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«PUBLIC STATEMENT European common enforcement priorities for 2016 financial statements The European Securities and Markets Authority (ESMA) issues ...»

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Date: 28 October 2016



European common enforcement priorities for 2016 financial statements

The European Securities and Markets Authority (ESMA) issues this Public Statement which defines the

European common enforcement priorities in order to promote consistent application of International Finan-

cial Reporting Standards (IFRS Standards) as indicated in the ESMA Guidelines on enforcement of financial


As in the previous years, ESMA, together with European national enforcers (hereafter referred to as “en- forcers”), identified financial reporting topics which listed companies and their auditors should particularly consider when preparing and auditing, respectively, the IFRS financial statements for the year ending 31 December 2016. In addition to these common priorities, enforcers might also set additional enforcement priorities focusing on other relevant topics.

ESMA, together with enforcers, will pay particular attention to these common priorities when monitoring and assessing the application of all relevant IFRS requirements. Enforcers will continue to focus on material issues in the financial statements that are relevant for an individual issuer under examination. On the basis of examinations performed, enforcers will take corrective actions whenever material misstatements are iden- tified. ESMA will report on findings regarding these priorities in its Report on the 2016 enforcement activities.

The common priorities for the 2016 financial statements encompass the following topics as detailed in this


 Presentation of financial performance;

 Financial instruments: distinction between equity instruments and financial liabilities; and  Disclosures of the impact of the new standards on IFRS financial statements.

ESMA and enforcers selected these topics based on the recurrence of problems identified when examining financial statements and on the expected significant changes that the new requirements will introduce to current accounting practices. In the light of their continuing relevance, ESMA and enforcers will continue to assess relevant issues described in European common enforcement priorities published in previous years.

These include, for instance, the requirements related to the impact of the financial markets conditions on the financial statements of issuers.2 Apart from the 2016 European common priorities, ESMA encourages issuers potentially affected by the result of the United Kingdom’s referendum to leave the European Union (EU) to assess and disclose the associated risks and expected impacts that the referendum result may have on their business activities.

1 Guidelines: ESMA Guidelines on enforcement of financial information, ESM

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This statement draws issuers’ attention to a number of potential additional descriptions or explanations in the notes to the financial statements. Issuers should consider the materiality and the relevance of the information before making additional disclosures.

2016 European common enforcement priorities Presentation of financial performance In the past, ESMA has drawn issuers’ attention to the need to provide good quality disclosures 3 in particular those that relate to financial performance, for instance, by providing relevant entity specific disclosures on the different revenues streams. Where necessary, enforcers have taken enforcement actions against issuers when the presentation of the financial statements reviewed did not follow the principles included in IFRS Standards.4 In July 2016, ESMA Guidelines on Alternative Performance Measures ( ESMA Guidelines on APMs) became effective.5 Also this year, the International Accounting Standards Board (IASB) underlined that one of its priorities for the following years is to increase the communication effectiveness of financial statements (which includes performance).6 Therefore, in 2017, ESMA and enforcers will focus their examinations on how financial performance is being presented in financial statements.

Presentation of information not specifically required by IFRS, within the financial statements While IFRS Standards allow the inclusion of additional information in the financial statements not specifically required by IFRS Standards, ESMA reminds issuers that all information included therein has to comply with the overall principles defined in IAS 1 Presentation of Financial Statements. Consequently, ESMA urges issuers to ensure that additional information included in the financial statements is compliant with IFRS Standards. For instance, when including in the financial statements measures of performance not defined in IFRS Standards, issuers should ensure that those measures are calculated and presented in an unbiased fashion (e.g. issuers should not eliminate, remove or omit only negative aspects or items of their performance).

ESMA also reminds issuers that in accordance with paragraph 99 of IAS 1, an entity shall present an analysis of expenses recognised in profit or loss using a classification based on either their nature or their function within the entity, whichever provides information that is reliable and more relevant. If an issuer chooses a presentation by function, additional information on the nature of the expenses shall also be disclosed in the notes (paragraph 104 of IAS 1).

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The amendments to IAS 1 on the information presented in the statement of financial position and/or in the statement(s) of profit or loss and other comprehensive income became effective for annual periods beginning on or after 1 January 2016. ESMA reminds issuers that in accordance with paragraphs 55 and 85 of IAS 1, issuers shall present additional line items, headings and subtotals in the statement of financial position and in the statement(s) of profit or loss and other comprehensive income when these line items, headings or subtotals are relevant to an understanding of the entity’s financial position or the entity’s financial performance.

While doing so, issuers should, in accordance with paragraphs 55A and 85A of IAS 1, ensure that any subtotals (i) are comprised of line items made up of amounts recognised and measured in accordance with IFRS Standards, (ii) are presented and labelled in a clear and understandable way, (iii) are consistently presented from period to period and (iv) are not displayed with more prominence than subtotals and totals required by IFRS Standards.

Some issuers include measures such as ‘operating profit’ in the statement of profit or loss or other comprehensive income. While there is no definition of the term “operating profit” in IFRS Standards, ESMA highlights the principles included in paragraph 85A and in paragraph 17 of IAS 1 regarding the relevance and fair presentation of the information disclosed. Therefore, measures such as operating profit, should be clear, understandable and reflect their content, as further explained in paragraph BC 56 of IAS 1. Like the IASB, ESMA is of the view that it is misleading if items of an operating nature (e.g. business combination impacts, depreciation of assets or inventory write-downs) are excluded from the results of operating activities even if that has been industry practice. Where significant judgement is required in the presentation of material items (e.g. service costs and net interest on the net defined benefit liability/asset, impairment of equity-accounted investments), issuers are encouraged to disclose these judgements.

Issuers shall not present any items of income or expense as extraordinary items (paragraph 87 of IAS 1) and labels used should be meaningful. For example, items that affected past periods and/or are expected to affect future periods can rarely be labelled or presented as non-recurring items such as most of the restructurings costs or impairment losses.7 Finally, in order to improve the readability of financial statements, cross-reference of significant elements of the primary financial statements to the notes should be provided, as well as details on material line items (e.g. other operating expenses) as required respectively by paragraphs 113 and 97 of IAS 1. ESMA also highlights that according to paragraph 30A of IAS 1, issuers shall not reduce the understandability of financial statements by obscuring material with immaterial information or by aggregating material items that have a different nature or function.

3Segment information

ESMA reminds issuers that IFRS 8 Operating Segments requires companies to disclose segment information “through the eyes of the management”. Although not required by IFRS Standards, ESMA expects that the elements presented in the segment information in the financial statements and those included in the press releases, management reports or analysts’ presentations are consistent in terms of segments presented and measures disclosed.

Where applicable, entity-wide disclosures should be provided in accordance with paragraphs 32 to 34 of IFRS 8. ESMA reminds issuers that disclosure of the judgements made by management in applying the aggregation criteria for operating segments is required by paragraph 22(aa) of IFRS 8 and segment information should be reconciled as required by paragraphs 21(c) and 28 of IFRS 8.

Movements in Other Comprehensive Income (OCI)

ESMA reminds issuers that some items in OCI will be reclassified to profit or loss whereas others will not.

For example, (a) foreign currency translation adjustments will be reclassified to profit or loss on disposal of a foreign operation (paragraph 48 of IAS 21) whereas (b) remeasurements of defined benefit liability (asset) will not be reclassified. (paragraph 122 of IAS 19 Employee Benefits). On disposal/ loss of control of a subsidiary, the items to be reclassified to profit or loss shall be included in the gain or loss calculation, whereas the items that will not be reclassified (i.e. the remeasurement of defined benefit plans) will remain in equity, either in the accumulated OCI or in another equity line item.

ESMA highlights that paragraphs 106A of IAS 1 require issuers to present, either in the statement of changes in equity or in the notes, for each component of equity an analysis of the OCI by item. In addition, when the accumulated OCI is material for a specific item, issuers are encouraged to provide more detailed information.

Finally, ESMA draws issuers’ attention to the discussions held in the International Financial Reporting Standards Interpretation Committee (IFRS IC) on the application of paragraphs 52A, 52B, 58 and 61A of IAS 12 Income Taxes on the presentation of income tax relating to tax payments on financial instruments classified as equity (i.e. whether these tax effects should be presented directly in equity or in profit or loss). At its June 2016 meeting, the IASB tentatively decided to propose amendments to IAS 12 to clarify that the presentation requirements in paragraph 52B of IAS 12 apply to all payments on financial instruments classified as equity that are distributions of profits as part of the next Annual Improvements Cycle.8 ESMA encourages issuers potentially materially affected by this issue to disclose separately the amount of the income tax related to these financial instruments already recognised in their financial statements.

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ESMA draws issuers’ attention to the calculation of EPS, a performance measure defined in IAS 33 Earnings per share and used to compare performance between different entities in the same reporting period and between different reporting periods for the same entity. Basic and diluted EPS shall be presented with equal prominence on the face of the statement of comprehensive income (paragraph 66 of IAS 33). Details of the EPS calculation, including the numerator, the weighted average number of ordinary shares and potentially dilutive instruments (such as stock-options, convertible bonds), should be presented clearly in the notes (paragraph 70 of IAS 33) together with reconciliations, where applicable. If issuers disclose earnings per share using a reported component of the statement of comprehensive income other than as required by IAS 33, such ratios should not be presented on the face of the statement of other comprehensive income, but rather in the notes together with the reconciliations required by paragraph 73 of IAS 33.

ESMA reminds issuers that paragraph 70(c) of IAS 33 requires information on instruments that are antidilutive in the period presented, but could potentially dilute basic EPS in the future (e.g. a standalone out-of-the money equity option).

ESMA Guidelines on APMs The ESMA Guidelines on APMs set out principles regarding the presentation of performance measures not defined or specified in the applicable financial reporting framework, such as the labelling, calculation, presentation and comparability. While the ESMA Guidelines on APMs are not applicable to financial statements, their aim is to ensure the usefulness and transparency of APMs included in prospectuses, management reports and market disclosures. The application of the guidelines to measures disclosed outside financial statements ensures that the presentation of those measures is consistent with the information included in the financial statements.

ESMA reminds issuers that they should make every effort to comply with the principles included therein.

The implementation of the guidelines is an opportunity for issuers to reassess whether all APMs used are useful and relevant. Enforcers will monitor the compliance of issuers with these guidelines.

Financial instruments: distinction between equity instruments and financial liabilities Over the years, ESMA and enforcers have identified several cases where the distinction between equity and liability require significant judgement and/or when IFRS Standards do not provide clear guidance. ESMA has brought some of those issues to the attention of the IFRS IC. In some cases, enforcers have taken actions for instance, when they have found errors in the classification of equity instruments or financial liabilities or when more information about the legal nature, the specific features and/or the contractual clauses related to these instruments was relevant.

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