Feedback ESEF preparation sessions

, ,

Earlier this month, right before COVID-19 put a stop to basically all social and professional events, XBRL Netherlands organized ESEF preparation sessions together with Dutch market supervisor AFM and auditors association NBA. These sessions were organized for issuers, to raise awareness and provide an opportunity to raise questions around the implementation of ESMA’s ESEF requirement.

In separate sessions in Den Bosch and Zeist, all parties that are touched by ESEF gathered, to share information and experiences, and to address specific questions and concerns. In this article I will try to summarize relevant feedback from the meeting in Den Bosch.

AFM

The AFM introduced the ESEF requirement and put it in its legal context. A good overview of ESEF can also be found on the ESMA website.

source: AFM slides (click on image)

AFM surveyed the awareness/readiness of companies in scope of the ESEF requirements at the end of last year and found that a large part of the test group still has to start the implementation project. A small fraction was not aware of the requirement, at the end of last year.

Other interesting feedback from the survey: only 16% of the companies questioned indicated that they would tag notes to the financial statements at a more granular level than required by ESEF. 41% of the population considered to extend ESEF reporting to quarterly- and semi-annual financial reports, once ESEF is implemented.

The project lead from AFM emphasized the scope of ESEF to include IFRS consolidated financial statements. Statutory accounts may be prepared using ESEF on a voluntary basis, only if local Market Supervisor has provided a taxonomy for that.

A substantial part of the AFM time slot was dedicated to a review of the ESEF requirement in more detail. I am referring to an earlier article to get up to speed on that.

The key challenges according to AFM are:

  1. Technical implementation, i.e. selection and implementation of the software that will facilitate iXBRL (block) tagging and generate XHTML output file
  2. Correctness tagging of primary financial statements, especially when extensions to the ESEF taxonomy are needed

Contrary to the current filing process, AFM wants to validate uploaded ESEF files before they are filed in its database. Depending on the nature and magnitude of an error in the file (if any), AFM will give a formal warning to the issuer, or reject the file all-together. See validation examples in these slides.

AFM expects that it can start testing the upload-portal with issuers at the earliest by Q3-2020. Realistically, that will slip into Q4 however. AFM will ask issuers to participate in the testing, by uploading test files based on FY19.

The AFM testing of their upload portal in H2-2020 is a great opportunity for companies to test the completeness and correctness of their tagging!

XBRL Netherlands

During this session the focus was on the technical aspects of XBRL-based reporting. The main elements of (Inline) XBRL were discussed (taxonomies, instances) and how they interact.

Source: XBRL NL slides (click on image)

Then we looked into specifics of the ESEF Taxonomy. This taxonomy is based on the IFRS taxonomy and will be updated every year. As this update process starts with updates on the IFRS taxonomy and all changes to the ESEF taxonomy need to go through an EC approval process, the updated ESEF taxonomy will become available only towards the end of a given year.

When the ESEF taxonomy does not provide a proper element to use for a company-specific line item, the issuer will have to “anchor” a self-made element to an ESEF taxonomy element.

As an example, a company can add an element called “Revenue from cloud and software” and anchor it to the ESEF element “Revenue”.

Clever extensions to the ESEF taxonomy will allow companies to maintain their existing aggregation in the primary financial statements. Be careful to avoid duplications with ESEF elements!

Issuer perspective

To provide insights from the issuer’s perspective, the Philips financial reporting team shared their experience with Digital Reporting. As a foreign private issuer in the US due to its secondary listing on the NYSE, Philips has been filing XBRL-based reporting to the SEC since FY2017.

During the presentation, the Philips team walked the audience through their digital reporting journey, which provided a great insight for companies in the EU facing ESEF:

Philips choose to take the opportunity of XBRL reporting requirement to implement a Content Management System (CMS). That triggered a discussion on the various strategies to deal with ESEF for companies:

  1. Fully outsource to a printing agency or other service provider: simply send the annual financial report in pdf to the service provider and receive back the XHTML file including iXBRL tagging of the financial statements. The benefits will be clear, however companies will have to thoroughly check completeness and correctness of the tagging as they are ultimately responsible for the document. Also, companies will not benefit from building up ESEF/XBRL knowledge internally.
  2. Embed the XBRL tagging into existing reporting process, by buying a license to an inline XBRL software. Although this will lead to building up solid ESEF/XBRL knowledge internally, it will increase workload and add complexity to already challenging production process of the annual financial report.
  3. Use ESEF requirement to radically change the production of annual financial reporting, by implementing a CMS. This CMS not only manages the iXBRL tagging but also significantly improves the way annual financial reports (and other company reporting) are produced.

For Philips, the implementation of a CMS meant that they are fully in charge of the XBRL process and have flexibility in timing of testing and production of XBRL reports. This translates in significant savings in terms of time, resources and money.

Based on their experiences with SEC EDGAR reporting, Philips team urged AFM to assure that the filing portal is user- and IT friendly and includes a sound validation mechanism. Also, to avoid missing deadlines due to technical constraints, AFM was asked to apply a “grow-in” period for filing first annual financial reports in ESEF.

One of the key takeaways from Philips experience with XBRL-based reporting: start the process in time, to avoid last-minute anxiety and missed filing deadlines!

User’s perspective

EUMEDION provided feedback on behalf of users of financial information. EUMEDION is an organization that represents institutional investors, focusing on topics of corporate governance.

The benefits of ESEF for investors and other users of financial information are evident. Due to its 100% coverage of all listed companies in the EU, investors and analysts can have a complete coverage of audited, tagged and detailed information. This ensures the availability of cheaper and faster information.

EUMEDION sees ESEF implementation for the financial statements as a very good first step but proposes to have it expanded to other parts of the annual financial statements (directors’ report, ESG, audit opinion) as well as to other reporting (quarterly reports, prospectuses).

Finally, EUMEDION expects that only very large investors will be looking to directly replicate the full ESEF database themselves. All others will be relying on third-party data providers to get to the information they need.

ESEF reporting will be very beneficial for investors and analysts, and will put digital reporting in Europe ahead of that in the US

External audit

The external audit profession was represented by the Dutch Auditors Association NBA. They shared with the audience some of the uncertainties around audit assurance on ESEF.

  1. What kind of assurance should be provided? The audit of compliance with ESEF regulation is considered part of the statutory audit requirements, according to guidance by the European Commission. This means in practice that auditors should provide assurance on the compliance of ESEF requirements.
  2. Materiality and risks to be covered? Materiality concept is the same as for the financial statements. The risks to be covered by auditors are in the areas of
    • Completeness: all figures disclosed are tagged, company ID is included
    • Accuracy: tagged information equals the human readable information, tagged information has the correct context (debet/credit, period), correctness of extensions
  3. How to include an audit opinion? Three possible scenarios are being discussed:
    • separate XHTML file with iXBRL tags (linked to NBA Assurance Taxonomy)
    • iXBRL tag file (NBA Tax) included in the other information of the XHTML financial statements
    • untagged text in the other information section of the XHTML financial statements
  4. How to sign off on financial statements? For that, two scenarios are considered:
    • Digital Linking and signing with the “PKI” government certificate. This is how currently auditors sign off on SBR filings of companies in the Netherlands
    • Hardcopy autorisation included in the text of the auditors opinion in the XHTML financial statements.

As to the “how” of assurance on ESEF, the procedures can include an inspection of mark-up’s and anchoring, and the development of an independent expectation to compare with the issuer’s marked-up financial statements. NBA is working on a worksteps guidance document.

As for form and format of audit opinion and sign-off, the Ministry of Finance will make the final decision.

ESEF is putting some practical challenges to audit firms, that still need to be sorted out

Conclusion

Of course, the above is just a high-level summary of a very useful and informative ESEF seminar. Plenty questions were raised during and after the presentations and you will likely have questions yourself. Do not hesitate to raise them, by adding a comment to this article or sending me a message.

Thanks to XBRL Netherlands, AFM and NBA for hosting this event!

/0 Comments/by

New IFRS standard in the making – and it will impact the presentation of financial statements!

,
We already discussed the draft new standard on Presentation and Disclosures in a previous article on non-GAAP performance measures.

As the comment period on this Exposure Draft will be closing by the end of 2020 (extended deadline due to COVID-19), now is the time to look in more detail at its impact on primary income statement and footnote disclosures.

Introducing Exposure Draft “General Presentation and Disclosures”

Investors ask for better comparability and disaggregation of financial information

Having consulted the investor community and hearing their demand for better comparability, improved quality of disaggregation and a connection to non-GAAP performance measures, IASB is proposing new requirements for presentation and disclosure in financial statements. These proposals focus on the P&L but can have a limited impact on cash flow statement and balance sheet as well.

In December 2019, the Board published an Exposure Draft that sets out its proposals for a draft IFRS Standard on presentation and disclosures in financial statements. When finalised, this Standard will replace IAS 1  “Presentation of Financial Statements“.

In this ED the Board proposes:

  • additional subtotals in the statement of profit or loss.
  • disaggregation to help a company to provide relevant information.
  • disclosure of some management-defined performance measures.
  • limited changes to the statement of cash flows to improve consistency in classification by removing options.

We will discuss the first two of these proposals in more detail below. Please read this article to learn more about disclosing performance measures.

Additional subtotals in the statement of profit or loss

Companies will have to present income and expenses included in P&L in the following categories:

(a) operating – this category includes information about income and expenses from an entity’s main business activities. It should include all income and expenses (included in P&L) that are not classified in one of the other categories.

(b) investing – the objective of the investing category is to communicate information about returns from investments that are generated individually and largely independently of other resources held by an entity. In this category, entities should report income and (incremental) expenses from investments (including non-integral associates and joint-ventures). Note that for companies for which investing is a main business activity (banks), the related income and expense should be reported within the Operating category.

(c) financing – the objective of the financing category is to communicate information about income and expenses from assets and liabilities related to an entity’s financing. That includes income and expenses from cash and cash equivalents and liabilities.

(d) integral associates and joint ventures – defining “integral” as “being integral to an entity’s business activities”, this category includes the reporting entity’s share in the income and expense of integral associates and joint ventures. In practice I would expect that joint ventures are often integral to an entity’s own business activities and associates are not, however that is a choice to be made by each reporting entity. The share in results of non-integral associates and joint ventures goes into the investing category.

(e) income tax

(f) discontinued operations

Acknowledging these categories, the P&L will have to include three subtotals:

P&L line items and subtotals per ED “General Presentation and Disclosures”
  1. Operating profit or loss
  2. Operating profit or loss and income and expenses from integral associates and joint ventures
  3. Profit or loss before financing and income tax.

Note that whilst this third subtotal equals the well-known EBIT measure, the proposal does not include an EBITDA equivalent!

Disaggregation to help a company providing relevant information.

Investors sometimes find it difficult to understand reported information by companies because items may be lumped together without proper explanation. Therefore, the ED includes new guidance to help companies disaggregate information in the most useful way for investors.

How? Well the ED clarifies one more time that:

(a) items shall be classified and aggregated on the basis of shared characteristics;

(b) items that do not share characteristics shall not be aggregated; and

(c) aggregation and disaggregation in the financial statements shall not obscure relevant information or reduce the understandability of the information presented or disclosed.

Disaggregating operating expense

An entity shall present in the operating category of the statement of profit or loss an analysis of expenses using a classification based on either their nature—the nature of expense method—or their function within the entity—the function of expense method. The entity shall present the analysis using the method that provides the most useful information to users of their financial statements. If a company chooses to present operating expense applying the function of expense method, it will have to add a footnote to provide the operating expense split by their nature.

Further, the ED provides guidance around the aggregation of items that are not material. Either these are aggregated with material items that have the same nature, or they are grouped together with other immaterial items of different natures. In that second scenario, an entity shall disclose in the notes information about the composition of the aggregated items. For example by indicating that an aggregated item consists of several unrelated immaterial amounts and by indicating the nature and amount of the largest item in the aggregation.

Note disclosure on Unusual Expense, from the Illustrative Examples

Companies would also be required to provide better analysis of their operating expenses and to identify and explain in the notes any unusual income or expenses, using the Board’s definition of ‘unusual’: “income and expenses with limited predictive value. Income and expenses have limited predictive value when it is reasonable to expect that income or expenses that are similar in type and amount will not arise for several future annual reporting periods.”

These requirements would help investors analyse companies’ earnings and forecast future cash flows.

Process and next steps

During a webcast on 11 February (see below), participants had an opportunity to ask questions to IASB staff members directly.

As said in the introduction, the consultation period on this ED was extended to 31 December 2020. Until then, stakeholders have an opportunity to provide their comments for IASB’s consideration. Given the process, this new standard can be applicable as soon as FY2021!

/0 Comments/by

HOW TO MAKE YOUR NON-GAAP MEASURES COMPLY WITH GAAP

, ,

It’s that time of the year again for closing the books and, very likely, a ritual discussion will take place at many corporate headquarters over the next weeks.

Reporting of performance measures

This debate between management and external audit firm will be around the presentation of the annual results, and it’s one that will not easily be settled. Simply because there’s an implicit conflict of interest: management wants to explain its operational performance and often has to use non-GAAP measures to do so, whilst external auditors need to validate the presentation of financial statements against GAAP Standards such as IFRS®.

As a consequence of this status quo, primary income statements in GAAP financial statements often are a mix of both worlds, confusing investors when they try to compare performance with other companies, and frustrating both management and auditors.

One solution can be to completely disconnect the presentation of formal, GAAP-compliant financial statements from other expressions made by the company around its earnings in its press release. 

That however does not help investors to make the connection between management’s comments in press release, and the annual financial statements.

Which complicates the understanding of the company’s performance significantly.

Regulators’ view

ESMA performed a desktop research on 2018 annual financial statements (Management Reports or MR) and ad-hoc reporting (mostly earnings press releases) by 123 issuers to see how companies comply with the rules regarding reporting of “Alternative Performance Measures” (APMs).

Not surprisingly, ESMA concluded that companies use a wide variety of APMs in their financial statements and other reporting.  For the most part (around 80%) companies do not sufficiently explain, disclose or reconcile APMs in their financial statements, and ESMA strongly encourages issuers to improve.

One area of attention flagged by ESMA for FY19 reporting is that issuers should properly disclose the impact of changes to the APM used. More specifically the impact of IFRS 16 on APMs such as EBITDA, EBITDAR, CAPEX, net debt or free-cash flow should be clarified by companies!

Standard setters

To address concerns raised by investors, the International Accounting Standards Board (IASB) launched an initiative called ‘Better Communication in Financial Reporting’ some years ago. 

As part of that initiative, IASB is looking to replace the existing IAS 1 ‘Presentation of Financial Statements’ with a new IFRS Standard “General Presentation and Disclosures”. The Exposure Draft of this new standard was issued in 2019, with the comment period ending in June 2020 (extended to 30 September 2020 due to COVID-19). The most important elements from the draft Standard are the following:

A. Introduction of 3 subtotals in the income statement to improve the comparability of financial statements: 

 i. Operating profit or loss;

 ii. Operating profit or loss and income and expenses from integral associates and joint ventures (effectively splitting results derived from integral- and from   non-integral associates and joint ventures!);

 iii. Profit or loss before financing and income tax (EBIT).

B. Introduction of specific footnote disclosure to identify and describe non-GAAP Management Performance Measures. It should include a reconciliation to IFRS sub-totals to help the readers make the bridge between press release and financial statements. Management Performance Measures:

i. are used in public communications outside financial statements;

ii. complement totals or subtotals specified by IFRS Standards; and

iii. communicate to users of financial statements management’s view of an aspect of an entity’s financial performance.

C. Introduction of specific footnote disclosure that identifies and explains certain ‘unusual items of income and expense’ (basically these are non-recurring items) within the primary income statement. 

Unusual items have limited predictive value and this disclosure will facilitate building more reliable future expectations by readers.  From ESMA’s desktop review, the most commonly adjusted items by companies are the following:

Investors will be able to better understand how- and why management excludes certain one-off elements when it presents its performance measures, and tie them back to the primary GAAP income statement by using the specific footnote disclosures.

What to do for your annual financial statements?

There is a lot of good sense in the IASB proposal. It will allow companies to use relevant performance measures in their financial communication even if those are non-GAAP and exclude certain one-off items.

So even if just a proposal for the moment, you may want to consider organizing your disclosures and communications for FY19 along the lines of IASB’s draft Standard. It will probably avoid painful discussions and certainly help the readers of your financial statements. And that includes your local regulator!

For now I am wishing you a very good and transparent FY reporting!

/0 Comments/by

ESEF reporting requirements explained

, ,

Great, you successfully implemented the “Big 3” IFRS Standards (9, 15 & 16) and expect to close the books on FY19 without too much trouble. Time to kick back and relax a bit in 2020? Not completely, if you are working for a company that is listed in the EU.

What it is about

European financial markets supervisor ESMA introduces the European Single Electronic Format (ESEF). 

The use of ESEF should make life easier for reporting entities and will improve accessibility, analyses and comparability of financial statements for users (analysts, investors and the like). 

To comply with the ESEF requirement, annual financial report documents will have to be prepared in XHTML format, which is human-readable and can be looked at using a standard web browser. Further, if a company includes consolidated financial statements under IFRS in its annual financial report, elements thereof will have to be tagged with an XBRL label, as part of ESEF.

Reporting using ESEF is mandatory for annual financial reports of companies that are listed on a EU market, over the first financial year that starts on, or after 1 January 2020.

XBRL tagging
XBRL, or eXtensive Business Reporting Language, is a software standard that makes communication of financial data possible between companies, and also between companies and public institutions such as regulators, tax authorities and chambers of commerce. We will leave it at that for now but I will dedicate an article to XBRL in the near future.

Introduction video to ESEF by ESMA

XBRL tagging of consolidated financial statements included in annual financial reports is mandatory if they are prepared under IFRS. 

XBRL tags need to be embedded in the XHTML document using a technology called Inline XBRL (iXBRL). This will make disclosures in financial statements structured and also machine-readable. 

A piece of good news: over the first two years, detailed XBRL mark-ups are only required for the primary financial statements (income statement, balance sheet and statements of cash flows and changes in equity). Footnote disclosures can be tagged by whole sections in once (“block tagging”). 

Starting 2022, footnote disclosures also have to be marked up in more detail.

What does it mean for preparers of financial statements

If ESEF sound like a complex technical challenge, don’t worry too much. We are among finance people here, and there are plenty of good tools that can help us with the technicalities (check out www.parseport.com, for example). Let’s focus on what is really important. Labeling data in your financial statements with XBRL tags will help people to compare it with similar data from other companies. How? Well, all annual financial reports of listed companies will be read and stored by machines, that can then report aggregated data for selections of companies upon request from users of financial data. As an example, an analyst following the construction industry can retrieve and compare all investments made in fixed assets during 2018 by listed construction companies.

It can only work however if companies use the same label for the same kind of data. The definitions of labels and the order in which data is presented is written up in dictionaries, called “taxonomies” in the XBRL world.

Taxonomies of different sorts exist, for various purposes. For example, companies in the US file their XBRL financials (10Q’s and 10K’s) with the SEC using a US GAAP taxonomy. The IFRS Foundation issues and maintains a dedicated taxonomy for IFRS appliers, which ESMA took as basis for its ESEF taxonomy. That makes ESEF compliant with IFRS. Preparers of financial statements will have to include a reference to the corresponding label in ESEF taxonomy for each and every number in the primary financial statements, as well as for large blocks of footnote disclosures.

Milestones for preparers of financial statements

The key steps to bear in mind, ahead of your 2020 annual financial reporting process are the following:

1. Find an iXBRL software solution that can bring your IFRS consolidated financial statements (including XBRL mark-ups) into the obligatory XHTML format. Consolidary’s partner ParsePort provides companies with tested iXBRL software. A good overview of other available solutions can be found at eurofiling.info/portal/ixbrl-solutions/

2. Start identifying the relevant labels from the ESEF taxonomy that cover the items in your primary financial statements (fixed assets, intangible assets, turnover etc). Note that it is allowed to extend (yes this is the X in XBRL) the ESEF taxonomy if no appropriate label is available to suit your specific needs. 

Expect a more detailed review of the ESEF taxonomy soon.

3. Have your tagging checked by your external auditor. At the moment there is no formal audit requirement of ESEF tagging at European level but regulators at country level may ask for it. Of course, companies can involve their auditors in the validation process on a voluntary basis. This can all be done well in advance of January-February 2021, to avoid last-minute anxiety!

Need a hand? Consolidary Financial Reporting Solutions can provide support in this process if needed, every step of the way.

Don’t hesitate to contact us at Consolidary with any question, suggestion or request for support you may have.

What’s in it for you

Finally, we get back to the objectives of ESEF reporting and more specifically to the goal of making the life of reporting entities easier. How did the folks at EU level figure that? Clearly ESEF brings benefits to companies, as in enhances transparency, which in turn attracts analysts and investors to the benefit of share price performance. ESEF will also make it possible to compare your company’s performance with that of your peers more easily.

Does it make reporting itself easier? Not sure, unless ESEF takes away a more complex legacy way of filing financial statements with regulators.

But I am happy to take your views on that!

/0 Comments/by