While Alternative Performance Measures have enjoyed a rising profile, it would be folly to think that IFRS financial reporting has diminished in value.
By Jamie Leavy
Today’s world is fast-paced and what was the norm yesterday, in certain cases, can seem to be redundant today. We are living through a technology revolution, which has changed the corporate world unrecognisably from that of five years ago.
One of the major changes is the exponential growth in the availability of real-time data that is providing existing and potential investors, lenders and other creditors (users) of companies with more valuable sources of information than ever before.
This has coincided with the proliferation of Alternative Performance Measures (APMs), which provide users with information on a company’s performance and financial position. In 2016, the European Securities and Markets Authority (ESMA) released a paper on APMs that defined an APM as “a financial measure of historical or future financial performance, position or cash flows of an entity which is not a financial measure defined or specified in the applicable financial reporting framework”. APMs are commonly disclosed outside of, or as a supplement to, a company’s annual financial statements.
These developments have led to a number of commentators suggesting that IFRS-based financial reporting is now of little importance and is seen as out-dated to users. It is suggested that users’ interest now focuses predominantly on APMs and non-financial information within annual reports and other announcements to provide them with an understanding of a company’s performance and financial position in order to make future investment decisions.
However, before the preparers and users of financial statements place their IFRS Standards book in the nearest recycling bin, I would suggest caution in both solely relying on APMs for decision-making and diminishing the importance IFRS financial reporting provides to users.
IFRS reporting
Given the vast increase in information available to users, it would be somewhat naïve to expect IFRS financial reporting to have sustained its importance on a relative basis. It is logical that users will make use of APMs when predicting how a share price might move. These measures act as an important tool in deciding whether to hold, sell or buy shares in a company.
However, these predictions depend heavily on one condition – the current share price being correct. This can only be the case if the underlying IFRS-based financial information is calculated consistently with other companies and is materially correct. Therefore, IFRS-based reporting, especially within the audited financial statements, remains a crucial element in the user’s decision-making process.
The benefits of IFRS
Comparability: financial reporting under IFRS provides a high level of transparency by enhancing the global comparability of companies’ financial statements. Users can easily compare a company’s performance and financial position to that of domestic and overseas competitors as well as to the prior year’s figures.
It also provides economic efficiency by helping users identify opportunities and risks globally. It facilitates the comparison of potential investment opportunities in numerous companies globally, safe in the knowledge that the figures of each company are based on identical, sound and clearly defined accounting principles.
IFRS creates a common accounting language. This level of transparency and comparability is not achieved by APMs, as they are not uniformly applied and are often uniquely adjusted at the individual company level. Not only is there a difficulty for users in comparing performance measures of different companies, it is similarly problematic to compare the current and prior year APMs. This is as a result of the various adjustments that are included or excluded in the calculation year-on-year.
Accountability: the use of IFRS in financial reporting strengthens accountability by reducing the information gap between users and management.
IAS 1 requires that all significant management judgement and estimates used in calculating IFRS amounts be explained within the notes to the financial statements. This ensures that users have information that provides them with an understanding of any adjustments or subjectivity involved.
On the other hand, the major risk of APMs, and the reason for such regulatory interest, is the lack of accountability. In many cases, APMs lack order and structure and there is widespread concern about the potential misuse of these measures by management.
Yes, when used appropriately these measures can provide users with valuable information. However, APMs can potentially be utilised by management to adjust important figures – such as profit and revenue, for example – to show a more positive figure than the IFRS-based equivalent, or be used to ignore ‘inconvenient’ expenses by excluding them from the calculation.
This has led to instances where, for example, companies have disclosed adjusted earnings figures as a positive highlight in announcements while the IFRS-based equivalent figure is actually a loss and is disclosed outside the highlights section. Further cases have been noted where a company discloses an APM in, for example, an unaudited preliminary announcement, but this measure is subsequently not repeated anywhere in the financial statements. In both examples, users need to exercise caution in interpreting these measures. They should closely analyse the adjustments being made and the associated reasoning.
APMs – not all bad
The intention is not to downplay the positive role that APMs, when used appropriately, can play. APMs are an important element in the communication between a company and its users. They can enhance financial analysis by segregating the effects of items that do not support an understanding of historical or future trends, cash flows or earnings.
To ensure that APMs are credible, however, they should supplement the IFRS information in financial statements rather than compete with them. This requires a level of discipline regarding measurement and presentation.
Working in harmony
While I disagree that IFRS reporting is no longer of prime importance to users, there is room for continued improvement. Nowadays, users want all available information to better explain and understand performance; this is one reason why APMs have risen in popularity.
The IASB has acknowledged that improvement is required and it is currently working on a Primary Financial Statements project. The aim is to provide better formatting and structure in IFRS financial statements, with the primary focus on the income statement. It has been suggested that this project will lead to additional subtotals, similar to current common APMs such as operating profit and EBIT, with more specific classifications of items being introduced. This should create more discipline around APMs by providing more reconcilable line items in the financial statements. The IASB has also suggested that it may require preparers to explain and reconcile APMs in the notes of the financial statements, which will provide users with a better understanding of the measures and lead to the measures being subject to audit. This project has the potential to improve IFRS-based reporting further and provide a defined and trusted link between financial reporting and APMs.
It is unknown when, if any, changes from this project are to be implemented. However, in 2016, ESMA released Guidelines on Alternative Performance Measures. These guidelines are not intended to eliminate the use of APMs but instead, to ensure that APMs clarify rather than obscure the financial performance and position of a company.
The prevailing principle of the guidelines is that APMs reported outside the financial statements must be consistent with the information disclosed within. The guidelines provide the opportunity for a company to present APMs while safeguarding against the manipulation of results by requiring that APMs be presented in a clear and transparent manner.
The guidelines include 48 paragraphs of detail regarding the presentation of APMs, but the main aspects are as follows:
- APMs should be meaningfully labelled and defined;
- The purpose of the APMs should be clearly set out;
- Comparative data should be provided for all APMs;
- APMs should not be displayed with more prominence, emphasis or authority than measures directly stemming from the IFRS-based financial statements;
- Clear reconciliations should be given; and
- Unless there is a good reason for change, the presentation of APMs should be consistent over time.
IAASA has received a number of undertakings in relation to the above aspects since the guidelines were published. Furthermore, IAASA has published a number of thematic reviews in relation to the use of APMs, namely:
- Alternative Performance Measures – Thematic Survey (September 2017);
- Alternative Performance Measures – A Survey of their Use Together with Key Recommendations: An Update (January 2015); and
- Alternative Performance Measures – A Survey of their Use Together with Key Recommendations (November 2012).
Conclusion
The substantial increase in information available to users has meant that IFRS financial reporting is no longer the only reporting type available. The use and prominence of APMs has increased over the last five years; however, IFRS financial reporting is still as important as ever in the user’s decision-making process. The aim of every company should be to provide as much relevant and reliable information to users as possible. To achieve this, APMs will play an important role – but only when used appropriately.
To ensure appropriate use, both APMs and IFRS-based reporting should work together to provide an overall view of the financial performance and position of the company. The ESMA’s guidelines will be critical in realising this goal – if companies follow the guidelines, the combined information within the financial statements should be defined, clear and reconciled in order for users to grasp and gain value from every page. Users will then benefit from the comparability and transparency that IFRS offers, supplemented by additional valuable information in the form of APMs.
Jamie Leavy ACA is a Project Manager in IAASA’s Financial Reporting Supervision Unit.
LOADING...