CPA AFR: Management Discussion and Analysis (MD&A)
ADVANCED FINANCIAL REPORTING
Management Discussion and Analysis (MD&A)
Management has a unique perspective on the entity. That perspective has value for users of financial reports. Generally, the information that is important to management in managing the business is the same information that is important to users of the financial reports for assessing financial performance and prospects. Management commentary provides a context within which to interpret the financial position, financial performance and cash flows of an entity. It also provides an opportunity to understand management’s objectives and its strategies for achieving those objectives. Users of financial reports in their capacity as capital providers routinely use the type of information provided in management commentary as a tool for evaluating an entity’s prospects and its general risks, as well as the success of management’s strategies for achieving its stated objectives.
Management commentary should provide existing and potential capital providers with information that helps them place the related financial statements in context. Management commentary that fulfills that purpose explains management’s view on not only what has happened, but also why management believes it has happened and what management believes the implications are for the entity’s futures.
Management commentary help users of the financial reports assess the performance of the entity and the actions of its management relative to stated strategies and plans for development. That type of commentary may help users of the financial reports to understand for example:
- The entity’s risk exposures, its strategies for managing risks and the effectiveness of those strategies.
- How resources that are not presented in the financial statements could affect the entity’s operations; and
- How non-financial factors have influenced the information presented in the financial statements.
In developing its commentary, management should bear in mind the principles that underpin decision-useful management commentary.
Commentary that is aligned with those principles:
- Provides management’s view of the entity’s performance, position and development.
- Supplements and complements information presented in the financial statements and
- Has an orientation to the future.
Content of management commentary
Although the relevant focus of management commentary will depend on the facts and circumstances of the entity, a decision-useful management commentary includes information that is essential to an understanding of:
- The nature of the business
- Management’s objectives and strategies for meeting those objectives.
- The entity’s most significant resources, risks and relationships
- The results of operations and prospects and
- The critical performance measures and indicators that management uses to evaluate the entity’s performance against stated objectives.
- Nature of the business
A description of the business helps users of the financial reports gain an understanding of the entity and the external environment in which it operates. That information serves as a starting point in assessing and understanding an entity’s performance, strategic options and prospects. Depending on the nature of the business, management commentary may include discussion of matters such as:
- The industries in which the entity operates.
- The entity’s main markets and competitive position within those markets.
- Significant features of the legal, regulatory and micro-economic environment and influence the entity and the markets in which the entity operates.
- The entity’s main products and services, business processes and distribution methods and
- The entity’s structure and its economic model.
- Objectives and strategies
Disclosure of objectives and strategies are most useful when they enable users of the financial reports to understand the priorities for action as well as the resources that must be managed to deliver results. Management’s explanations about how success will be measured and over what period of time it should be assessed may also be useful. For example, how management intends to address market trends and the threats and opportunities those market trends represent provides users of the financial reports with insight that may shape their expectations about the entity’s future performance. Discussion of the relationship between objectives, strategy, management actions and executive remuneration is also helpful.
- Resources, risks and relationships
Management commentary that includes a clear description of the most important resources, risks, and relationships that management believes affect the entity’s long-term value and how those resources, risks and relationships are managed provides useful information for users of the financial reports.
Disclosure about resources depends on the nature of the entity and the industry in which the entity operates. Management commentary should set out the critical financial and non-financial resources available to the entity and how those resources are used in meeting management’s stated objectives for the entity. Analysis of the adequacy of the entity’s capital structure, financial arrangements (whether or not recognized in the statement of financial position), liquidity and cash flows, as well as plans to address any identified inadequacies or surplus resources, are examples of disclosures that can provide useful information.
Disclosure of an entity’s principal risk exposures, its plans and strategies for bearing or mitigating those risks, and the effectiveness of its expected outcomes. It is important that management to distinguish the principal risks and uncertainities. Management should disclose its principal strategic, commercial operational and financial risks, being those that may significantly affect the entity’s strategies should cover both exposures to negative consequences and potential opportunities.
Management commentary provides useful information when it discusses the principal risks and uncertainities necessary to understand management’s objectives and strategies for the entity-both when they constitute a significant external risk to the entity and when the entity’s impact on other parties through its activities, products or services affects its performance.
Management provides information useful to users of the financial reports when it identifies the significant relationships the entity has with stakeholders, how those relationships are likely to affect the performance and value of the entity, and how those relationships are managed. This type of disclosure helps users of the financial reports to understand, for example, whether a single customer, or a small group of principal customers, represents a significant portion of an entity’s business and whether that entity and its investors may be exposed to substantial risk if that customer takes its business to a competitor.
- Results and prospects
Management commentary should include a clear description of the entity’s financial and non-financial performance, the extent to which that performance may be indicative of future performance and management’s assessment of the entity’s prospects. Useful disclosure in that area can help users to make their own assessments about the assumptions and judgements used by management in preparing the financial statements.
Explanations of the performance and development of the entity during the period and its position at the end of that period provide users of the financial reports with insight into the main trends and factors affecting the business. Those explanations are useful when they describe the relationship between the entity’s results, management’s objectives and management’s strategies for achieving those objectives. Discussion and analysis of significant changes in financial position, liquidity and performance compared with those of the previous period(s) can help users to understand the extent to which past performance may be indicative of future performance.
An analysis of the prospects of the entity, including targets for financial and non-financial measures, helps users of the financial reports to understand how management intends to implement its strategies for the entity over the long term. When targets are quantified, management should explain the risks and assumptions necessary for users to assess the likelihood of achieving those targets.
- Performance measures and indicators
The disclosure of performance measures and indicators (both financial and non-financial) that are used by management to assess progress against its stated objectives can help users of the financial reports assess the degree to which goals and objectives are being achieved. Performance measures are quantified measurements that reflect the critical success factors of an entity. Indicators can be narrative evidence describing how the business is managed or quantified measures that provide indirect evidence of performance.
The performance measures and indicators that are most important to understanding an entity are those that management uses to manage that entity. The performance measures and indicators will usually reflect the industry in which the entity operates. Comparability is enhanced if the performance measures and indicators are accepted and used widely, either within an industry or more generally. Consistent reporting of performance measures and indicators increases the comparability of management commentary over time. However, management continue to be relevant. As strategies and objectives change, management might decide that the performance measures and indicators presented in the previous period management commentary are no longer relevant. When management changes the performance measures and indicators used, the changes should be identified and explained.
If information from the financial statements has been adjusted for inclusion in management commentary, that fact should be disclosed. If financial performance measures that are not required or defined by IFRSs are included within management commentary, those measures should be defined and explained, and possible, reconciled to measures presented in the financial statements.
December 2009 Question 3(b)