Returning the Relevancy of the P&L: Proposed Model
Ehud Lurie, CPA (Isr.) Shlomi Shuv, CPA (Isr.) 1* 1. Introduction Profit or Loss, or more commonly known as Profit and Loss (P&L), has always been a significant statement for most reporting entities. The primary reason lies in the fact that the P&L is the basis for evaluating the ability of reporting entities to generate profits in the future. This issue is reflected, among others, by the various earning multipliers which are used often in appraising companies and in determining acquisition transaction prices. Executive pay is often based on performance as measured by the P&L. Performance under financial covenants as well as financial ratings rely on current profitability ratios. In addition, the P&L statement is the most reviewed and examined report by investors, credit providers, analysts, the financial press and others. Although during the past few years, there have been many changes in performance measurement, such as Comprehensive Income reporting, Earnings Per Share continues to calculated on the basis of net profit (loss) and will continue in this manner in the future. There can be no dispute, therefore, that the relevancy of the P&L is important for the public trust in financial reporting. Any harm to the relevancy of the P&L, on the other hand, will lead the search for alternative solutions by various economic reports and non-GAAP adjustments. Over the last decades the accounting standardization began to use Other Comprehensive Income (OCI) as a tool for deferring the recognition of certain profits and losses. Although many years have passed since the first use of this tool, no one until now has dealt with the theoretical infrastructure that differentiates the cases in which items are to be recognized in the P$L or deferred to OCI. Recently, new items are added to OCI sporadically and without structured methodology. We have witnessed last year a new phenomenon in the IFRS - income and expenses are charged through OCI to equity and are not to be included in the P&L in the future. This phenomenon represents a clear growing trend of the IASB. It should be mentioned that the only case in the past that was referred to this unusual category was the Revaluation model of fixed assets. According to IAS 16, the reevaluation model requires the charge of the differences of revaluation of fixed assets directly to equity without recycling them to the P&L. Although the theoretical basis for this concept was not provided in the past, we can assume that the Capital Reserve derived from the Capital Preservation Concept that does not recognize the revaluation of fixed assets as profit unlike the Financial Capital Concept, both established in the Conceptual Framework. However, we should keep in mind that the reevaluation model is very problematic, and therefore rarely implemented by the companies that adopt IFRS. Recent examples of this trend are as follows: A. Actuarial profits or losses - According to the present policy of IAS 19 regarding imputed actuarial profits or losses to retained earnings thorough OCI, without recycling, is an accounting policy alternative. Moreover, according to the proposed amended to IAS 19, this accounting policy will be the mandatory. * Both authors are members of the Accounting Standards and Financial Reporting Board of the Institute of CPAs in Israel. Ehud Lurie served as CEO & CFO in several major publicly traded companies in Israel. Shlomi Shuv is the head of Accounting Program at the Interdisciplinary Center (IDC) College, Herzliya
B. Measurement of financial assets – The recently published IFRS 9, allows the selecting of accounting policy whereby the investment in equity instruments may be measured at fair value, and changes in fair value are recorded to OCI without recycling, except for dividends. C. Credit risk - In accordance with the proposal for a new Financial Instruments standard, measurement of financial liabilities at fair value...
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