This article addresses the requirements of IAS 1 Presentation of Financial Statements relating to the disclosure of key judgements management has made in the process of applying accounting policies and of assumptions and other sources of estimation uncertainty underlying amounts included in the financial statements.
When reporting in uncertain times, it is particularly important to provide users of the financial statements with sufficient information to enable them to understand the key assumptions and judgements made when preparing financial information.
Two key IAS 1 requirements
There are two distinct requirements in IAS 1 relating to disclosure of the judgements and estimates made by management that have the most significant effect on the amounts recognised in the financial statements:
a) Judgements in applying accounting policies
IAS 1.122 requires disclosure of the judgements, apart from those involving estimations, that management has made in the process of applying the entity’s accounting policies that have the most significant effect on the amounts recognised in the financial statements.
b) Assumptions and sources of estimation uncertainty
IAS 1.125 requires disclosure of information about the assumptions the entity makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, which have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
In respect of those assets and liabilities, the notes to the financial statements include details of their:
- nature; and
- carrying amount at the end of the reporting period.
The difference between these two requirements is not that one involves the exercise of judgement and the other does not. Rather, it is that the judgements disclosed under IAS 1.122 explicitly exclude those that involve estimations, which are addressed by the requirements of IAS 1.125.
Matters do not fall within the scope of these IAS 1 disclosure requirements merely because they require the exercise of judgement or involve significant assumptions or estimates. It is important to keep in mind that these requirements are concerned only with:
- the most complex or subjective judgements that have the most significant effect on amounts recognised; and
- the assumptions and other sources of estimation uncertainty where there is a significant risk of material adjustment to the carrying amounts of assets or liabilities within the next year.
If a matter does not meet these criteria, it should not be included in the disclosure of key judgements or sources of estimation uncertainty. In straightforward cases, it is possible that an entity will not have any issues falling within the scope of these disclosures.
The disclosure of key judgements or sources of estimation uncertainty are often best provided as a separate note or separate section of the accounting policies note with cross references, where appropriate, to other notes where further details may be found.
Judgements made in applying accounting policies other than those involving estimations
To be a key judgement disclosed under IAS 1.122, the subject matter must relate to something other than assumptions about the future or making estimates. Therefore, disclosures of key judgements do not usually address measurement although they may when the issue relates to determining the appropriate measurement basis (e.g. fair value, amortised cost etc.) rather than what goes into arriving at the amounts recognised.
Typically, these disclosures cover significant issues in applying accounting standards where management has had to exercise judgement in situations where a different judgement might have led to a materially different accounting treatment.
Examples of potential areas where judgements may arise that require disclosure under IAS 1.122 include:
- revenue recognition, e.g. in complex cases involving multiple element arrangements;
- lease classification;
- derecognition (or not) of an asset or liability;
- whether an investee is a subsidiary;
- whether an acquisition is of a business or group of assets;
- whether a joint arrangement structured through a separate entity is a joint operation or a joint venture under IFRS 11 Joint Arrangements; and
- which entity is the acquirer in a business combination under IFRS 3 Business Combinations (i.e. whether the combination is an acquisition or reverse acquisition).
However, these areas will not necessarily involve the application of judgement significant enough to warrant disclosure under IAS 1. For example, revenue recognition may be straightforward or it may be clear without detailed consideration whether a business combination is an acquisition or a reverse acquisition.
Disclosures need to identify the specific judgements that management has made in a manner that enables the reader to understand their impact. Generic statements that judgement has been exercised should be avoided.
Assumptions about the future and other sources of estimation uncertainty
For a matter to fall within the IAS 1.125 disclosure requirement relating to assumptions about the future and other sources of estimation uncertainty, there needs to be subjectivity around assumptions and estimates. There also needs to be a significant risk that a material adjustment to the carrying amount of assets or liabilities may be required as a result of changes in those assumptions or estimates in the next period, not just in any future period whenever that might be. Such situations could arise, for example, when:
- reasonably possible different assumptions could have led to measurement at a materially different amount;
- an uncertain factor could cause the carrying amount of an asset or liability to change materially in the next year; or
- a reasonably possible change in an assumption could occur, with a consequential material impact on the amounts recognised.
Potential examples of areas where disclosure may be necessary, depending on the individual facts and circumstances of a particular case, include, amongst others:
- recognition and measurement of provisions where there are uncertainties relating to the future outcome of litigation;
- recognition and measurement of liabilities relating to uncertain tax positions;
- forecast of future profits affecting the amount recognised for a deferred tax asset;
- assumptions underlying the estimation of recoverable amounts of assets for impairment tests; and
- fair value measurements that depend on significant unobservable inputs.
However, these and other issues will fall within the IAS 1 disclosure requirement only if there is a significant risk of material adjustment to the carrying amounts of assets or liabilities in the next year.
When there are uncertainties that have a significant risk of causing a material adjustment to the carrying amount of assets and liabilities within the next financial year, the notes to the financial statements need to disclose:
- information about the assumptions concerning the future; and
- other major sources of estimation uncertainty at the end of the reporting period.
In respect of those assets and liabilities, the notes need to include details of:
- their nature; and
- their carrying amount at the end of the reporting period.
IAS 1 states that the disclosures should be presented in a way that helps users of the financial statements to understand the judgements management makes about the future and about other key sources of estimation uncertainty. It is also important to distinguish between estimates which have a significant risk of material adjustment to the carrying amount of assets and liabilities in the next financial year (and hence require disclosure under IAS 1:125) and those which might affect asset and liabilities over a longer timescale (and hence are not within the scope of that paragraph but might usefully be disclosed separately).
Cutting out the clutter
It is also important to identify what is within the scope of either the IAS 1.122 or IAS 1.125 disclosure requirements and what is not, so that the disclosures provided are not obscured by irrelevant material that detracts from the key messages. The measurement of a particular asset or liability should not be described as a key source of estimation uncertainty merely because the associated calculations are complex. What matters is whether there is a significant risk of a material adjustment to the measurement of assets or liabilities as a result of changes in assumptions or estimates in the next period. In addition, the disclosure of key judgements and sources of estimation uncertainty under IAS 1 should not be in substitution for, or a repeat of, information that belongs in the accounting policies for the areas discussed.
More information, including examples of disclosures, can be found in the publication IFRS in Focus – Spotlight on key judgements and estimates disclosures.
Sources: IFRS in Focus – Spotlight on key judgements and estimates disclosures, www.iasplus.com