Clarity and the consistency in reporting non-GAAP financial measures.
We held an interesting discussion with the corporate and investor community at an International Corporate Governance Network (ICGN) event in Frankfurt on how corporate reporting can be improved to better serve investor needs.
This was continued at the joint ICGN and International Integrated Reporting Council conference in London recently when attention turned specifically to non-GAAP financial measures – a hot topic for investors, regulators and standard setters alike.
Why is it so hot? As became clear in the panel discussion, there are a number of key issues that relate to the clarity and the consistency of what is reported.
Firstly, clarity. As Jeanette Andrews, Corporate Governance Manager at Legal & General Investment Management, said: “There is a lot of ‘transparency’ out there already – but very limited clarity as to what is actually going on underlying in the business.” There may be plenty of disclosures, but how much light do they shed?
This is important when, as Jeanette further observed, there seem to be “increasing gaps” between the accounting numbers and the management numbers that are reported. In addition, non-GAAP measures are sometimes given more prominence than GAAP numbers, which Vincent Papa, Interim Head of the CFA Institute, said “can be misleading.”
Possibly the greatest issue, though, and one of the ‘bugbears’ of the investment community, is the lack of consistency in the measures used or presented from year to year. There is the suspicion that companies pick and choose so as to present the most favourable picture.
For Jeanette Andrews, audit committees need to be challenging management if “different things are added back in or taken out year after year.”
And Robin Freestone, audit chair at Moneysupermarket.com Group plc, concurred that where there are changes, these “absolutely need to be justified.”
One of the underlying issues of course is that things are not always black and white. ‘Adjusted measures’ are a difficult area, as Robin observed. Then there are ‘exceptional’ items which in Robin’s view have become too common and need to be tightened up on.
But if the problems one runs into with non-GAAP measures are fairly well-acknowledged, what can actually be done to address them?
The answer from the panel was – several things.
Firstly, standard setters can continue their work to improve IFRS. This is important because, as Vincent Papa remarked, there are areas of IFRS under which “you do not get clarity” meaning that “one can understand the need for supplemental measures.”
There is also a role for regulators in better monitoring and ensuring consistency of non-GAAP reporting.
And of course, auditors have an important role to play. While many non-GAAP measures are outside the scope of the audit, those that are included within the financial statements do fall within it. In the UK, some long-form audit reports identify the non-GAAP measure as a significant audit area with the definition and judgements referenced in the audit report.
We recognize that it is vital for the audit profession to continue the dialogue with the investor community to agree the right level of assurance and over what information, and then seek a way together with the regulators and the standard setters to implement a solution.
Other elements are also likely to help over time – such as integrated reporting joining up the different strands of reporting.
In many respects, we have come a long way in terms of company disclosure and transparency. But without doubt there is more to do – we need to work together as a financial community to shape the best solutions and deliver them.