The new world of corporate disclosure

Garreth Hanley:
This is With Interest, a business, finance, and accounting news podcast, brought to you by CPA Australia.

Ram Subramanian:
Hello and welcome to With Interest. I'm Ram Subramanian, senior manager reporting and audit Policy at CPA Australia. Financial statements remain an important source of information on corporate performance. However, how well a company does is no longer just about its financial performance. Investors and the public information needs are evolving towards a broader set of performance measures. Information is being sought on climate change, modern slavery and human rights, just to name a few. Social media and the other communication technologies are also revolutionising corporate disclosure. Although financial statements are sometimes referred to as the gold standard of corporate disclosure, this well-established ractice must evolve and remain relevant and aligned with other corporate information provided to the market. Joining me in person to discuss this and other financial reporting issues all the way from the United Kingdom, a special guest, Dr. Andreas Barckow, chair of the International Accounting Standards Board, or the IASB.

Andreas Barckow:
Thanks very much, Ram. Pleasure to be here.

Ram Subramanian:
Perhaps to start with, what role do you see financial reporting playing in promoting public confidence in capital markets today?

Andreas Barckow:
I think the role is probably not much different to what it has been five, 10 years ago. I think it still is the backbone of our entire capital market oriented system. The point that you don’t any longer hear people make comments about financial reporting and is it still up to date and things like that to me is a sign actually that people have trust in the system. They don’t question it anymore. I have vivid memories 15 years back when the global financial crisis broke out and when we were on the headline pages. I take confidence that that's now an issue of the past. It doesn't mean that we are no longer relevant. I think we are highly relevant, but we are a well-oiled machine and people have confidence and trust. I think our mission should really be to support that trust in keeping up a high quality through rigorous due process.

Ram Subramanian:
Yeah, I actually agree with your point there that it's a well-oiled machine. It's there on the side. It's doing its job very well, and people trust it so well. One of the things that everyone's talking about today is climate, obviously. How does this topic of climate change, impact on the role of financial reporting in today's world?

Andreas Barckow:
It's a very good question. Our literature is principle based. When it comes to reflecting climate risk probably, in particular, but also climate opportunities, we would hold that our literature is risk and opportunity agnostic. We don't really care whether a risk is a financial risk, whether it's credit risk, or whether it's an ESG risk. We are maintaining that if you do have a risk that has the potential of having a material impact on the financial position or the financial performance, you must consider it. I deliberately say consider it because it doesn't mean necessarily you have to reflect it or you have to report on it, but you need to consider it. And the areas that come to mind probably most prominently are impairment considerations where you're making cashflow forecasts and climate risk obviously is one of the factors that could heavily impact long-lived assets. You want to take that into account and build your impairment test from the same set of assumptions that potentially would drive your sustainability reporting. The other area that comes to mind is provisioning. If you're looking into obligations that you have entered into that are very long ranging and that may be impacted by climate related risk, then obviously you need to consider that and need to consider what the impact of climate risk on your liability position would be.

Ram Subramanian:
Maybe we'll come back to those two points on impairment and provisioning in a bit. But before I jump into that, your organisation, the IASB, the International Accounting Standards Board, what is it doing to increase the level of awareness and maturity of global financial markets in this respect, in the respect of climate change?

Andreas Barckow:
This question has first arisen probably three years ago when we have been asked exactly that issue. How do I reflect climate risk in financial reporting? A colleague of mine, Nick Anderson, has written a board member article on this issue that has been widely received. He stated in his own words the same thing that I just said. We are risk agnostic. We have principled-based literature. Areas like the materiality principle, like disclosures around significant judgement, areas of material uncertainty. They apply across the board, but let me take you through the issues and show you how you would apply these general principles in the area of climate risk. He has written that article. A year later, we have taken his article to produce educational material. That's obviously not binding because the binding nature, the mandatory nature comes through our statements themselves. But arguably, they help facilitate implementation of these general principles in that we relate them to the specific area of climate related risks. Now, we know that these two publications, the board member article and the educational material, have had huge numbers of hits by people who have downloaded the material. Arguably, we have already done something. But still, climate related risk featured very highly in our recent agenda consultation and was named by many as an area that we ought to do more work on. We currently are looking into what we can do in order to improve the understanding of our principle-based literature better.

Ram Subramanian:
Earlier you talked about impairment and provisioning as issues that may have some resonance in financial reporting when you're looking at climate risk. You've already talked about some of the things that your organisation, the IASB, is doing to address some of these challenges. There are a number of new emerging areas beyond financial reporting that corporate disclosures are increasingly expected to incorporate. How is the IASB addressing some of these emerging demands for corporate information? I know you already talked about the project the IASB is looking at on climate risk. What else is the IASB doing in this space?

Andreas Barckow:
Probably not that much for the time being because we are quite aware and quite judicious in producing further disclosure. We have been charged in the past of having gone overboard with disclosure requirements. People have said there is a disclosure overload and people can't cope with reports that are several hundred pages thick, right? It's all good to say, I can't see this information anywhere. Could you just put out further disclosure? Well, we would then contribute obviously to the reports becoming even bigger. Rarely have I seen any standards setter around the globe who would contemplate taking away existing disclosures. Arguably, we have to be very judicious and have to ask ourselves, is there a deficiency in the market that has the potential of leading investors up the garden path and letting them make ill-informed decisions? That's really the test case. And only if we say, "Yeah, that has the potential. We need to step in because nobody else is stepping in, and that's really a financial reporting issue," then we may be thinking about bringing further corporate disclosures. But I wouldn't go as far to say anything where there is a need that has arisen is really for us to be taking up. Our remit is really the financial statements. We are not the holistic Encyclopedia Britannica where people could address all their wishes and beliefs and say, "I want the answer." This is not an oracle. This is really a place where you get financial information about the past and the present period and limited information about an outlook that may be housed in the narratives in the OFR here in Australia. But certain information we just have to accept is going beyond the classic financial statements and therefore should be better housed in a different report.

Ram Subramanian:
Now, this is a question that perhaps does go beyond financial reporting and feel free to say what you think. How else do you think we can enhance corporate disclosure to benefit markets, economies, and ultimately society? You already made it very clear that financial statements has a very set role and it plays that role beautifully. I think we've agreed on that. How do you see broader corporate disclosure addressing the needs of society?

Andreas Barckow:
I would say corporate disclosures, you could look at it from two angles. If I use corporate disclosures with our traditional audience, the participants in capital markets, you could say that we are currently missing out on future oriented information. The financial statements stop largely at the balance sheet date. They don't take into account transactions and events that happen in the future because we only report on things that have already happened. Yes, we do look ahead when it comes to measurement, especially in fair valuation or impairment assessments, but we don't take future information into account otherwise. That's really the bit that currently is missing in informing investors in capital markets. I think that is the huge bit that the ISSB is now addressing. But arguably, there is another set that goes beyond that addresses your societal effect, because arguably the entities don’t operate in a vacuum. Their purpose is not contrary to Milton Friedman just to make money, but they need to have a purpose and they need to be able to demonstrate that purpose. Now, arguably, if you are a long-term investor, you should actually be taking any impact that the entity has on society has on the environment into account, because ultimately it may affect your future cash flows. The potential to generate value both to the entity and to society are both really looking at the same things. It's just the question of do you take one further iteration because there are repercussive effects. But there are arguably standard setters that concentrate more fully really on the impact on society. The IFRS Foundation trustees have so far taken the view that let's concentrate on our traditional audience, being the participants in capital markets, and let other standards that just deal with the societal bit. This is exactly why the foundation has struck memorandum of understanding with GRI, the Global Reporting Initiative, whom we know actually addresses broader spectrum of sustainability reporting.

Ram Subramanian:
You earlier talked about more disclosures or more information in financial reports being a challenge. Maybe to that point, how do you see financial reporting having changed over the years to keep up with other forms of communication that we see today, social media, technology-based communication platforms. How do you see financial reporting fitting into this new world of communication?

Andreas Barckow:
Well, I would say we are still way behind. If you think about newspapers, I'm German, I love my paper. I love the lettering, and I like my CDs. I have something in my hand, but I acknowledge actually that the world has moved on. People more often than not tend to go to a website to address their information needs rather than buying a newspaper. They go to streaming platforms rather than switching on their TV or hearing music. In financial reporting, it seems that we are still largely paper-based, and that is an oddity in a digital world more generally. I think you are absolutely right and spot on in saying digital plays a very important role in addressing that disclosure overload conundrum. I think we have to become smarter in thinking digitally first rather than paper first, and then thinking about how can we produce a digital version of that paper-based report. If we win digital first, obviously there are different varieties. The IASB has already thought about digital in producing the IFRS Taxonomy that enables tagging of information and digital digestion of information. Our stakeholders seem to have liked that approach because they have asked us in our latest agenda consultation to increase our efforts modestly on spending time on digital. Well, if you become visionary, you could obviously take it much, much further than that. You could think about areas of tagging on a transactional basis rather than online items in the financial statements, which arguably wouldn't have the benefit of further disaggregation. If users think, yeah, it's good that I have that information, but actually I would like to drill down two, three levels below, well, you can only do that if you provide the information in that disaggregated form. Arguably, digital would be the means to do that if you don't want to go to font size two or three on your A4 page. The other area concerns timing. At the moment, we only provide reports in certain intervals, be it quarterly or half-yearly or even annually only. If you think about digital, is there a way where it can go to continuous reporting? I know I'm talking to a representative of the audit profession who probably would go ballistic about this. How do I define the reporting period? How could I think about after balance sheet events if there was continuous reporting? Well, point taken. These are interesting questions. But if we want more timely information coming from the entities that don't just have confirmatory value, but are actually sending signals out to the market, I think we need to open our eyes up and think about new ways.

Ram Subramanian:
Thank you. That is truly visionary, and I certainly hope we get there one day. But of course, there are risks that have to be mitigated as we get to a much more deeper and broader set of corporate disclosures.

Andreas Barckow:
Absolutely.

Jacqueline Blondell:
If you're enjoying this podcast, you should check out our in-depth business and finance show INTHEBLACK. Search for INTHEBLACK on your favourite podcast app today. And now, back to With Interest.

Ram Subramanian:
On a slightly tangential note, there have been some big name banking collapses in the US recently. Do you see a need to improve accounting standards to address some of these issues?

Andreas Barckow:
Our counterpart in the US have actually been asked to change their accounting requirements for financial instruments because of alleged deficiencies. There have been quite vocal points being made by the CFA Institute and other user-based organisations. On the IASB, we haven't really heard anything to that regard, and it may be due to two factors. One is, our literature is slightly different from US GAAP and some of the issues that were obviously having an effect in the US are no longer allowed under IFRS 9, our new standard that we have developed post the financial crisis. The second bit is that we've just come out of a post implementation review that was looking actually into classification and measurement, exactly the issues that may have contributed or may not have contributed to the fall of these banks. Our stakeholders have not suggested that we make any changes, not in the direction of more fair value or less fair value. Now, there's one area where I could see room for improvement, and that is the area of disclosures. Again, disclosures because there is little to no information about what we call correlation risk. If we think about risk disclosures, we tend to be thinking in silos. We look at interest rate risk, credit risk, liquidity risk for banking purposes, but we don't really show how they're interconnected and how they're applying into each other, which the regulators would call correlation risk. I think they have a fair point. It may very well be that the side of risk is actually overlooked. Now, with the banking issues at hand, we were in contact with the securities and prudential regulators, and I think I tend to agree with them that this is really rather an oversight issue. It’s probably an issue of mismanagement and consciously entering into a large open risk position that at some stage had the potential to actually create the issues that the bank faced. I don’t think that the accounting was the trigger of that. It may have sent false signals. But in all fairness, if you look at the reports of these banks that have gone under, the information was all there.

Ram Subramanian:
To perhaps turn to the work of the board that you chair, the IASB, the International Accounting Standards Board, what are the most important forthcoming new requirements from the board that our listeners should be aware of? In particular, how will these impending changes to financial reporting make a difference to investors and the economy at large?

Andreas Barckow:
I think our biggest project at the moment that is nearing completion is our work on primary financial statements where we try to bring rigour to the layout of the income statement. Our current literature only defines the top line revenue and then doesn’t define anything thereunder. Before you get almost to the end where you say, I have some disclosures about discontinued operations and taxes. So we leave it largely to entities as to how they display their expenses and how many subtotals they create. A subtotal that’s very pertinent in the market is operating profit or EBIT. The problem is it's widely defined and used differently. Our team has done desktop research and has come up with more than 20 different variations of how entities construe their operating profit. And that has the potential to confuse users really greatly, because users basically start their assessments not working from profit or loss, but really starting from operating profit, so further up in the income statement. We’ve taken this on board and we want to bring rigour to that one line item and number, and we define what is operating profit under IFRS Accounting Standards. But we don’t stop there. We actually use the classification thinking the concept that’s already pertaining to the cashflow statements, so the three buckets of operating, investing and financing, and do the same thing in the income statement. We’ll have in the future an operating category, an investing category, and a financing category. We’ve decided that the operating category should hold all income and expenses from the major business activities of an entity, but not only those. There may be other items that have to be mandatorily disclosed and presented in the operating statement because we define income and expenses from investing and financing, that’s easier to do and everything else has to be shown in the operating section. We hope that this will bring rigour to that one line item, operating profit. We also do have another subtotal operating profit and investment income, so everything before financing basically. We will also allow entities to bring in their own thinking by allowing entities to present what we call management performance measures. In some jurisdictions, these are better known under the name of non-GAAP measures. You could ask why would we allow a non-GAAP measure in a GAAP statement? There have been long debates, but ultimately the board agreed with users that actually if they are seen as creating value to users, why should we prohibit them? If we brought them into the financial statements, actually they become a part of an audit requirement. That adds greater reliability to these numbers being communicated to the market. That's certainly an area that's greatly appreciated. However, we don't give companies a carte blanche. If they use an MPM, they must reconcile it to the existing subtotals. The third area that we will be commenting on is requirements for further disaggregation, because users have often said the numbers are too aggregated. If you think about line items like other expenses or other income, there's a lot that is mashed into this other line item. We said we give you some guidelines and principles as to when you have to disaggregate further. This is probably a standard that we believe has the potential of really being a game changer and much better informing users. Arguably, if users are better informed, then society will be informed better because this contributes to the well-functioning of the capital market and financial stability.

Ram Subramanian:
A profit loss statement that makes better sense to the broader market in providing them the information that they've always asked for, things like EBIT, operating profit, et cetera.

Andreas Barckow:
Absolutely.

Ram Subramanian:
You've already made a couple of comments, which I would say are visionary. If you look slightly further down the line, what other meaty topics is the IASB planning to tackle in the future, and how is this expected to make a difference to capital markets and those who invest in them?

Andreas Barckow:
I think our biggest project that we are going to take on our plate is actually our project on intangibles. I've long said that there is a deficiency in information. Yes, we do have a standard on intangibles, but it's 25 years old. It was developed with a completely different objective and mindset and in a totally different environment. Over the past 20, 30 years, many economies have actually moved from a manufacturing world into a service oriented world, and that has a huge consequence. If you look into the financial statements of a manufacturing company, you see the machinery. You see the inventory. Arguably, you see everything from input into processes. Not only can you see the value drivers on your balance sheet, you also can see the consumption or the depletion or the investment in those. Now, if you make the comparison to the service oriented world, you can't see anything of that because you don't see the value creation potential. You only see charges flowing through the income statement, and that's about it. That's not really informative. I think our thinking was really evolving from the entire debate around the sustainability disclosure standards, because the ISSB's work is starting from, tell me how you're creating or depleting value in the future. Tell me something about what drives value for your company and how that value will be valued to the shareholders, but also to broader society. We apply that same notion and say, arguably, the biggest loss that you have in information is actually around intangibles. Now, I don't want to frighten the horses here. We are not seeking to put every single intangible onto the balance sheet, but we certainly want to review whether there is a case for more intangibles onto the balance sheet, but we might also look into redefining some of the criteria that we have currently in our IAS 38, so what we would otherwise be known as a post implementation review. We might look into setting further disclosures and creating narratives where companies would actually be asked to talk to that value creation potential more broadly. And that may be an interim step before we think about should we actually be bringing something onto the balance sheet. Now, intangibles is a very interesting topic because you could think of it very, very narrowly in terms of individual items like software, like patents, but you could also go very broadly if you think about intellectual property, intellectual capital, human capital, social capital. In that sense, it starts to smell, is that really for the financial statements, or is that leaping into the sustainability space? A prime area for connectivity of our work with the ISSB's work.

Ram Subramanian:
Well, that's all we've got time for today. Thanks very much to our special guest, Dr. Andreas Barckow from the International Accounting Standards Board. If you'd like to know more about today's topic, link to the Connectivity in Reporting article is included in the show notes. With Interest is CPA Australia's regular business, accounting, and finance podcast. If you like what you've heard today, why not subscribe on your favourite podcast app? From all of us here at CPA Australia, thanks for listening.

Garreth Hanley:
You've been listening to With Interest, a CPA Australia podcast. If you've enjoyed this episode, help others discover With Interest by leaving us a review and sharing this episode with colleagues, clients, or anyone else interested in the latest finance, business, and accounting news. To find out more about our other podcasts and CPA Australia, check the show notes for this episode. We hope you can join us again for another episode of With Interest.