Investors and audit committee chairs discuss ways to improve non-GAAP reporting.
At the International Corporate Governance Network’s joint conference with the International Integrated Reporting Council in London on 7 December 2016, KPMG chaired a panel discussion on non-GAAP financial measures, which have received a lot of attention in recent months and become a topical issue for regulators, standard setters and investors alike. Are companies presenting them in a way that meets investors’ needs?
Paul Korolkiewicz, Head of Audit for International Markets and Government at KPMG in the UK, chaired the discussion and acknowledged that the issue “has huge interest”. He observed that “there’s a fair degree of confusion around this topic, starting with the different names used to refer to them.”
Paul then invited Vincent Papa, Interim Head of the CFA Institute, to give his perspectives, as the CFA had conducted an extensive survey on the subject among its members. Vincent Papa said that, while the CFA supported IFRS, there are several areas such as recurring versus non-recurring revenue where “you do not get clarity under the existing reporting framework” meaning that “one can understand the need for supplemental measures.”
However, CFA members had expressed concerns around certain calculations and adjustments that are made, one example being earnings before stock option expenses. Non-GAAP measures were often given more prominence than GAAP. “That can be misleading, particularly when the non-GAAP measure is presenting a more exuberant picture of performance,” he said.
However, the CFA’s research had shown that investors do not just accept non-GAAP measures “in an unsophisticated fashion”. They also adjust the figures themselves. What they are really looking to get to is a notion of “earnings quality.”
Vincent also raised concerns over the quality, consistency and comparability of the reporting of non-GAAP measures. He said: “Companies sometimes change on a periodic basis the type of non-GAAP measures that they provide and it’s not necessarily the level of transparency that investors would require to be able to meaningfully delineate trend analysis.”
Jeannette Andrews, Corporate Governance Manager at Legal & General Investment Management, echoed many of these issues and said that despite a mass of disclosure from companies, much of it did not in fact shed a lot of light: “There is a lot of ‘transparency’ out there already – but very limited clarity as to what is actually going on underlying in the business.”
She further elaborated that “we are seeing increasing gaps between the accounting numbers [in accordance with GAAP] and the management numbers that are reported” – something that recent research from the FRC had also highlighted. A further concern was how robust the numbers are. “They are not subject to the same audits and assurance that the accounting numbers are,” she said.
Investors would welcome deeper insights into the drivers for the use of some non-GAAP numbers, for example the effect on remuneration, and how this affects decisions on what to adjust. Jeannette Andrews also stressed that audit committees have an important role to play. She said: “Different things are added back in and taken out year after year, and we want audit committees to be challenging management on this.”
It felt like some trust issues existed between companies and investors, as Paul Korolkiewicz observed – and invited Robin Freestone, audit chair at Moneysupermarket.com Group Plc, Non-Executive Director at Michael Kors Holdings Ltd, and former CFO of Pearson Plc, to give some views from the company perspective.
Robin Freestone underlined that GAAP numbers remain the “foundation stone” for company reporting, and added that the amount of disclosure nowadays showed how things were “light years” ahead of where they used to be.
However, he agreed that if changes were made to the basis or comparators referenced for non-financial disclosure, “they absolutely need to be justified and they need to be consistently reported.” For Robin, the difficult area was when you get into “adjusted measures”. He agreed that there is “little consistency” when you get into areas such as adjusted profit, earnings or tax rates. “It must make life impossible when trying to compare how different companies are doing, frankly. We have got to do a better job in explaining these adjustments and in reconciling GAAP to non-GAAP measures,” he said.
Speakers in the video: Jeannette Andrews, Corporate Governance Manager, Legal & General Investment Management Limited; Robin Freestone, Audit Committee Chair, Moneysupermarket.com Group Plc, Non-Executive Director, Michael Kors Holdings Ltd; Adrian Stone, Head of Audit, KPMG in the UK; Paul Korolkiewicz, Head of Audit, International Markets and Government, KPMG in the UK.
Robin also said that too many things are also classed as “exceptional” now. “We have got to get a lot tighter in order to get trust back.” One important area is that of remuneration, with Board pay levels having “escalated” in recent years. Robin Freestone said: “When you are looking at non-financial measures or you’re looking at adjusted measures, for me, the key question to ask is, are management being paid as a result of that?” This is a key area if trust is to be won back.
So what needs to be done? According to Vincent Papa, accounting standard setters have a role in reducing the need for non-GAAP measures through projects to improve the main financial statements; and regulators and auditors in better monitoring and ensuring consistency of non-GAAP reporting.
Jeannette Andrews also pointed to an “expectation gap” over what level of assurance investors think is actually given over the non-GAAP numbers.
David Littleford, Partner at KPMG in the UK, agreed. He noted that a measure that is included within the financial statements themselves is within the scope of the audit, and some UK long-form audit reports even identify the non-GAAP measure as a significant audit area: “You will actually see the definition and the judgements referenced in the audit report...evidencing our focus on those measures and the work that we did.” However, where the measure appears outside the financial statements, it falls outside the scope of the audit opinion.
David stressed that it was important to continue a dialogue on the issue, “to work with the investment 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.” In doing so, we should not forget non-financial non-GAAP measures, which are often of significant relevance to investors.
Vincent Papa observed that technology has a role to play in the way information is delivered, as does the move towards integrated reporting. Both can help create greater connectivity across different strands of reporting so that we are getting better and more insightful information.
Ultimately, whatever methods are used the aim is quite simple. As Jeannette Andrews said: “This is about ensuring that the information at the front end of the report truly reflects the performance of the company and that there is appropriate oversight on that.”