Remi Forgeas
Remi Forgeas

MD&A Disclosures Relating to Financial Instruments

How they impact debt covenants.

July 26, 2010
by Remi Forgeas, CPA

When reading financial statements prepared under International Financial Reporting Standards (IFRS), you may be surprised by the notes and disclosures section. Even compared to the disclosures required under U.S. Generally Accepted Accounting Principles (GAAP), they are more extensive and cover far more topics that are usually found in the Management's Discussion and Analysis Disclosures. (MD&A) section of the annual report of a U.S. public entity.

In this column, I reveal why IFRS requires more extensive disclosures than any other accounting standard and then briefly provide the content of IFRS disclosures and focus on the disclosure related to financial instruments and their impacts when dealing with debt covenants.

Why Do IFRS Have More Extensive Disclosures?

One of the purposes of the IFRS is to provide large public international companies with a common set of standards that will facilitate the comparisons and benchmarking between these large groups. Therefore, IFRS focus on disclosures useful to public companies and to the inherent complexity of large groups. Considering stock markets have different rules and regulations especially with regards to the content of reporting of financial information, extensive disclosures as part of financial statements lead to a more comparable level of information not depending upon local market regulations. On a practical matter, some of the additional disclosures may represent a shift of information, that is currently found in the MD&A section of the 10-K for a U.S. Securities and Exchange Commission (SEC) registrant, whereas it would represent a totally new set of information for private entities.

As IFRS are principles based, its standards require more detailed information on the basis for judgment and assumptions used in the preparation of the financial statements than what you would find in a more rules-based environment.

We believe that this is due to the historical trend of the increase of the size of disclosures. If you refer to U.S. GAAP, you will see that compared to standards issued 15 years ago, these standards require even more disclosures, especially on estimates and assumptions (illustrations: disclosures on post employment benefits or information on fair value).

Content of IFRS Financial Statements

Several standards deal with financial statements presentation and disclosures:

  • IAS 1 — Presentation of financial statements
  • IAS 7 — Cash flow statements
  • IAS 8 — Accounting policies, changes in accounting estimates and errors
  • IFRS 7 — Financial instruments — disclosures
  • Specific disclosures requirements in standards

Content of IFRS Financial Statements

Financial statements are prepared by the company for the users, which leads to the four key characteristics (see sidebar):

Characteristics of Financial Statements

Understandable – plain English and detailed disclosure. This is not always easy to combine both since some transactions may be complex, hence complexity in the disclosure.

Information to be relevant – explanations to be sufficient and fair.

Reliable – accounting principles must be correctly applied and data gathering process must be efficient.

Comparable – consistency of accounting methods between years and as well with peers.

The content of the IFRS financial statements is very similar to the U.S. GAAP:

  • Statement of financial position as at the end of the period.
  • Statement of comprehensive income for the period.
  • Statement of changes in equity for the period.
  • Statement of cash flows for the period.
  • Notes, comprising a summary of significant accounting policies and other explanatory information.

Similar to U.S. GAAP, accrual basis of accounting must be applied. One difference with U.S. GAAP, at least for private entities, is that IFRS require comparative information on the face of the financial statements.

A disclosure that does not exist under U.S. GAAP is the explicit and unreserved statement of compliance with IFRS. This is to ensure there is no cherry picking when applying IFRS (i.e. national flavor of IFRS).

Content of the Notes and Disclosures

The notes and disclosures shall:

  • Present information about the basis of preparation of the financial statements and the specific accounting policies used;
  • Disclose the information required by IFRS that is not presented elsewhere in the financial statements; and
  • Provide information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them.

Notes and disclosures are the key piece for financial statements under IFRS, even more than under U.S. GAAP. They provide information on underlying assumptions and explanation not just in notes that provide information on accounting principles and methods and detail significant lines presented on the face of the financial statements.

Note that information to be provided is not limited to the one that is required by standard. There is a broader requirement that forces management to make a judgment on the extent of the disclosures.

Disclosures on Financial Instruments

IFRS 7 is dedicated to disclosures on financial statements. While many believe that this statement impacts mostly financial institutions, it in fact, broadly defines financial instruments and almost all companies will need to comply with its requirements.

Though this statement does not create a new requirement in terms of recognition or measurement, some of its aspects can have significant consequences for companies that deal with loans. The objective of this statement is to provide users with sufficient information to understand how the management of the risks attached to financial instruments impacts the financial position and the performance of the company.

As a consequence:

  • Information on credit, liquidity and market risks found in the MD&A of the 10-K is now fully integrated to financial statements; and
  • Management must disclose how it monitors its exposure on financial instruments. The disclosure may include details in terms of the size of the team and decision-making process with regards to risk management. The decision with regards to the level of detail is judgmental.

Some practical impacts include:

  • Breach of loan covenants. When a loan covenant has been violated and results in accelerated repayment, the debt is required to be classified as current under IFRS, unless the breaches were remedied or the terms of the loan were renegotiated before the balance sheet date. Under U.S. GAAP, if the lender agrees to waive the right to demand payment for more than a year and the waiver is received before issuance of the financial statements, the borrower may classify the debt as non-current.

    Borrowers moving from U.S. GAAP to IFRS will have to revisit loan agreements with the lenders to avoid unintended consequences due to this requirement.
  • Information on the aging of account receivable. Companies have to disclose the aging of their accounts receivable. This has a practical impact in multi-locations and complex companies in which the aging may be based either on the date of the invoice or the due date (local requirements may force the use of one or the other). Systems have to be adjusted to ensure consistency in aging as well as generate an effective audit trail. Under U.S. GAAP, such information is not required and if auditors use the aging report to perform their audit procedure, aging is rarely audited. Under IFRS, since this aging is part of financial statements, auditors must be provided with the proper audit trail.

    In addition, financial statements have to include a roll-forward analysis of the impairment of receivable.


Overall, CPAs and financial execs may think that the shift of information currently found in the MD&A section to the financial statements will have limited impact for public companies at the end. This view overlooks the fact that such shifts imply that such information being part of the financial statements, will be subject to the audit procedures and, de facto, raise the requirement in terms of documentation.

Until the SEC requires IFRS, such disclosures are not mandatory for U.S. companies. While this underestimates the convergence project between International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), some of these IFRS-only requirements may soon be part of U.S. GAAP as well.

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Remi Forgeas, CPA, who is an audit and assurance partner for Mazars in the U.S. For U.K. IFRS, you can contact Steven Brice who is a technical partner in the financial reporting advisory group for Mazars UK and provides his views on international convergence of GAAP and whether progress is really being made in light of recent developments.

* The views expressed in this article are the author’s own and do not necessarily reflect the views of the AICPA or AICPA CPA Insider™.