In the beautiful BMW Group Classic location in Munich the Accounting Standards Committee of Germany (Deutsches Rechnungslegungs Standards Committee, DRSC) and the International Financial Reporting Standards Foundation (IFRS Foundation) hosted a stakeholder dinner on 26 June in order to discuss the “relevance of financial reporting in today’s global environment”.

On behalf of the CFA Society Germany I participated in a panel discussion together with Ute Wolf (CFO Evonik, second to left), Hans Hoogervorst (Chair of the International Accounting Standards Board, IASB, second to right) and Andreas Barckow (President of the DRSC, very right) with the moderation of Jörg Rocholl (President of ESMT, in the middle) where I shared some thoughts from the investors’ perspective on recent developments in IFRS – but also on the big picture. The main results from my (subjective) perspective were:

  • The big standards upgrade cycle of the IASB is mainly completed. With the new rules for reporting for financial instruments, revenue recognition, leasing and insurance contracts now in place, the IASB has brought the big construction works of the last years to an end. Now it is time for them to go deeper into some more general topics: Non-GAAP performance measures and intangibles reporting (more on this below) are on their agenda.
  • From the viewpoint of companies and investors, IFRS sometimes seem to be a bit too complicated and difficult to apply – and for the wrong reasons. I highlighted the inconsistent treatment of liability valuation as an example for investors’ confusion: While e.g. long-term provisions are often overvalued because of an inadequate discount rate definition, the new IFRS 16 (lease accounting) under certain circumstances allows for relatively high discount rates and therefore for an undervaluation of the lease liability. Such deviations from economic values and inconsistencies make it difficult for investors to understand the real monetary relevance of liabilities without going very deep into the accounting rules.
  • Now most of us eventually have reached the state where they are no longer happy anymore with the impairment-only approach in goodwill accounting. What investors have been complaining a lot about for almost 15 years since the introduction of IFRS 3 has now finally infected also all the other stakeholders (interestingly, the IASB itself commented critically on this issue already a couple of years ago). At my opinion, goodwill impairments are mostly too little, too late. The information content for decision makers is very limited. And it might incentivise wrong corporate investment activities. See the post on ProSiebenSat1 (in German) for more funny stuff about impairments in practice. However, there is no easy way out of this situation. Transformation to a scheduled-amortisation approach might bring a lot of companies into trouble (the ones with the big and long dated goodwill positions on the balance sheet). And auditors will not be happy to hear about the end of a lucrative business activity. So far the IASB sticks to the impairment-only approach, but the board members are scratching their heads a lot now. Let’s see how this important issue develops…
  • There was a lot of discussion around the big topic of how to deal with the core value drivers in our more and more digitalised and intangibles-driven world. The problem is that the success of companies today is driven heavily by economic assets which cannot be recognised as assets from an accounting point of view (e.g. intangibles such as knowhow, network effects, data sets, etc.). The consequence is that financial reporting in general and the balance sheets in particular lose a lot of decision usefulness these days (Interesting: I am certainly not the only one who thinks this way [see e.g. Lev/Gu, The End of Accounting, 2016], but at the stakeholder dinner I was the only one in the room who dared to raise the hand when being asked about whether there is a shrinking relevance – however, there were also not many investors in the room).
  • At my opinion, the problem with such intangible economic assets is that we cannot easily fix it with a) allowing to recognise more intangibles as an accounting assets or b) just requiring companies to disclose more information in the Management Commentary section (btw: this latter way is the path the IASB initially wants to follow). a) Doesn’t work because it is not a problem of black-and-white, it is rather a problem of shades-of-grey, a probabilistic problem. We simply do not know exactly how much of the cash spent relates to an economic asset and how much is a real expense (from an economic point of view) This is also the reason for why IFRS sofar cannot really find a way of how to bring them as an asset onto the balance sheet. If you are running a digital business and you build up en-passant a nice data set and some network effects, you cannot easily quantify the generated assets in a black-and-white world. We know that there are some assets but not how big they are (or at least it would require a lot of additional analysis to become adequately confident about this measure). In most cases investors will end up somewhere between the extremes, i.e. some cash-out is an expense, some is an asset. But they need independent data and sensitivities to come to this conclusion. b) does not work at my opinion (at least if not added by other measures) because I do not want to allow the management too much to guide investors’ thinking. With the experience from the impairment-only goodwill accounting (THE field where management discretion plays out in its most extreme way) I would certainly expect some relevant but also a lot of distracting Information from this proposition – at least if not helped by additional measures.
  • But what is the solution? I do not know exactly – nor do other investors that I spoke to. I think it would be a good idea to accompany the current black-and-white (either asset or expense) accounting by some more probabilistic information and some more sensitivities. And of course it is a good idea to force the management to comment on these intangibles (as long as no business secrets are touched, as Ute Wolf correctly mentioned) but it will not fix it alone. Nevertheless, this whole issue is a very tricky one which will keep us busy for a long-time. Hopefully, we will find a good solution here, because if we don’t, the relevance of Financial Reporting in general and of IFRS in particular is going to decrease further – simply because of the nature of our changing world. Not a very good perspective for investment decision making.
  • Certainly related to the intangibles-issue discussed in the bullet point above, but also a result of the growing field of ESG-based investing: The IASB gets a lot of questions on why they do not require companies to provide more Non-Financial Information. The IASB made clear that they do not want to service all needs of information gathering. They see themselves rather as an institution to deal with financial reporting – certainly supporting financial reporting by delivering non-financial information related to it, but not more. Specific ESG related non-financial information will not be a focus area of the IFRS. And I agree with this! Non-Financial Information is super-important for valuing companies and making investment decisions – and it has always been. And ESG related information is also super-relevant – no matter if it has financial implication or only for satisfying the specific investment approach. Investors need different kinds of non-financial information – some of which is related to the numbers in the accounts (this is the IASB’s job to provide it), some can be found in other sources, some stem from discussions with the CFO or Investor Relations, and some has to be investigated in other ways by investors. But the IASB is not here to cover all of this. It should focus on their core competencies.

To sum it up: The IASB has achieved a lot over the last decade. The IFRS have become clearly the world leading financial reporting standards. Congrats to this, and well deserved! But from an investors’ point of view there is still some room for improvement. If you follow my blog from time to time you know what I mean. My three main wishes for the IASB agenda for the next months: 1) Bring it to a consistent framework by better integrating the single statements. 2) Try to find a good (better than the proposed) way on how to deal with the intangible issue. 3) Get investors involved more into standard setting. They are the ultimate addressees and should have stronger say in the whole process.