The use of Alternative Performance Measures (APMs) is widespread. A recent analysis of reporting practices in the UK FTSE 100 revealed a need for more transparency, especially under the light of the ESMA guidance applicable for all announcements after 3 July 2016. Jennifer Lau and Anna Schweizer from Accounting Consulting Services look into the details.
The good news first: Our review of all the FTSE 100 companies with year-ends from 1 April 2014 to 31 March 2015 revealed that most companies explain their APMs and reconcile these to GAAP measures. However, such reconciliations are not always easy to find.
Our surveys show that investors find APMs useful, but would like more transparency over the information disclosed. We expect increasing regulator scrutiny (not only in Europe) over the use and disclosure of APMs and that the ESMA guidelines will significantly impact the disclosure of APMs. Companies should now be thinking about what they need to do to publish transparent, unbiased and comparable information on their financial performance.
Our key findings can be summarised as follows:
- 95% of the FTSE 100 adjust their GAAP profit numbers.
- Adjustments almost always have a favourable impact on profit.
- Companies commonly adjust for: acquired intangibles amortisation; asset impairment; interest, depreciation, amortisation and tax.
- Descriptions of reconciling items are often too broad to understand what they relate to.
- Inconsistencies as to where and how reconciliations are presented.
These findings may not surprise, but they do suggest more work is needed by companies to ensure they comply with the ESMA guidelines.
Use of adjusted profit measures
95% of the FTSE 100 disclose an adjusted profit number. There was a range of alternative terms used to describe the adjusted profit figure with the most popular being:
- Adjusted operating profit (39%)
- Adjusted PBT (35%)
- EBITDA/adjusted EBITDA (11%)
Such a variety of approaches, sometimes between competitors and industries, often makes it difficult for readers to understand and compare APMs.
A review of the total number of adjustments showed that movements in aggregate for all companies with an APM went from a GAAP figure of roughly £119bn to £187bn. Of the 95 companies that presented an adjusted profit figure only 12 reported a number less than the original GAAP figure.
What is being adjusted?
A variety of terms is used to describe the adjustments from GAAP numbers to APMs. The most common adjustments relate to:
- acquired intangibles amortisation,
- asset impairment;
- interest, depreciation, amortisation and taxation;
- bank specific adjustments for those in the banking industry.
Although there are a large number of adjustments being made, the value of adjustments represents a small proportion in comparison to the overall value. For example, 10% of companies are adjusting for pension-related items and nearly 30% of companies are adjusting for acquisitionrelated costs yet these represent only 0.4% and 0.7% of the total value of adjustments. The question for companies to ask is whether these adjustments are material enough to be separately identified.
28% (£6bn) of adjustments remain uncategorised because the descriptions provided were not adequate to assign the adjustment to a category.
Placement of the reconciliation
While most companies (98%) provided a reconciliation of the APM to GAAP, there was no consistency in where they were reported and in some circumstances they were reported in more than one place:
- Front half (45%),
- Face of the primary statements (37%),
- Notes to the financial statements (57%),
- Other sections (7%). This is not a problem unless, as was the case with a few companies, there is a lack of signposting to where the reconciliation could be found.
The guidelines apply to APMs disclosed in regulated information published by issuers with securities traded on regulated markets. These include APMs presented in the ‘front half’ of annual reports and interim financial reports, but exclude financial information provided in the audited financial statements of the accounts. They also apply to APMs in other regulated information published by an entity such as management reports, prospectuses, or ad-hoc disclosures on financial earnings.
An APM is “a financial measure of historical or future performances, financial position, or cash flows, other than a financial measure defined or specified in the applicable financial reporting framework.”
Under the guidelines, issuers are required to:
- Define APMs in a clear and readable way and give meaningful labels (impairments and restructuring charges are ‘rarely … unusual or nonrecurring’).
- Reconcile APMs to the most directly reconcilable GAAP line item explaining material reconciling items.
- Explain the use of APMs so users understand relevance and reliability.
- Not display APMs with more prominence, emphasis or authority than GAAP measures.
- Present APMs with comparatives which also need to be reconciled.
- Define APMs consistently over time and justify any changes made.
APMs continue to be a hot topic for many from regulators and investors right through to the media. Based on our findings we think that more work will need to be done by companies to make their reconciling items relevant, understandable and not misleading.