(a) (i) The IFRS Practice Statement Management Commentary provides a broad, non-binding framework for the presentation of management commentary. The Practice Statement is not an IFRS Standard. Consequently, entities applying IFRS Standards are not required to comply with the Practice Statement, unless specifically required by their jurisdiction. Furthermore, non-compliance with the Practice Statement will not prevent an entity’s financial statements from complying with IFRS Standards.
It can be argued that the International Accounting Standards Board’s (the Board) objectives of enhancing consistency and comparability may not be achieved if the framework is not mandatory. A standard is more likely to guarantee a consistent application of the principles and practices behind the management commentary (MC).
However, it is difficult to create a standard on the MC which is sufficiently detailed to cover the business models of every entity or be consistent with all IFRS Standards. Some jurisdictions take little notice of non-mandatory guidance but the Practice Statement provides regulators with a framework to develop more authoritative requirements.
The Practice Statement allows companies to adapt the information provided to particular aspects of their business. This flexible approach could help generate more meaningful disclosures about resources, risks and relationships which can affect an entity’s value and how these resources are managed. It provides management with an opportunity to add context to the published financial information, and to explain their future strategy and objectives without being restricted by the constraints of a standard.
If the MC were a full IFRS Standard, the integration of management commentaries and the information produced in accordance with IFRS Standards could be challenged on technical grounds, as well as its practical merits. In addition, there could be jurisdictional concerns that any form of integration might not be accepted by local regulators.
(ii) The Framework states that ‘an essential quality of the information provided in financial statements is that it is readily understandable by users’. The MC should be written in plain language and a style appropriate to users’ needs. The primary users of management commentary are those identified in the Conceptual Framework. The form and content of the MC will vary between entities, reflecting the nature of their business, the strategies adopted and the regulatory environment in which they operate. Users should be able to locate information relevant to their needs.
Information has the quality of relevance when it has the capacity to influence the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. Relevant financial information is capable of making a difference to the decision made by users. In order to make a difference, financial information has predictive value, confirmatory value or both. The onus is on management to determine what information is important enough to be included in the MC to enable users to ‘understand’ the financial statements and meet the objective of the MC. If the entity provides too much information, it could reduce its relevance and understandability. If material events or uncertainties are not disclosed, then users may have insufficient information to meet their needs.
However, unnecessary detail may obscure important information especially if entities adopt a boiler-plate approach. If management presents too much information about, for example, all the risks facing an organisation, this will conflict with the relevance objective. There is no single optimal number of disclosures but it is useful to convey their relative importance in a meaningful way.
Comparability is the qualitative characteristic which enables users to identify and understand similarities and differences amongst items. It is important for users to be able to compare information over time and between entities. Comparability between entities is problematic as the MC is designed to reflect the perspectives of management and the circumstances of individual entities. Thus, entities in the same industry may have different perceptions of what is important and how they measure and report it. There are some precedents on how to define and calculate non-financial measures and financial measures which are not produced in accordance with IFRS Standards but there are inconsistencies in the definition and calculation of these measures.
It is sometimes suggested that the effectiveness of the overall report may be enhanced by strengthening the links between financial statements and the MC. However, such suggestions raise concerns about maintaining a clear distinction between the financial statement information and other information.
An entity should ensure consistency in terms of wording, definitions, segment disclosures, etc between the financial statements and the MC to improve the understanding of financial performance.
(b) Current tax is based on taxable profit for the year. Taxable profit is different from accounting profit due to temporary differences between accounting and tax treatments, and due to items which are never taxable or tax deductible. Tax benefits such as tax credits are not recognised unless it is probable that the tax positions are sustainable.
The Group is required to estimate the corporate tax in each of the many jurisdictions in which it operates. The Group is subject to tax audits in many jurisdictions; as a result, the Group may be required to make an adjustment in a subsequent period which could have a material impact on the Group’s profit for the year.
Tax reconciliation
The tax rate reconciliation is important for understanding the tax charge reported in the financial statements and why the effective tax rate differs from the statutory rate.
Most companies will reconcile the group’s annual tax expense to the statutory rate in the country in which the parent is based. Hence the rate of 22% is used in the tax reconciliation. It is important that the reconciliation explains the reasons for the differences between the effective rate and the statutory rate. There should be minimal use of the ‘other’ category. In this case, the other category is quite significant ($14 million) and there is no explanation of what ‘other’ constitutes.
One-off and unusual items can have a significant effect on the effective tax rate, but financial statements and notes often do not include a detailed discussion of them. For example, the brand impairment and disposals of businesses should be explained to investors, as they are probably material items. The explanation should include any potential reversal of the treatment.
Some profits recognised in the financial statements are non-taxable such as the tax relating to non-taxable gains on disposals of businesses and in some jurisdictions, taxation relief on impairment losses will not be allowable for taxation. The reasons for these items not being allowed for taxation should be explained to investors.
Tax rates
As the Group is operating in multiple countries, the actual tax rates applicable to profits in those countries are different from the local tax rate. The overseas tax rates are higher than local rates, hence the increase in the taxation charge of $10m. The local rate is different from the weighted average tax rate (27%) of the Group based on the different jurisdictions in which it operates. Investors may feel that using the weighted tax rate in the reconciliation gives a more meaningful number because it is a better estimate of the tax rate the Group expects to pay over the long term. Investors will wish to understand the company’s expected long-term sustainable tax rate so they can prepare their cash flow or profit forecasts.
Information about the sustainability of the tax rate over the long term is more important than whether the rate is high or low compared to other jurisdictions. An adjustment can be made to an investor’s financial model for a long-term sustainable rate, but not for a volatile rate where there is no certainty over future performance. For modelling purposes, an understanding of the actual cash taxes paid is critical and the cash paid of $95 million can be found in the statement of cash flows.
Deferred taxation
Provision for deferred tax is made for temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and their value for tax purposes. The amount of deferred tax reflects the expected recoverable amount and is based on the expected manner of recovery or settlement of the carrying amount of assets and liabilities, using the basis of taxation enacted or substantively enacted by the financial statement date.
Deferred tax assets are not recognised where it is more likely than not that the assets will not be realised in the future and reference to IAS 37 Provisions, Contingent Liabilities and Contingent Assets is useful in this regard. The evaluation of deferred tax assets’ recoverability requires judgements to be made regarding the availability of future taxable income.
Management assesses the available evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the loss incurred in the period prior to the period ended 30 November 20X7. Such objective evidence may limit the ability to consider other subjective evidence such as projections for future growth. Deferred taxes are one of the most difficult areas of the financial statements for investors to understand. Thus there is a need for a clear explanation of the deferred tax balances and an analysis of the expected timing of reversals. This would help investors see the time period over which deferred tax assets arising from losses might reverse. It would be helpful if the company provided a breakdown of which reversals would have a cash tax impact and which would not.
As the proposed tax law was approved, it is considered to be enacted. Therefore, the rate of 25% should be used to calculate the deferred tax liability associated with the relevant items which affect deferred taxation.
At 30 November 20X7, Holls has deductible temporary differences of $4·5 million which are expected to reverse in the next year. In addition, Holls also has taxable temporary differences of $5 million which relate to the same taxable company and the tax authority. Holls expects $3 million of those taxable temporary differences to reverse in 20X8 and the remaining $2 million to reverse in 20X9. Thus a deferred tax liability of $1·25 million ($5 million x 25%) should be recognised and as $3 million of these taxable temporary differences are expected to reverse in the year in which the deductible temporary differences reverse, Holls can also recognise a deferred tax asset for $0·75 million ($3 million x 25%). The recognition of a deferred tax asset for the rest of the deductible temporary differences will depend on whether future taxable profits sufficient to cover the reversal of this deductible temporary difference are expected to arise. Deferred tax assets and liabilities must be recognised gross in the statement of financial position. However, it may be possible to offset the deferred tax assets and the deferred tax liabilities if there is a legally enforceable right to offset the current income tax assets against current income tax liabilities as the amounts relate to income tax levied by the same taxation authority on the same taxable entity.
After the enactment of a new tax law, when material, Holls should consider disclosing the anticipated current and future impact on their results of operations, financial position, liquidity, and capital resources. In addition, Holls should consider disclosures in the critical accounting estimates section of the management commentary to the extent the changes could materially affect existing assumptions used in making estimates of tax-related balances. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and the effective tax rate in the future.​​​​​​​