MD&A Disclosures Relating to Financial Instruments
How they impact debt covenants.
July 26, 2010
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:
Content of IFRS Financial Statements
Financial statements are prepared by the company for the users, which leads to the four key characteristics (see sidebar):
The content of the IFRS financial statements is very similar to the U.S. GAAP:
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:
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:
Some practical impacts include:
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.
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™.