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Valuation in Financial Reporting: An Interview with EFRAG Leaders

1 July 2020

The European Financial Reporting Advisory Group (EFRAG) is a private not-for-profit association established in 2001, with the backing of the European Commission, to develop and promote European views which inform the standard-setting…

The European Financial Reporting Advisory Group (EFRAG) is a private not-for-profit association established in 2001, with the backing of the European Commission, to develop and promote European views which inform the standard-setting work of the International Accounting Standards Board (IASB).

The IVSC works closely with the EFRAG on a range of issues which overlap the valuation and financial reporting disciplines.  Both organisations provide input to respective work programmes, and earlier this year the IVSC Business Valuation Board hosted a meeting with their EFRAG counterparts in Brussels.  IVSC Europe Board member, Jesús F. Valero, is a member of the EFRAG Advisory Panel on Intangibles and IVSC SRB member, Colin Martin, is a member of the EFRAG Financial Instruments Working Group.

We spoke to EFRAG CEO, Saskia Slomp; Chair of the EFRAG Technical Expert Group, Chiara Del Prete; and Senior Technical Manager, Rasmus Sommer, to find out more about EFRAG’s work and how it interacts with valuation.

  1.  How do you see the role of the valuation profession, and valuation standards, as it relates to the work of EFRAG? Is it becoming a more important/prevalent area of focus for financial reporting bodies and if so, what is driving this?

Members and Associations of the valuation profession are a key component of the financial reporting community and particularly important in EFRAG’s due process as they can bring a dual perspective. As advisors of business valuation processes (such as advisors in investment processes, M&A, restructuring, divesting, etc.) they are users of financial statements. As advisors and members of the audit teams offering and reviewing accounting valuation processes (e.g. goodwill impairment, PPA, fair value, but also actuarial valuations, etc.) they bring specialised insight into preparing financial statements in the most complex areas of measurement.

They have always been an important component of the financial reporting community. However, we may say that their importance is growing in todays’ economic systems. Firstly, investments in intangibles, which are particularly challenging to measure and require highly specialised valuation skills, have achieved a notable level of importance, as entities nowadays tend to have less physical assets and their processes are intangibles-intensive. EFRAG has started its proactive project on intangibles, aiming at influencing IFRS developments on how to better report on intangibles. Secondly, as the academic literature review on the reporting of intangibles issued by EFRAG in February 2020 has confirmed, that investment in intangibles is associated with high levels of risk and uncertainty and entities having heavily invested may be more vulnerable.

Reporting about uncertainty is a challenge for which accountants will have to rely on valuation skills, to illustrate areas of judgement applied, disclose useful sensitivity measures and provide high quality and reliable financial information. In addition, as often occurs in periods of crisis, assets become more illiquid and, with the peculiarities and unpredictability of the effects of the covid-19 crisis, accounting valuation measurement processes become more complex, as they have to cope with additional uncertainties. Disclosures about valuation judgement and sensitivities play a key role.

  1. How important do you believe internationally accepted valuation standards are, both in a financial reporting sense and, also in terms of establishing transparency in market information?

Comparability across jurisdictions around the globe is an overarching principle that, to the maximum extent possible, policy makers should pursue, as it supports greater transparency and facilitates a better functioning of capital markets. In addition, European entities often compete on a global scale. This is valid for financial reporting and, as accounting valuation techniques derive from measurement principles set forth in accounting standards, including IFRS Standards, it may be seen as valid also for valuation standards.

  1. EFRAG provides formal input to the IASB’s standard-setting process and the IVSC also works closely with their technical committees; how important do you think it is to have an open and consultative approach to setting international standards? Why is this important? 

Part of our mission is indeed to serve the European public interest by developing and promoting European views in the field of financial reporting and ensuring these views are properly considered in the IASB standard-setting process and in related international debates. We seek therefore input from a wide range of stakeholders and obtain evidence about specific European circumstances throughout the standard-setting process.

Public consultation is an essential part of our transparent public due process since it ensures that the diversity of accounting, economic models and views in Europe are considered when developing EFRAG’s positions. EFRAG is publishing Draft Comment Letters on the IASB Exposure Drafts (ED’s) and Discussion Papers (DP’s) for public consultation. The comments received together with other forms of input contribute to the discussions by EFRAG TEG and the EFRAG Board to arrive at EFRAG’s Final Comment Letter and are summarised in a feedback statement. This provides transparency about how the input gathered in the public consultation(s) was considered in developing and agreeing EFRAG’s final positions.

In addition to our Draft Comment Letter we have various other ways to consult such as discussions with accounting expert groups of EFRAG’s member organisations and other organisations; events and webinars; surveys; field tests; and early stage and impact analyses. For example, we may mention the recent the input from the exchange of views with the IVSC’s Business Valuation Board, which has been valuable in preparing the EFRAG Draft Comment Letter on the IASB’s DP Business Combinations—Disclosures, Goodwill and Impairment.

  1. EFRAG recently set up a panel to look at intangible assets within the financial reporting framework; what will this group look at and how do you think it could enhance the standards issued by the IASB?

The EFRAG Advisory Panel on Intangibles (API) was established in 2020 to help EFRAG provide suggestions on how information about how an entity creates, maintains and enhances value can be improved. The API is thus looking at how entities provide such information, what information is useful for users of financial statements and suggested alternatives to enhance and provide additional useful information in a cost-benefit and effective manner. The API is discussing real-life examples based on information reported in the financial statements as well as tailored examples developed for the purpose of the discussions.

The API consists of users of financial statements, valuers and preparers.

The API is not only looking at intangible assets, but also intangibles that would not meet the definition of an asset, for example because the resource is not controlled by the entity. For example, if certain employees are vital for the entity in how it generates value, information related to this would be covered by the scope of the project.

The API will initially focus on the following sectors:

  • Biotech, pharmaceuticals and health care equipment & supplies;
  • Interactive media and software;
  • Household products, personal products, textiles and apparel & luxury goods.

EFRAG will then examine whether/how the findings can be generalised and can be used for other sectors as well.

The work of the API will be relevant for several IASB projects. Firstly, the IASB will consult on whether to include a project on intangible assets to its work plan in its next agenda consultation. EFRAG expects such a project to be supported by the IASB’s constituents given the perceived issues with information on intangibles in financial reports. The work of EFRAG (including the API) can thus provide direction for the IASB’s future standard-setting on the topic. EFRAG acknowledges that many suggestions have already been developed on how to provide more relevant information on intangibles. It would thus be relevant to ask what EFRAG can do better than in its previous attempts. In this regard the API is important because unlike many previous attempts, the suggestions provided by EFRAG will reflect the views of both users and preparers. In addition, as the API will consider previous suggestions, the possible proposals to be put forward by EFRAG will be based on what users and preparers find most useful in those previous suggestions.

The other projects where the input of the API will be useful for EFRAG – and finally should result in better information in financial reports are the IASB’s projects on the management commentary (the IASB is expected to issue an exposure draft in the second half of 2020 on which EFRAG will provide its comments) and the IASB’s Discussion Paper Business Combinations – Disclosures, Goodwill and Impairment on which EFRAG already has issued its Draft Comment Letter.

  1. The subject of internally generated intangibles is an area of great interest to the valuation profession as this is where the majority of value in most companies resides. As there is limited info in the financial statements on these assets, valuers and other users are forced to use other data sources when performing analyses that don’t involve significant access to management. How does EFRAG look upon this issue and what insights have you garnered through your various working groups?

EFRAG’s work on this topic is ongoing and for this reason it is too early for EFRAG to share a formed view on the topic. What EFRAG is trying to find out is whether better information about internally generated intangibles can be provided in the financial statements or the management commentary. EFRAG has generally not heard much support for an approach under which internally generated intangibles would be recognised at fair value on the face of the statement of financial position. However, information that would be useful for users of financial reports to make their own estimations could be warranted. EFRAG is aware that entities sometimes provide information on important intangibles at investor briefings or by other means. The information is often considered useful but, for different reasons it does not find its way to the financial reports.

There are many issues related to how to report on internally generated intangibles. Besides the challenges for preparers (including costs of reliable valuations, audit complexity, risk of providing competitors with commercially sensitive information) and the problems related to separating different intangibles, one of the issues is that there are currently many suggestions on how it could be done, but no generally accepted and consistent manner of doing it.

  1. EFRAG is ostensibly a European-focused body; to what extent do you think the issues you are looking at are specific to Europe as a region? Do you work with other like-minded organisations outside Europe?

As indicated before, EFRAG’s mission is providing the European voice in financial reporting. We are doing so by developing and promoting European views in the IASB standard-setting process. EFRAG is also providing endorsement advice to the European Commission on whether IFRS Standards and Interpretations meet the endorsement criteria in the IAS Regulation, including whether endorsement would be conducive to the European public good. The endorsement advice role of EFRAG is specific for the EU (EEA).

However, in our work to influence the IASB standard-setting process both by reacting to IASB EDs and DPs and our research work’, the liaison and discussion with global organisations, such as the IVSC and organisations including standard setters in other parts of the world are important. With our research work we provide thought leadership influencing not only the European but also the global debate. The support of organisations outside of Europe for EFRAG views and research, is important to get projects on the IASB agenda or to accelerate IASB projects. EFRAG participates in meetings of the IASB’s ASAF (Accounting Standards Advisory Forum), the IFRS Advisory Council, IFASS (International Forum of Accounting Standard Setters)) and World Standard Setters and maintains bilateral relationships with various international organisations and national standard setters.

  1. The IVSC has recently issued a three-part series looking at the subject of goodwill and, in particular, how the impairment framework might be enhanced to improve the information value to investors.  How is EFRAG approaching the subject as it becomes more prevalent in the rhetoric of accounting standard setters? How do you assess the value of outputs such as the article series mentioned, in developing robust standards?

Goodwill and impairment are key topics in the current EFRAG and IASB agenda. EFRAG has issued in May 2020 its Draft Comment Letter in response to the IASB’s DP Business Combinations – Disclosures, Goodwill and Impairment. Comments are welcome by 30 November. When preparing its Draft Comment Letter, EFRAG considered the responses to its previous consultations on the topic, relevant academic studies, including input from EFRAG Academic Panel, and the first two articles published by the IVSC on the topic. Particularly, the arguments provided for why goodwill could be considered to be a non-wasting asset were considered. The last paper in the IVSC series was published too late for EFRAG to consider in its Draft Comment Letter. However, it will be considered when EFRAG is finalising its (Final) Comment Letter in response to the IASB’s DP.

How to account for goodwill and the impairment test has been a topic EFRAG has examined for several years. In 2012, EFRAG issued a questionnaire together with the Italian standard setter (OIC). The questionnaire considered issues such as what goodwill consists of, how goodwill information is used by users of financial statements, whether the goodwill impairment test is pro cyclical and whether goodwill should be amortised.

Following this questionnaire EFRAG issued the DP Should goodwill still not be amortised? – accounting and disclosure for goodwill together with the OIC and the Japanese standard setter. Most respondents agreed with the main conclusion of the discussion paper that the impairment-only model for acquired goodwill did not provide the most appropriate solution for subsequent measurement of goodwill. These respondents agreed with the preliminary views of EFRAG’s DP that amortisation of goodwill should be reintroduced, but also pointed out that there are areas for improvement in the goodwill impairment testing.

Then in 2016, EFRAG issued the quantitative study What do we really know about goodwill and impairment and in 2017 the DP Goodwill impairment test: Can it be improved was issued. EFRAG’s DP suggested additional guidance on the allocation of goodwill to cash generating units (CGUs), additional disclosure of information on the composition of goodwill, introduction of a ‘Step Zero’ in the goodwill impairment test, a single calculation approach: fair value less costs of disposal (‘FVLCD’) or Value in Use (‘VIU’), allowing consideration of cash flows from future restructurings when testing for impairment of assets under  IAS 36 Impairment of Assets and allowing the use of a post-tax rate when calculating VIU under IAS 36. Finally, the paper proposed to deduct an accretion amount from the recoverable amount of a CGU for the purpose of the goodwill impairment test. The accretion amount would be calculated as the carrying amount of goodwill multiplied by an accretion rate (e.g. the discount rate used for the goodwill impairment test). However, the majority of respondents did not support this accretion approach as it would add complexity and subjectivity to the goodwill impairment model.

  1. The Steering Group of the European Corporate Reporting Lab @EFRAG (European Lab) has recently announced the second project which will look at reporting of non-financial risk.  What can you tell us about this initiative and the Lab itself? What role do you anticipate there being for valuers interested in this topic and how can they find out more?

The European Lab has been established in September 2018 by EFRAG, following the call by the EC in its March 2018 Action Plan on Financing Sustainable Growth. The European Lab’s objective is to stimulate innovations in the field of corporate reporting in Europe by identifying and sharing good practices. The work of the European Lab also complements and contributes to our work in financial reporting. In February 2019, the European Lab launched its first project undertaken by the Project Task Force on Climate-related Reporting resulting in the interactive and digital publication How to improve climate-related reporting? A summary of good practices in Europe and beyond.

In the second half of 2019, the European Lab carried out a public consultation on its future agenda to which a wide range of stakeholders responded. On the basis of these results, the European Lab Steering Group decided that the second project would address the reporting of non-financial risks and opportunities, and linkage to the business model.

The aim of this second project is to identify good practices on the reporting of non-financial risks and opportunities and their linkage to the business model from a sustainability perspective and addressing what is commonly known as ESG (Environmental, Social and Governance) factors. The project is expected to consider the information needs and expectations of a wide range of users and other stakeholders, the extent to which they are addressed by current corporate reporting practices, and the challenges faced by companies in providing that information.

Assessing risks and opportunities have an impact on the whole valuation of a company also if in first instance there is no financial valuation. Several stakeholders therefore prefer the term extra-financial information instead of non-financial information. The narrative information on risks and opportunities and the business model should enhance the financial information and contribute to providing a more holistic view of the company.

  1. The IVSC’s Business Valuation Board held a bi-lateral meeting with counterparts at EFRAG earlier this year.  How productive was this session and do you foresee benefits to ongoing engagement? If so, why?

We would first like to mention that back in December 2017 EFRAG organised a conference Accounting meets Valuation, bringing together valuation and financial reporting perspectives on the use of fair value in financial reporting. The former Chair of the IVSC Board of Trustees, Sir David Tweedie was the keynote speaker and brought through his background, having been the first Chairman of the IASB, both worlds together. Mauro Bini, member of the IVSC Standards Review Board and Henk Oosterhout, member of the IVSC Business Valuation Board gave introductory speeches for the panel discussions on the merits, limitations, and challenges of fair value in financial reporting.

We welcomed the possibility to enhance contacts and cooperation when the IVSC Boards and IVSC leadership were meeting in Brussels in March just before the covid-19 crisis. The IVSC and, in particular, its IVSC Business Valuation Board gave valuable input to our Draft Comment Letter on the IASB Discussion Paper on Goodwill and Impairment. Also, the broader exchange of views on the topic that are relevant to both our organisations helped to provide further insight on our future cooperation, notably EFRAG’s research project on Better Information on Intangibles. From the EFRAG side we welcome a regular dialogue on projects of mutual interest.

Sir David Tweedie gave the keynote address at the 2017 EFRAG conference ‘Accounting meets Valuation’

  1. ESG is becoming a more prominent driver of corporate and investment strategy today.  The IVSC has recently launched an initiative to look at the topic from a valuation perspective. Given the proliferation of info on ESG from companies, rating agencies and others, what do you see as the role of EFRAG in this space?

EFRAG is active in the ESG space since the establishment of the European Lab. This allowed EFRAG to open its area of activity to additional topics within broader corporate reporting and to new stakeholders. There is a big momentum for evolving financial reporting and keeping it relevant and we expect this trend to continue. ESG factors are key in illustrating the components of business models and we see them in perspective integrated in the financial reporting, including (but not limited to) the new proposed management commentary that the IASB is developing. They are also being considered in the possible solutions explored by the EFRAG proactive research on intangibles, from the perspective of the information needed by providers of financial capital.

In addition, the Project Task Force on Climate-related Reporting had extensive discussions on the status of current practice for reporting on the use and integration of scenario analysis within the entity’s policies, which is an area where the valuation profession may have a role to play. The European Lab report has confirmed that scenario analysis is the area of climate-related reporting that companies find most challenging to develop and implement. Companies should use scenario analysis to assess the resilience of their strategies under a range of plausible future climate states. The report shows that this area of ESG reporting has significant space for improvement.

  1. What opportunities do valuers have to provide input to the broader work of EFRAG, and where can they find details of current and planned initiatives?

Providing input to the EFRAG financial reporting work and the European Lab activities can be done in several ways as part of our public and transparent due process. This goes from providing a comment letter to EFRAG reacting on our draft comment letters or research discussion papers to having an exchange of views with expert groups on specific topics. EFRAG also has public outreach events. We are very open to input in all kinds of forms that best suits the individual stakeholder organisations. EFRAG therefore welcomes the exchange of views and discussions with the IVSC and its Boards and we hope that also individual valuers are interested and will contribute to our work.

In addition, EFRAG renews on a regular basis the composition of its working groups and advisory panels and establishes new advisory panels based on a public call for candidates. The European Lab operates with project task forces which also require public calls for candidates. With our Advisory Panel on Intangibles we have seen that some topics are of deep interest to valuers given the number of applications we received with a valuer background.

Information about all EFRAG projects can be found on the EFRAG website. We have the possibility to subscribe to our news items to be regularly informed about all our activities and public consultations. We issue monthly EFRAG Updates summarising what happened in the month concerned. The discussion of technical topics in EFRAG TEG and the EFRAG Board are public (webcast live and available afterwards on our website) as well as the supporting agenda papers. The EFRAG Board public papers include each month our Technical Work Plan.

  1. How is EFRAG set up in terms of governance and how are recommendations formed/presented to the IASB?

EFRAG is a private not-for-profit association established in 2001 with the encouragement of the European Commission to serve the public interest. EFRAG’s member organisations are European stakeholder organisations and national organisations (usually national standard setters) with an interest in financial and corporate reporting and a commitment to EFRAG’s public interest mission.

Since the last reform, the so-called Maystadt reform in 2013, EFRAG’s governance structure operates with the EFRAG Board responsible for all EFRAG positions and EFRAG TEG providing technical advice to the EFRAG Board. The views of EFRAG TEG are formed with input from Working Groups and Advisory Panels that provide specialised expertise in the topic area. An example is our Advisory Panel on Intangibles in which several valuers participate. The EFRAG Board evaluates and considers as well the European public good: the wider effects, in particular the risk of unintended consequences, on financial stability economic development and competitiveness.

The European Lab (Steering Group) operates directly under the EFRAG General Assembly of EFRAG member organisations and is, like the EFRAG Board accountable to the EFRAG General Assembly.

Thanks to Saskia Slomp, Chiara Del Prete and Rasmus Sommer of EFRAG for their contributions to this interview.

Find out more about EFRAG online:

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of the IVSC, operating in 137 countries worldwide. Join them.

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There are more than 200 member organisations
of the IVSC, operating in 137 countries worldwide. Join them.

Become part of a global network working to enhance valuation standards and professionalism.