G4+1 Reporting for Financial Performance - Proposals for Change

22 March 2000

Mr Greg Pound
Acting Executive Director
Australian Accounting Research Foundation
211 Hawthorn Road
CAULFIELD VIC 3162

Dear Sir

Reporting Financial Performance - G4+1 Proposals for Change

The Group of 100 provides the following comments on the G4+1 paper "Reporting Financial Performance: G4+1 Proposals for Change."

The Group of 100 disagrees with the approach adopted in this paper which shifts the focus away from the traditional reporting of a "headline" net profit and operating income for the period to a movement in equity. This approach represents a fundamental change in the manner of reporting financial performance and the focus of the statement of financial performance.

We believe that proposals relating to reporting financial performance cannot be considered in isolation from the effects of other developments such as the trend towards the use of fair values. The Group of 100 supports the use of fair value measurement for assets and liabilities for recognition in the statement of financial position. For example, for SGARAs and financial instruments, provided that unrealised valuation increments and decrements are recognised in comprehensive income and subsequently transferred to profit or loss from operations (operating income) once a signal event such as realisation occurs.

Our principal concern with the proposals is that the prohibition on recycling of items from "other gains and losses" or some other category of items to "operating income" upon the occurrence of a signal event such as realisation will, for certain companies, have the effect that the performance of what management and shareholders regard as the core operating activity of the entity being reported as "other gains and losses" or some other category, without ever being reported within operating activities and reflected in such measures as earnings per share. In an Australian context the approach may also have adverse consequences on a company’s ability to pay dividends. These are major concerns for companies, particularly those engaged in the extractive industries and in agriculture that manage, develop and exploit long-term strategic assets, such as mineral reserves and growing assets.

These issues are particularly relevant in the Australian business environment, given the relative importance of the mining and
agricultural industries.

Recycling

Recycling, in the context of the discussion paper, refers to reporting of an item of financial performance in more than one accounting period because the nature of the item is deemed to have changed in some way over time (for example, unrealised gains or losses become realised in a subsequent period) or some other signal event such as recovery of mineral reserves occurs.

The G4+1 asserts that there is no conceptual justification for recycling because once an item has been recognised in a statement of financial performance it should not be recognised again in a future period in a different component. Although the prohibition on recycling within a statement of financial performance will not result in any significant changes to the current Australian requirements and practice, the prohibition is likely to raise concerns about its impact as a number of new and industry specific accounting standards that are expected to require movements in fair values to be recognised are issued. However, even if the G4+1 view is accepted, on a practical level some impurities and trade-offs by the G4+1 may be necessary in order to achieve movement towards a long-term objective while, at the same time, seeking improvements in current reporting requirements.

The Group of 100 proposes that unrealised changes in fair values that are being held for recycling should be included under a separate category in the statement of financial performance. The items held for recycling would be as specified in the relevant Accounting Standards and, for example, could include unrealised movements in fair values of agricultural assets, investments by pension plans which are presently dealt with by applying a "corridor" approach and for certain classes of financial instruments. As such we propose that the statement of financial performance include four sections rather than three.

We believe that recycling of amounts recognised in this separate category of items to operating activities once a signal event occurs is necessary if the proposals are to achieve general acceptance. In this context we strongly support the approach to recycling which is adopted in SFAS 130 " "Comprehensive Income" and used by many G100 companies when providing reconciliations between US and Australian GAAP.

For example, if a proposed standard were to require mineral reserves, a long term strategic asset which is not of a trading or operational nature, to be recognised at fair values significant volatility in asset valuations and income may result. This would be likely to occur because of uncertainties about both the quality and quantity of the mineral reserves and the fluctuations in prices used in the valuation process. We believe that in these circumstances the changes in values of mineral reserves should be "parked" in a separate "for recycling" category in the statement of financial performance. Under this approach amounts would be released to operating income on the occurrence of a signal event such as mining or realisation through sale.

Conclusion

The Group of 100 believes that the G4+1 proposals are likely to significantly disadvantage the reported financial performance of companies with long term strategic assets because the prohibition of recycling means that realised gains/losses will not be recognised in operating income.

The Group of 100 supports the proposals for a statement of financial performance (comprehensive income) provided that an additional category of items is created. Items held in this category would comprise unrealised movements in fair values from which transfers (recycling) to operating income are made on realisation or the occurrence of another signal event as required by another accounting standard.

We believe that reporting of operating income and net profit is, and should remain, the primary focus of reporting financial performance. Accordingly, while we support the adoption of the concept of comprehensive income we believe that the financial reporting focus should be on the "operating and financial income after taxation" line of the Statement of Financial Performance (per page 20), not on a movement in equity.

Yours sincerely,

Bryce JH Denison
National President