International Accounting Standards Board
30 Cannon Street
London EC4M 6 XH
United Kingdom
Dear Sirs,
Comments: IASB Exposure Draft on Management Commentary (ED/2009/6)
I appreciate the opportunity to provide my comments regarding the IASB Exposure Draft
on Management Commentary (ED/2009/6). Overall, the guidance is very welcome and
one way to make financial reporting globally more harmonized. Because the IASB needs
viewpoints from the reporting practices of different European countries, I provide some
implications based on the research results of studies which have been conducted by using
data of Finnish listed firms. The answers to your questions are as follows:
Question 1: Do you agree with the Board’s decision to develop a guidance document
for the preparation and presentation of management commentary instead of an IFRS?
If not, why?
I do not agree with the Board.
Question 1 can be interpreted in various ways. Because the IASB is an impartial
organization, it can not make decisions whether management commentary should be
mandatory or not. Hence, one interpretation for the question is that the Board has decided
to develop a general guidance document instead of detailed IFRS standard. In Question 3
I will provide my viewpoints on why I do not agree with the Board’s decision not to
include detailed application guidance and illustrative examples in the proposal for
management commentary.
Second interpretation for Question 1 is that the Board asks whether the final guidance
should be mandatory or voluntary. Next, I will elaborate on this question.
Compliance with the management commentary should be mandatory. It does not matter
whether it is a requirement of IFRS or required by CESR. For me the most important
objective is that reporting on management comments improves. Management
commentary should determine the minimum reporting requirements as a starting point for
the reporting of every EU country. This is so because there are large differences between
the institutional settings in Europe. For some countries, a recommended guideline would
be a sufficient way to improve reporting practices. These countries have a culture of
providing transparent financial information and complying with guidelines (King, 1999;
Dargenidou, 2006). The results of my study (Miihkinen, 2008) documented that in
Finland recommended guideline improved quality of corporate disclosure. A
Recommendation for Additional Guidance Regarding the Transition to IFRS which was
issued by the CESR in 2003 provided guidelines on how listed firms should manage their
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disclosure on the adoption of IFRS. In Finland, the Finnish Financial Supervision
Authority (FIN-FSA) was active in providing information on the recommendation, and
also urged Finnish firms to follow it. I found that Finnish listed firms took seriously these
recommendations and most of them provided the suggested information. However, there
are also European countries where financial reporting and compliance culture is not as
high as in Finland (King, 1999; Dargenidou, 2006). Voluntary guideline will not be
sufficient in these countries. If we consider the harmonization of financial reporting from
the European perspective, I believe that a mandatory standard would improve reporting
more effectively because also countries with low compliance culture would be required to
provide the same information. In addition, management incentives may influence too
much on its willingness to comply with a voluntary guideline. Those firms that do not
need external financing in the near future may consider that they do not benefit from
additional reporting. However, this might have adverse effects on the secondary markets
of the stocks of these firms. Increased information asymmetry might decrease their
liquidity which would have harmful effects on the capital markets as a whole.
Global harmonization of financial reporting is likely to take place in the near future.
Publicly accountable enterprises will adopt IFRS in Canada in 2011. There is also an
ongoing discussion whether US firms should adopt IFRS in 2014. If this is decided, there
might be two different management commentary guidances for US listed firms; one
published by the IASB and one published by the SEC. I do not see this kind of “dual
guidance” problematic. Management commentary guidance issued by the IASB would
set the minimum requirements for the US listed firms. Because these firms already have a
tradition of reporting the required items, their reporting would remain mostly unchanged.
Consequently, I suggest that the management commentary guidance should provide
mandatory minimum reporting requirements.
Question 2: Do you agree that the content elements described in paragraph 24-39 are
necessary for the preparation of a decision-useful management commentary? If not,
how should those content elements be changed to provide decision-useful information
to users of financial reports?
I agree.
The essential subjects that might interest the capital providers are included in the content
elements. I provide some specific comments relating to risk disclosure later in this
comment letter.
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Question 3: Do you agree with the Board’s decision not to include detailed application
guidance and illustrative examples in the final management commentary guidance
document? If not, what specific guidance would you include and why?
I do not agree.
Whether or not to include illustrative examples in the management commentary guideline
is a difficult decision for standard-setters. On one hand, if you do not provide any
examples, some firms will have difficulties in understanding what they are expected to
disclose. On the other hand, if you provide too detailed examples, you may get boiler
plate disclosures that are copied from the examples. The IASB Management Commentary
ED seems to be a flexible guideline which leaves a lot of room for judgment to the
reporting firm. However, some firms will consider this “judgement task” to be difficult.
They will have difficulties to perceive what they are expected to disclose. Many firms
will encounter this problem during the first years after the release of the management
commentary guideline because the best practices have not yet evolved. Consequently,
some illustrative examples would be desirable. It would make it easier for the firms to
interpret the recommendation. In addition, illustrative examples may facilitate higher
comparability of the management commentary sections between European listed firms.
This would increase the harmonization of financial reporting which is one essential
motivation for the adoption of IFRS.
One problem with illustrative examples is that they encourage some firms to provide
boiler plate disclosure. This is so because a reporting firm can copy the examples without
giving any firm-specific information that would be useful to investors. However,
avoiding boiler plate disclosure by not providing illustrative examples is not either very
likely. Although we would not give any examples, some poorly disclosing firms would
probably only copy some general phrases from the reports of other firms. Consequently,
we probably encounter the boiler plate problem in some form even if we would let the
“best practices” develop among the reporting firms. In addition, if we rely too much on
the evolving reporting practices, there always is a risk that in some countries or in some
industries, they develop in an undesirable direction. Illustrative examples might mitigate
this problem.
To conclude, if we want firms in every EU country and in all industries to publish high
quality information in the management commentary sections, we have to provide
disclosure examples that can be benchmarked by the reporting firms. Next I will compare
British and Finnish guidelines for the preparation of operating and financial review. They
will demonstrate alternative ways to provide illustrative disclosure examples.
British guideline:
The British ASB’s OFR Reporting Statement was published in 2006. It is designed as a
formulation and development of best practice and it is intended to be a voluntary
statement of best practice rather than a standard. It replaced the former statutory
requirement on British listed firms to publish operating and financial review because the
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Government wanted to follow its policy not to impose regulatory requirements on UK
businesses over and above the relevant EU directive requirements. For example,
paragraph 52 of the statement recommends the following:
The OFR should include a description of the principal risks and uncertainties
facing the entity, together with a commentary on the directors’ approach to them.
In the British guideline reporting recommendations are augmented with implementation
guidance. It is highlighted in the guideline that implementation guidance accompanies,
but is not part of, the Reporting Statement. Implementation guidance provides several
disclosure examples. The examples follow the same formula throughout the guideline.
“Recommended disclosure should incorporate the following information” sentence is
followed by a list of information items that the reporting firm should take into account.
For instance, implementation guidance for paragraph 52 provides the following
information:
As set out in paragraph 52 of the Reporting Statement, the OFR should include a
description of the principal risks and uncertainties facing the entity, together with
a commentary on the directors’ approach to them. In addition to risks related to
environmental, social and community matters addressed in Examples 12 to 14,
and 17 and 18, other risks might arise due to the external environment,
dependencies on others, and the management of resources, both non-financial
and financial, as illustrated in Examples 20 and 21.
Example 20:Market risk
A bank might measure market risks arising from uncertainty about changes in
market prices and rates (such as interest rates, equity prices, exchange rates,
commodity prices) by using “value-at-risk” approaches as a KPI. Recommended
disclosure should incorporate the following information:

Definition and calculation: Value-at-risk (VaR) uses a Monte Carlo simulation
process. Volatilities and correlations of market parameters are observed over the
most recent twelve-month period and used on an unweighted basis. The VaR
estimates are made at 99% confidence level for a one-day time horizon

Purpose: Tracking the daily VaR allows the bank to derive a quantitative measure
of market risk in order to monitor the risk profile it has taken on related to all
market risk areas.

Source of underlying data: VaR or trading units in the UK and of the units
responsible for management of interest rate and foreign exchange risk of nontrading units.

Target: The goal is not to exceed the limit set by the VaR calculation on any day
of trading during any year.
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
Quantified data: VaR histogram, showing the number of days VaR was at certain
levels.

No changes have been made to the source of data or calculation methods used.
Finnish standard:
The Finnish standard on the reporting of operating and financial review goes further than
the British in advising firms. It does not only give a detailed description of the
information items that should be incorporated in the reports, but also provides practical
disclosure examples in its appendices. Practical disclosure examples demonstrate how a
firm could report the information in its operating and financial review.
The Finnish Accounting Practice Board decided to publish the standard in 2006. Its
purpose was to help in the interpretation of the law. Previously, many Finnish firms
considered it difficult to understand how they should report in their operating and
financial reviews. Although the Finnish Accounting Act demands that listed and large
private firms have to include operating and financial reviews in their financial statements,
it provides very little information on the expected form of the report. The purpose of the
standard is to increase the comparability of the operation and financial reviews between
Finnish firms. In the preparation of the standard also the British ASB’s OFR Reporting
Statement was used as a starting point. The appendices 5 and 6 of the standard provide
reporting examples on risks, future prospects, personnel, and environment. For instance,
the standard provides one page long example on the reporting of strategic and operational
risks. The following extract describes a couple of sentences from the example. It
demonstrates that the sentences of the example are written like a reporting firm would
report them in its operating and financial review:
“… The businesses of the group are based on working and reliable information systems.
The information system risks are managed for example by copying critical information
and data communication systems, paying attention to the selection of partners in
cooperation, and standardizing used workstation models, softwares and data security
procedures. The group will introduce new enterprise resource planning system in the
near future in every country in which it operates. Despite careful preparation, there may
be some quality of operations decreasing disturbances in the introductory phase which
may have temporary adverse effect on sales and profitability. The board of directors
believes that the biggest operational problems occurred during the first introductory
phase in Finland and that there will be fewer disruptions when the system will be
introduced in other countries...”
It is explicitly mentioned in the standard that these examples are not meant to be purely
copied to the financial reporting of the firms as such. However, firms are encouraged to
assess the applicability of the examples taking into account the industry, volume of the
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operations, etc. Every firm should make the needed adjustments to make the reporting
useful to the reader.
Research evidence:
I have done empirical research on the immediate impact of the Finnish standard on the
quality of the risk disclosure of the Finnish listed firms (Miihkinen, 2009). I examined
whether firms improved the quality of their risk reporting in their following operating and
financial reviews after the publication of the standard. The results provided evidence that
the risk disclosure standard had increased firms’ quality of risk disclosure on several
dimensions. There was more risk information, it was more evenly scattered across risk
topics, and it was more descriptively written. The dispersion of the quality of risk
disclosure had also decreased among the reporting firms, which provided evidence that
the standard had been able to harmonize risk reporting in Finland. However, the results
documented that monetary information on risks had not significantly increased. By
monetary information I mean risk disclosure that provides some euro values or some
other numerical values. It seemed to be difficult to improve risk disclosure in monetary
terms although most of the firms wrote that they had internally evaluated the amount and
significance of their major risks. Mandatory reporting requirements together with very
detailed risk disclosure examples would be needed if standard-setters want firms report
this kind of sensitive information. My empirical findings are from Finland which has a
rules-based accounting tradition. Hence, the results should be generalisable to other
European countries with similar legal roots.
The results have also useful practical implications for the IASB. They demonstrate that
disclosure improvements could be achieved by augmenting management commentary
guidance with illustrative examples. Although disclosure examples may cause some
boiler plate disclosure, there are still many firms that really benefit from the examples.
Hence, I suggest that the IASB includes illustrative examples into its management
commentary guideline. These examples could be provided in appendices and in a form
that imitates the reporting of a firm. This kind of approach could help firms to interpret
the guideline which would have a positive effect on the overall quality of the provided
information in the EU countries.
If you have any questions concerning my comments, or if you want to get the references
please contact me by email to: antti.miihkinen@hse.fi.
Helsinki, February 19, 2010
Yours sincerely,
Antti Miihkinen
PhD student
Assistant in Financial Accounting
The Aalto University School of Economics*
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* Established in 2010, the Aalto University is created from the merger of three Finnish universities: the
Helsinki School of Economics, Helsinki University of Technology, and the University of Art and Design
Helsinki. The Helsinki School of Economics is now called the Aalto University School of Economics.
References
Dargenidou, C., McLeay, S., Raonic, I. (2006), Expected earnings growth and the cost of capital: an
analysis of accounting regime change in the European financial market, Abacus, Vol.42, No.3/4, pp.
388-414.
King, C.G. (1999), The measurements of harmonization in the form and content of the auditor’s report in
the European Union, Journal of International Accounting, Auditing & Taxation, Vol.8, No.1, pp. 2342.
Miihkinen, A. (2009) Can the Quality of Firm Risk Disclosure Be Improved by a Judgement-Based
Disclosure Standard, paper presented at the Doctoral Colloquium of the 32nd Annual Congress of the
European Accounting Association, Tampere, 9-12 May.
Miihkinen, A. (2008) Efficiency of authoritative disclosure recommendations: Evidence from IFRS
transition disclosure in Finland, Journal of Financial Regulation and Compliance, Vol.16, No.4, pp.
384-413.
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