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Using the business model of a company to help analyse its performance -…
Using the business model of a company to help analyse its performance
business model in the context of Integrated Reporting :
is a company’s system of ‘transforming inputs, through its business activities, into outputs and outcomes
describe
entity’s activities
asset configuration
the way in which the business adds value, including
the generation of its cash flows
generation of customers, products and services
aim
fulfil the organization’s strategic purposes and create value over the short, medium and long term
to provide users with insight on the ability of the business to adapt to changes, for example
in the availability, quality, and affordability of inputs,
how these changes can affect the organisation’s longer-term viability
Business model information
fundamental to investor analysis
provides context and understanding to the other information in the annual report
demonstrate an entity’s understanding of its business and key drivers
which can create investor trust and reduce risk
can help investors understand
the business
how the business has performed
how this performance has been affected by various factors
how the business model is responding to market trends
how the strategy supports the key components of the business model
how management considers the risks and opportunities across the business model
how money is made and value generated and re-distributed
help users assess the resources and liabilities of the entity
Investors will look at the Key Performance Indicators (KPIs) and how they reflect the key components of the business model
presumes that investors have a good understanding of it prior to assessing the entity’s financial position and performance.
There is an argument/ discussion
the information regarding the business model should be presented outside the financial statements, such as in the management commentary
as to whether the business model should be considered in standard setting and in particular whether the term should be defined in the Conceptual Framework for Financial Reporting (the Conceptual Framework)
IASB has decided not to define the business model in the Conceptual Framework even though there was reference to the business model in an early Exposure Draft
However, the term has been implicit in International Financial Reporting Standards (IFRS®) for a while
For example, International Accounting Standard (IAS®) 2 Inventories generally requires inventories to be measured at the lower of cost and net realisable value
However, IAS 2 includes an exception that allows commodity traders to measure their inventories at fair value less cost of sale with changes in fair value less cost to sell recognised in profit or loss
The justification for this different treatment is that the inventory of commodity traders is principally acquired with the purpose of selling in the near future and generating a profit from the fluctuation in prices
This approach may reduce comparability
as it could result in different classification, measurement or disclosure of the same transaction
This may introduce bias in the way the financial statements of an entity are reported, and therefore make comparisons between entities difficult
It could encourage less neutral reporting as preparers may present the most favourable outcome which creates a conflict with faithful representation
Thus, the difficulties with the definition of the business model and its consistent application should not constitute a reason for excluding it because it has relevance in terms of the financial decision-making needs of the users of the accounting information
It has always been the case that different businesses will account for the same asset in different ways depending on what its role is within the firm’s business model
A change in the entity’s business model is a significant event, because it implies a change in how assets and liabilities are used in the cash flow generation process, that is when and how gains and losses are recognised
IFRS 9
requires classification and measurement of financial assets based on an entity’s business model
It states that an entity should classify financial assets as subsequently measured at either amortised cost or fair value on the basis of both
The entity’s business model for managing the financial assets and
The contractual cash flow characteristics of the financial asset.
Although IFRS 9 does not contain a definition of the term ‘business model’, it does include some implicit assumptions about its meaning
IFRS 9 views the business as based upon how the entity’s assets and liabilities are managed
To qualify for an amortised cost classification
financial asset must be held to collect contractual cash flows rather than be held with a view to selling the asset to realise a profit or loss
For example, trade receivables held by a manufacturing entity are likely to fall within the 'hold to collect' business model if the trade receivables do not contain a significant financing component in accordance with IFRS 15 Revenue from Contracts with Customers
FVTOCI
A debt instrument is classified as subsequently measured
if it meets the 'hold to collect' and the 'sell' business model test
This business model typically involves greater frequency and volume of sales than the hold to collect business model
The asset is held within a business model whose objective is achieved by both holding the financial asset in order to collect contractual cash flows and selling the financial asset
Integral to this business model is an intention to sell the instrument before the investment matures
FVTPL
residual category in IFRS 9.
If the business model is to hold the financial asset for trading, then it is classified and measured at FVTPL
Some stakeholders have suggested that the requirements for equity investments in IFRS 9 could discourage long-term investment
Their view is that the default requirement to measure those investments at fair value with value changes recognised in profit or loss may not reflect the business model of long-term investors
IFRS 8 Operating Segments
defines an operating segment as
component of an entity that engages in business activities from which it can earn revenue and incur expenses
An entity with more than one business model is likely to also have different segments.
If an entity has a business model, it would have internal reporting information which measure the performance of the business model which may in fact be the business segments
IAS 40 Investment property
An investment property differs from an owner-occupied property because the investment property generates cash flows largely independently of the other assets
IAS 40 sets out the two main uses of property (owner occupied and investment) which implicitly correspond to different business models
An owner-occupied property should be measured at depreciated cost less any impairment loss, which is an appropriate way of reflecting the use of the property
Whereas, investment property is measured at either fair value with fair value changes recognised in the statement of profit or loss, or on the same cost basis as for an owner-occupied property.
The business model is not discussed in the latest Conceptual Framework and, as a result, it may be argued that there is no consistency of its use in IFRS
The United Kingdom’s decision to leave the European Union highlights the unpredictability and disruptive nature of the business environment
However, it also illustrates the need for business models to be resilient and flexible to what is happening inside and outside an organisation and to help stakeholders better understand how a company will adapt to significant change