FRC's Thematic Review: Judgements and Estimates
Giles Mullins
UK Head of Financial Accounting Advisory Services | Head of Advisory Operations | Member of UK Endorsement Board that endorses IFRS in the UK
I do find the thematic reviews from the Financial Reporting Council a really useful way of taking the temperature of a particular theme. This week it was the turn of IAS 1 'Presentation of Financial Statements', and in particular, the requirements of IAS 1 paras IAS1.122 to IAS1.133 to disclose significant judgments and the application of estimates.
The sample was biased towards the natural resource sector which seemed odd to me but it contained some valuable reminders of the disclosures required. There was even a nod towards disclosures associated with climate disclosures with IAS 1 being one of the key areas in IFRS where there is clear linkage to the sustainability standards, and perhaps a reason for the skewed sample towards natural resources?
As a reminder financial statements prepared using IFRS should:
'...disclose, along with its significant accounting policies or other notes, the judgments, apart from those involving estimations....that management has made in the process of applying the entity's accounting policies and that have the most significant effect on the amounts recognised in the financial statements."??
'...disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year...'
Judgements should not be conflated with estimates
The financial statements need to disclose both the judgments that management use in applying accounting policies, and the estimates that have a significant risk of causing a material adjustment to assets and liabilities in the next financial year. They are therefore two very different things which the FRC is at pains to remind us and you would expect the disclosure to differentiate between these two. What's nice to see is that this principle is largely being adhered to.
Estimates are capable of causing material adjustment in the next financial year
Secondly, estimation uncertainty needs to be capable of causing a material adjustment to assets and liabilities within the next financial year. Take note that equity, income and expenses are absent from this and therefore there are areas which fall through the gaps such as equity-settled share-based payment transactions that are identified by one preparer in the sample.
IAS 1 requires disclosure of the sensitivity of estimates to the methods and assumptions underpinning them and the range of possible outcomes within the next financial year. It appears most of the sample complied with this requirement well and the FRC reminds us of the power of simply presented tables (or in my view, diagrams if you are brave) to demonstrate the impact of estimation on outcomes.
I am a sucker for a league table and coming in at the number 1 most commonly disclosed estimate are impairment reviews, closely followed by pensions and then purchase price allocations. No surprises there you say!
Connections between items
The most useful narrative disclosure tends to create 'golden threads' through a set of financial statements. If the front-end narrative discusses an acquisition and its impact on the business, you would expect that 'golden thread' to go through the audit report, to the estimates section (purchase price allocation), to the accounting policies section, to the notes to the financial statements, etc. Too often these 'golden threads' are broken and the FRC identifies an example where an audit report identified a judgment revenue recognition but this wasn't discussed at all in the judgements and estimates section.
Climate change
This is clearly an emerging area in terms of the linkages between financial and sustainability reporting and something that users of accounts are looking for more disclosure about. The bit of IAS 1 that (in my view) needs greater thought in the future, is the need for estimation uncertainty disclosure to be underpinned by the next 12-month rule. Clearly, climate risks are far more pervasive and longer term than that rule is designed for.??
The FRC uses the 'catch all' IAS 1.112(c) para which requires '...information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them.' I'm not a fan of that approach, to be honest as it was not designed for such a pervasive introduction of such a very different lens on a business and could cause very wide-ranging estimate disclosures interpreted differently by different parties such as regulators and auditors.??
We need to support and encourage the introduction of global sustainability standards as soon as possible without compromising due process. This will give a framework of clarity to all stakeholders. That said, I do see the need to signpost climate-related matters and this needs to be woven into the 'golden thread' of the narrative with attention in the front end and the risk sections of financial statements.??
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Financial and non-financial reporting professional who has expertise in IFRS and many sustainability reporting requirements
2 年A useful article, with some helpful commentary by Giles, that reminds us all to "stand back" when considering this aspect of financial reporting. Simply put, if in doubt on what to disclose on judgments and estimates: I would always encourage disclosing more rather than less!