Changes in Debt Under Scrutiny
Remember about key new requirements in your 2017 financial statements
IAS 7 introduces a requirement to provide detailed information about changes in debt
As the year-end approaches the European Union is endorsing new and amended standards published by the IASB. Recently it has endorsed an amendment to IAS 7 Statement of Cash Flows that was published by the IASB as part of its initiative to improve disclosures in financial statements. This amendment is effective in financial statements for 2017 and applies to all entities not only financial institutions. The amendment introduces a requirement to include detailed information about changes in debt. Furthermore in October 2017 ESMA identified this amendment as one of the three key enforcement priorities for regulatory authorities in the coming year.
Why is the disclosure of changes in debt so important?
In the dramatically changing business environment, which we are experiencing, the level of indebtedness and associated liquidity issues are perceived by investors as one of the principal risks faced by an entity. In recent years the level of corporate debt has often changed significantly and this has not always been caused by cash flows such as those arising from the receipt or repayment of loans or the issuance or redemption of bonds. The level of debt and associated changes are also affected by non-cash events such as liabilities assumed under finance lease agreements, fluctuations in foreign exchange rates (particularly painful in recent years) as well as changes in group structure such as the acquisition or disposal of subsidiaries and other businesses. For many years, investors and analysts have demanded more detailed information about changes in debt. In their experience reading a balance sheet (showing opening and closing debt balances) and a cash flow statement (showing cash flows related to the raising and repayment of debt and interest) was often not sufficient to explain the reasons for large changes in debt during a year. In addition searching for the truth by analysing thirty, forty or more pages of, sometimes vague, financial statement disclosures was a burden and often fruitless. The amendment to IAS 7 is aimed at addressing this expectation.
How to best meet the new requirements?
The basic requirement of the amendment is to present changes in debt distinguishing between cash and non-cash events. The standard does not prescribe a particular form of presentation, but suggests that one of the possibilities is to present information by providing a reconciliation of opening and closing balances of debt in the form of a table. Such a table would be similar in appearance to the tables of changes in fixed assets or provisions already included in financial statements. In addition to opening and closing debt balances it would include an analysis of changes during the period e.g: the receipt or issuance of new debt, debt repayments, changes due to the acquisition of a subsidiary or other business, changes due to foreign exchange differences etc. An illustrative example is included in the appendix to the standard. While this example meets the basic requirements, in our view it appears slightly too aggregated. Some further disaggregation would make the information presented more comprehensible and easier to reconcile to the remainder of the financial statements e.g. foreign exchange differences should be analysed between those recognized in the profit or loss and those recognized in other comprehensive income. Using the tabular form is not obligatory, as the Board observed that, for some entities, in particular those in the financial services sector, other methods of presentation may be more relevant, given the different way in which capital may be defined and managed. Those of you looking for a new adventure and a more exotic manner of presentation may be inspired by the graphical form of a debt reconciliation shown in the illustration accompanying this article.
Debt or perhaps net debt?
One of the issues debated by the IASB was whether the disclosure requirement should concern debt or rather net debt (i.e. debt net of liquid assets). The concept of net debt is familiar to analysts and is widely used by companies when communicating with investors or lenders. However, it appears that many preparers and users of financial statements have their own definition of net debt. The Board decided to address this problem by requiring the analysis of changes in those liabilities whose cash flows are recognized in financing activities under IAS 7. Providing additional information concerning changes in other assets or liabilities (such as changes in certain liquid assets) in the reconciliation is permitted but must be clearly separated from those relating to financing activities. So while it is possible to present changes in “net debt” a preparer should remember that the term remains undefined and that it will also be expected to comply with the requirements on Alternative Performance Measures (APM) published as part of ESMA guidance.
And finally …
An interesting fact to finish off with. In Poland the practice of reporting on changes in debt already exists. Some of the largest listed companies voluntarily included such disclosures in their financial statements for 2016.
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