SUMMARY - IASB draft revised framework for preparing Management Commentaries
By Julia Schneider, HLB Germany
On May 27, 2021, the IASB issued a new draft (ED/2021/6) with a revised framework for preparing Management Commentaries. According to the IASB, the revision was necessary to better meet the "contemporary information needs" of investors and creditors, which have evolved since the existing framework was issued in IFRS Practice Statement 1 "Management Commentary" in 2010.
What is a Management Commentary?
A Management Commentary is a report that supplements an entity's financial statements. Management Commentaries are known by various names around the world, including management discussion and analysis (MD&A), strategic report, integrated report or, in German-speaking areas, management report.
Background for the revision of Practice Statement 1
Many entities publish a report issued by their management concerning the situation of the entity that is not part of the financial statements. IFRS does not ask for the presentation of such information, although IAS 1.13 provides a brief description of matters that could be included in the annual report. The 2010 IFRS Practice Statement 1 Management Commentary, provided a non-binding framework for the presentation of a report concerning the situation of an entity that relates to the financial statements prepared in accordance with IFRS.
However, since the publication of the Practice Statement in 2010, reporting on sustainability and environmental, social and governance (ESG) issues, for example, has gained increasing traction and the information needs of investors and creditors have increased. In this regard, the IASB has noted that the currently published Management Commentary does not always provide those users with the information they need.
According to the Board, the current preparation of Management Commentaries based on the 2010 Practice Statement also reveals deficits in reporting practice. Investors and creditors complain, says the Board, that the reports do not always contain the information they need and that the information is not always presented in an easily understandable and usable way.
In response to the changing information needs of investors and creditors as well as developments in the reporting community, the IASB has developed proposals for a comprehensive new framework that would allow entities to bring together in Management Commentaries the information that investors and creditors need to assess an entity's long-term prospects.
Objective of ED/2021/6
The IASB's objective is that the new Management Commentary should not only explain the financial performance and position reported in the entity's financial statements, but also provide insight into other factors that affect the entity's ability to create value and generate cash flows, both in the short and long term.
To clarify the ED's focus, investors and creditors are explicitly named as addressees in the introduction (ED/2021/6 IN4). This is a significant restriction of the addressees compared to the Framework (par. 9).
According to ED/2021/6 par 3.1, the Management Commentary should serve to provide the addressees:
- with a better understanding of the financial performance and financial position, complementary to the financial statements.
- provision of insight into the factors that may affect the company's ability to create value and generate long-term cash flows in the future.
Main focus of the reporting
To achieve the above objective, key matters and information should be presented for the following six interrelated areas (ED/2021/6 par 4.1).
- Business model
- Strategy for maintaining and developing the business model
- Overview of the resources and relationships that undepin the business model and strategy
- Risks that could jeopardise the business model, strategy, resources and relationships
- Factors and trends from the external environment that influence the business model, the strategy, the risks, resources and relationships
- The financial performance and financial position of the entity, including a description of how the aforementioned areas have affected or may affect it.
Focus on essential key matters
Key Matters are defined as those issues that, in the relation to the above areas of focus, from the management's perspective, are fundamental to the company's ability to create value and generate cash flows in the short and long term.
Because these Key Matters are fundamental to an entity's ability to create value and generate cash flows, the IASB concludes that it is therefore likely that much of the information that is material to investors and creditors relates to Key Matters.
Selection and presentation of information
In the ED, the IASB proposes guidance to help management identify material information, including guidance on identifying material matters and three indicators of material information:
- Information that relates to a material matter
- Information used by management
- Information used in capital market communications
The Board anticipates that other reporting requirements or guidance issued by, for example, industry associations or organisations with an interest in sustainability reporting may be helpful in identifying material information.
The IASB requires in the ED that the information in the Management Commentary be complete, balanced, accurate and consistent to meet the objective. It also states that information is more useful if it is clear and concise, comparable with information from previous reporting periods and with information from other entities, and verifiable. For each of these attributes, guidance on application is presented in the ED.
Except for consistency, the identified attributes correspond to the characteristics of useful financial information in the Framework (para. 12).
Because the six domains are interrelated, the ED requires that when an issue addressed in one content area has an impact on other content areas, information is provided to enable users to assess that impact.
The ED also requires that information be presented in a way that users can relate to the information in the financial statements and that explanations be provided for any inconsistencies between the information in the Management Commentary and information provided elsewhere (e.g., in presentations to investors or on the website).
Recognising that material information includes key performance indicators used by management to monitor qualitative or quantitative aspects of important matters, the ED requires companies to define, explain and reconcile any key performance indicators that are not presented in the financial statements.
Under IFRS, companies are not required to prepare a Management Commentary - the new draft does not require this either. The (proposed) Practice Statement is not an IFRS, so its application after finalisation is voluntary.
However, in the IASB's view, such a report could be required by local regulators and legislators based on the Practice Statement or could be prepared by companies voluntarily. The IASB expects that entities may apply the proposed framework in conjunction with national requirements and/or also in conjunction with other frameworks (e.g. sustainability reporting).
For an entity to claim compliance with the revised IFRS Practice Statement 1, the Management Commentary must meet the above objective and provide material information that meets the public disclosure objectives for all six focus areas.
In this context it should also be mentioned that on 31 March 2022 the ISSB (International Sustainability Standards Board) published two draft standards (ED IFRS S1 - General Requirements for Disclosure of Sustainability-related Financial Information and ED IFRS S2 - Climate-related Disclosures) on the subject of ESG reporting.
Effective date of the revised IFRS Practice Statement 1 and comment period
ED/2021/6 proposes that the Practice Statement should replace IFRS Practice Statement 1 Management Commentary for reporting periods beginning on or after the date of its issuance.
The comment period has ended on 23 November 2021.
While the IASB's guidance or proposals in the ED represent a comprehensive revision of the requirements and guidance for Management Commentaries, the core principles from PS1 2010 are retained. The Board's focus was on clarifying the objective of Management Commentaries and assisting management in identifying and presenting the information necessary to achieve that objective.
It is clear that the IASB considers the Management Commentary to be an appropriate venue for information about ESG matters that are material to investors and creditors. It is also clear that the Board intends to use the revised PS 1 in conjunction with, for example, sustainability reporting requirements and guidelines.
In examining the Board's proposals, the main question is whether they provide sufficient guidance for management to navigate this complex reporting landscape and to identify and present entity-specific information that is relevant to investors and creditors in one single report. It should also be questioned whether the numerous examples in the ED (also in the context of the Key Matters) are actually regarded by users only as indications, as intended by the IASB, or as requirements.