The Question
An entity is required to disclose a summary of what constitutes capital, based on internal reporting to key management. For example, capital may not simply be total equity because some entities consider subordinated debt to be capital. Others consider the equity components of cash flow hedges to be excluded from capital. To date this quantitative disclosure has been provided in a note to the financial statements.
With the amendments to IAS 1, Presentation of Financial Statements, the question arises: Can a subtotal of “capital under management” be presented in the statement of financial position?
Prior to the Amendment
For annual periods ending on December 31, 2015 and before, the minimum line items to be included in the statement of financial position were listed. Guidance was also provided on when to include line items, namely: when the “size, nature or function of an item” is relevant to understanding the financial position.
The standard explicitly stated that the “order or format” of line items is not prescribed and that the terminology and the ordering and aggregation of similar items can be determined by the entity to suit the nature of the business and the balances reported. However, different measurement bases used for different balances would suggest that their nature or function differs therefore warranting presentation on separate lines.
Preparers were allowed to include headings and subtotals where relevant to an understanding of financial position. However, the requirements were typically interpreted as prescribing the minimum line items to be presented and subtotals were therefore used sparingly.
The Amended Standard
IAS 1 was amended in December 2014, effective for annual periods beginning on or after January 1, 2016, to address these application issues (with similar changes related to the income statement) by:
i. explicitly stating that the minimum line items should be disaggregated; and
ii. that when additional subtotals are presented, they “shall:
(a) be comprised of line items made up of amounts recognized and measured in accordance with IFRS® Standards;
(b) be presented and labelled in a manner that makes the line items that constitute the subtotal clear and understandable;
(c) be consistent from period to period…; and
(d) not be displayed with more prominence than the subtotals and totals required in IFRS Standards for the statement of financial position.”
Such subtotals are explicitly required when they are relevant to an understanding of an entity’s financial position. They are therefore referred to as “additional GAAP measures.”
As examples of line items that could be disaggregated, the standard refers to the classifications that are often provided in note disclosures. For example, property, plant and equipment into the classes used by IAS 16 and receivables between trade receivables, balances due from related parties, prepayments and so on. Clearly any disaggregation that is applied by an entity will depend on the circumstances.
Answer
Consider an entity that has convertible debt and considers that instrument plus equity to constitute the capital it manages. In such a case, ordering the statement of financial position line items in a way that a subtotal of capital under management can be presented appears to be supported by these amendments. Similarly, using some other descriptive term (Permanent capital, perhaps) would also be permitted with appropriate explanation provided in a note.
Including such a subtotal on the balance sheet would assist users in assessing the entity’s financial strength.
In arriving at this conclusion, we make the following observations:
• All the items included in the subtotal are recognized and measured in accordance with the relevant IFRS Standards.
• Users of financial statements are already familiar with the concept of capital under management as a measure of the risk of an entity and its ability to weather economic adversity. Various regulatory requirements have existed for eons and the disclosure requirements for capital under management in IAS 1 became effective for annual periods commencing on or after January 1, 2007.
• There is no requirement in IAS 1 to present on the statement of financial position a subtotal of liabilities. This is even the case where an entity presents current and non-current liabilities.
• An entity is able to order the line items to suit the business or nature of the entity.
• Furthermore, information that is required to be disclosed can be included in either the statements themselves or in the notes unless ‘specified to the contrary’ by an IFRS. The fact that the capital disclosures are listed, amongst other required disclosures, under a section labelled “Notes” appears to be a drafting convenience given the qualitative nature of most of the required information. I do not read this as being “specified to the contrary.”
• For a public company, management’s discussion and analysis (MDA) should complement and supplement the financial statements. Therefore, the regulator would be satisfied if management discusses and refers to the subtotal presented.
Some Caveats
As with most financial reporting, consistency would be needed from period to period, and the subtotal cannot be displayed with more prominence than required subtotals.
Given the different nature of equity and convertible debt these amounts would still have to be presented separately with a subtotal and could not be combined on one line.
Some entities have more than one class or type of convertible debt instrument issued. IAS 1 comments that “some entities consider some forms of subordinated debt” to be capital. Therefore, how each convertible debt instrument is presented would have to be given some thought.
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