its accompanying explanatory notes, operating profit was the critical trigger for issuing the new standard. Yet paradoxically, the operating category — whose items collectively constitute operating profit — is the only category defined residually, as a default. This residual definition serves as a wide-open back door, permitting (and indeed requiring) the inclusion of income and expenses entirely unrelated to operating activities, such as investment property maintenance costs, credit facility commitment fees, and government grant income. In certain hedging transactions, classification may even be contingent on formal documentation and consequently could be subject to manipulation. To avoid misleading investors regarding the most important category in the new income statement, an independent definition of the operating category should be established.
An Opportunity to Correct the Derivative-on-Derivative Distortion in IAS 32: A Forward Contract to Issue an “Equity Option” should be Classified as Equity, not as a Financial Derivative
The anticipated amendment to IAS 32, which addresses the critical distinction between equity and financial liabilities, should tackle a fundamental distortion in the standard regarding the classification of derivatives on derivatives. Under the standard as currently drafted, and in contrast to US GAAP, a commitment to issue an "equity option" in the future results in the recognition of a financial derivative until the "equity option" is actually issued, even though there is no doubt that the transaction is, in its entirety, an equity transaction. The distortion can be even more severe in a forward transaction to issue a package comprising shares and options, because the distorting requirement to measure the option component of the forward at fair value may drag the share component of the forward into similar treatment. Beyond the distortion in the statement of financial position, since the derivative is measured at fair value through profit or loss,
The IASB’s Quick Fix for the Distortion Created by IFRS 18 in the Presentation of Operating Profit in Entities Whose Primary Business Activity is Investment in Assets
A fast-track amendment to IAS 28 will allow the designation of investments in associates and joint ventures at fair value through profit or loss. The amendment comes in response to a distortion that exists under IFRS 18, whereby results arising from measuring investments in associates and joint ventures using the equity method — including those whose activity is synergistic and closely related to that of the holding company — would be classified in the statement of comprehensive income under the investment category rather than the operating category. The amendment, which was aimed at insurance companies, is a very significant positive development for income-producing real estate companies and additional companies, and we hope that it will be further extended to additional sectors going forward.
Advancing Toward an Economic Principle for Cash Flow Reporting: How to Prevent Distortions and Manipulations in the Statement of Cash Flows
The statement of cash flows currently contains numerous distortions resulting from a view that the presentation of cash flows is merely a technical exercise, rather than applying an economic principle. This leads to the ability to easily structure the same transactions in a different legal form and arrive at a completely different reporting result in the statement of cash flows. This can have problematic implications for each of the three categories of the statement, including potential inflation of operating cash flows. In our view, an economic principle of presenting cash flows should be applied that ignores cash flow "shortcuts", thereby providing more relevant information to investors. According to this principle, cash flows would be presented on a gross basis when the underlying transaction is a cash payment (or receipt) at the instruction, or on behalf, of the reporting entity to (or from) third parties, such as financial institutions with which
Classification Inconsistency in Equity Method Results under IFRS 18: Further Evidence—The Case of Separate Financial Statements
An IFRS Interpretations Committee staff paper provides further evidence of potential inconsistency arising from the requirement under IFRS 18 to always classify in the investing category the share of profit or loss of investments accounted for using the equity method. This unequivocal requirement in IFRS 18 has left the staff with no choice but to […]
