Abstract
The use of the discount rate within financial reporting deserves particular attention from international standard-setting bodies because it has achieved prominence over time. This chapter uses archival research as a method and content analysis as a technique to assess mandatory and voluntary disclosure levels related to discount rates. The consolidated accounts for the year 2020 of listed entities in Euronext Lisbon are the sources of information. The results show differences in mandatory and disclosure levels regarding IAS/IFRS under analysis. Disclosures related to discount rates have been assessed either as an incidental topic or from a limited-scope analysis. Therefore, understanding the proper set of items to be disclosed and the factors that explain its disclosure, aligned with the efforts to ensure its compliance by legal authorities, may reduce asymmetries and enhance transparency in entities' financial reporting.
TopIntroduction
Paragraph (§) 1 of Chapter 5 of the Conceptual Framework issued by the International Accounting Standards Board (IASB) defines recognition as the process of capturing for inclusion in the statement of financial position or the statement(s) of financial performance an item that meets the definition of one of the elements of financial statements (FS), which involves depicting the item in words and by a monetary amount and including that amount in one or more totals.
Next, in §1 of Chapter 6, it is explained that the elements recognized in FS are quantified in monetary terms, which requires the selection of a measurement basis. In this same chapter, the possible measurement basis is detailed, that is, the historical cost and the current value. The latter includes the fair value, the present value, and the current cost. One of the parameters widely used in the measurement basis designated by the current value is, precisely, the discount rate.
Whether in the measurement through present value or even using fair value as a measurement basis, the discount rate is a fundamental variable and can cause relevant impacts on the FS of the entities, depending on the amounts involved. This is corroborated by PwC (2018) when it advocates that the discount rate is a fundamental financial assumption in the valuation of various types of assets and liabilities. Then, changes in discount rates to be applied in the measurement of long-term assets and liabilities can lead to materially relevant differences in the recognized amounts.
The present value as a measurement basis for the current value has achieved relative prominence over time (Alberto & Lopes, 2010; He, 2020). According to Peasnell (1977), for some accounting experts, or even most, the present value is the ideal concept for determining an asset's value. Thus, Alberto and Lopes (2010) conclude that measurement or evaluation techniques based on the concept of present value have been widely used for different purposes, namely for project assessments, in the Finance field, or for the measurement of tangible fixed assets and intangible assets, provisions, post-employment benefits, financial instruments, among others, in the accounting area.
Discount rates are associated with the concept of current value through the time-value of money and associated uncertainties, as it is through the inclusion of a discount rate in the calculation that it seeks to obtain the best estimate of the current value of future inflows or outflows (§B13, IFRS 13). Discount rates are required or permitted in some International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS). However, when the different standards are assessed, some inconsistencies regarding the definition can be seen, as well as the lack of objectivity in determining the discount rate to be applied. When standards are less explicit regarding their formulation, it creates an opportunity for discretion (IASB, 2019).
According to the IASB (2019), inconsistencies between the IAS and IFRS also occur regarding the disclosure requirements on the discount rates, which may cause a deterioration in the financial information quality. Further, it may result in a lack of the necessary information for decision-making from the users’ perspective. For instance, Alberto and Lopes (2010) conclude that the information disclosed by the entities in their FS does not provide users with a comprehensive understanding of the process of calculating the discount rate and its inputs. The authors also pointed out relevant differences in the discount rates used in the measurement of assets or liabilities between the different entities, even if they have the same nature or approximately the same risk. Finally, based on a sensitivity analysis, they warn that small changes in the discount rates used significantly impact the entity's FS.
Thus, the complex and subjective choice of the discount rate to be used in the measurement of assets and liabilities can affect the companies’ financial position and performance with users of these FS not being able to understand this process and its effects, leading to inadequate decision-making. This subject has also been assessed by different theories. Husmann and Schmidt (2008), Carlin and Finch (2009), and He et al. (2021), supported by the agency's theory, suggest that discount rates are selected based on the interests of managers, as they seek to maximize results for their shareholders.
Key Terms in this Chapter
Measurement basis: An identified feature—for example, historical cost, fair value or fulfilment value—of an item being measured.
Current value: Current value measures provide monetary information about assets, liabilities and related income and expenses, using information updated to reflect conditions at the measurement date. Because of the updating, current values of assets and liabilities reflect changes, since the previous measurement date, in estimates of cash flows and other factors reflected in those current values. Unlike historical cost, the current value of an asset or liability is not derived, even in part, from the price of the transaction or other event that gave rise to the asset or liability. Current value measurement basis include: (a) fair value; (b) value in use for assets and fulfilment value for liabilities; and (c) current cost.
Fair Value: Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.
Measure: The result of applying a measurement basis to an asset or liability and related income and expenses.
Fulfilment value: Fulfilment value is the present value of the cash, or other economic resources, that an entity expects to be obliged to transfer as it fulfils a liability.
Current Cost: The current cost of an asset is the cost of an equivalent asset at the measurement date, comprising the consideration that would be paid at the measurement date plus the transaction costs that would be incurred at that date.
Value in use: Value in use is the present value of the cash flows, or other economic benefits, that an entity expects to derive from the use of an asset and from its ultimate disposal.