Understanding performance – underlying profit

Issue 8 June 2012

Understanding performance ? underlying profit

The reporting by entities of alternative profit measures such as `EBITDA', `EBITDAF', `normalised profit' or `underlying profit' has continued at similar levels since our prior year survey with 89 out of 100 companies in the sample providing 250 alternative earnings or profit measures. This compares to 87 companies providing 214 measures in their 2010 annual reports based on largely the same sample (refer to page 16 for details of the companies surveyed).

In line with developments in Australia this is a topic that has caught the attention of New Zealand's new regulator, the Financial Markets Authority (FMA). The FMA has issued a draft guidance note on "Disclosing non-

GAAP financial information" in May 2012. This draft guidance note covers the provision of financial information by issuers that is not prepared in accordance with New Zealand generally accepted accounting practice (NZ GAAP) in investor communications other than financial statements, and in transaction documents (such as prospectuses, investment statements, advertisements, meeting notices etc). Elaine Campbell, FMA Head of Compliance Monitoring, noted that alternative performance measures "can provide useful information to investors, but they also have the potential to be misleading if used to mask bad news"1. The draft guidance is intended to assist issuers in ensuring that their communications with investors and

1FMA media release: FMA consultation on disclosure of non-GAAP financial information. 22 May 2012. Available at t.nz 1

other stakeholders are transparent and not misleading.

The draft guidance note is largely consistent with guidance issued by the Australian Securities Investment Commission (ASIC) in December 2011 on "Disclosing non-IFRS financial information" with one notable exception. ASIC prohibits the presentation of non-IFRS financial information in financial statements with limited exceptions. The FMA draft guidance does not cover financial statements except to note that "nonGAAP financial information should not be provided except as is permitted or provided for under GAAP or the Financial Reporting Act and GAAP information should be given

prominence. For example, on the face of an income statement the IFRS reported profit or loss should always be the bottom line and given primary prominence and emphasis". However, we note that the FMA is asking for feedback on whether excluding financial statements from the scope of their guidance note is appropriate. We think that it is.

This year's survey considers current practice in annual reports against the ten principles for presenting non-GAAP financial information in investor communications in order to provide an indication of where practice will need to change to align with the FMA guidance if it is issued as proposed. In summary:

Principle

How do the results compare?

Outline why the information is useful

Consider prominence

Ensure an appropriate label is used

Explain the calculation Provide a reconciliation Apply a consistent approach period to period

Only 32% of measures provided this information (either directly or due to being part of the entity's segment reporting disclosures).

27 companies clearly emphasise their underlying profit figure/s to the exclusion of their statutory measure.

Some labels are not used clearly. For example EBITDA may be the label but the measure excludes items other than just interest, tax, depreciation and amortisation.

59% of measures had a narrative explanation of the calculation.

81% of non-GAAP measures are currently reconciled to a GAAP measure.

We identified 62 new measures and 27 measures in the 2010 report that were not continued in the 2011 annual report.

Further, the FMA notes that providing multiple non-GAAP profit measures in the same reporting period may cause confusion. 50% of entities in our sample provided three or more alternative profit measures with nine different measures provided by one entity.

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Issue 8 June 2011

Principle Adjustments - corresponding items should be adjusted in comparatives Ensure the measure is unbiased

Take care referring to one-off items Explain if audited or reviewed

How do the results compare?

The comparatives for 20 measures were restated for consistency with the current year measure.

As most measures remove expense items, judgement will be needed to determine whether they are biased.

18% of measures referred to `one-off' or `non-recurring' items

One company noted that its measures, presented outside of the financial statements, were taken from audited financial statements.

The FMA is asking for feedback by 29 June 2012 and aims to issue a final guidance note in August 2012. The guidance will be used by the FMA in its review of non-GAAP measures for documents published on or after January 2013. The draft guidance note also includes guidance for reporting non-GAAP measures in transaction documents (pro forma financial information) which is not considered in this publication.

We note that the International Accounting Standards Board (IASB) has recently been consulting on its future agenda for standards development. Patrick Finnegan, a member of the IASB, reported that there was one project that stood out as a high priority and that is around performance presentation and in particular the definition of "other comprehensive income" (OCI). He notes that "it is becoming increasingly challenging to

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understand performance given the expansion of the use of fair values mixed with the use of historical costs, particularly when the focus is on a single statistic ? profit or loss"2. He considers that more thorough analysis and better decisions can be made by investors if there is more than one clear performance measure ? for example, if the reporting format provided a better understanding of changes in net assets compared to reported profit or loss (which would cover recurring, or operating, or controllable items). This would go some way to removing the need for many of the adjustments made by entities in determining underlying profit, but would be several years away if added to the IASB's agenda to allow time for development and consultation.

In the interim, we recommend that entities consider whether the proposed guidance would require a change to their current reporting practices, and whether they should respond to the FMA's request for views on the proposed guidance note by 29 June 2012.

To assist, this publication considers the practice of reporting underlying profit measures for a sample of one hundred 2011 annual reports against the FMA's proposed guidelines, compares the requirements to those in Australia, outlines what directors should consider when reporting underlying profit, and provides an illustrative disclosure example.

2Patrick Finnegan: Performance Reporting: Back to the Future. 31 January 2012. Available at:

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Issue 8 June 2011

What we found ? Non-GAAP measures in practice

Deloitte analysed the 2011 published annual reports of 100 companies (refer to page 16 for details of the companies surveyed) in order to determine the extent of reporting non-GAAP underlying earnings or profit measures (referred to as underlying profit or alternative profit measures). Non-GAAP financial information is defined by the FMA as "financial information that is presented other than in accordance with all relevant GAAP". Underlying profit is the presentation of an entity's earnings or profitability that is not the profit currently determined in accordance with New Zealand equivalents to International Financial Reporting Standards by the companies in our sample.

89 companies provided 250 alternative profit measures. This is an increase from the 214 measures provided by 87 companies in 2010 annual reports.

Companies provide alternative profit measures in a variety of places, often with multiple references throughout the annual report. The most common places for discussion as noted in Figure 1 were in the annual report, either in the Director or CEO commentary or in a table of financial highlights (such as a five-year summary), and in many instances both. It was also common to include a subtotal on the face of the income statement.

Figure 1: Where do companies discuss underlying profit?

Table below income statement Other financial statement note Other section of annual report

Segment reporting note Director/CEO report

Income statement subtotal Financial highlights/summary

0

2011 2010

20

40

60

80

100

120

140

Number of alternative measures

5

Figure 2: Number of alternative profit measures shown per entity

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