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FMA seeks tighter disclosure of non-GAAP measures that can make companies look better

Tuesday 28th March 2017

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The Financial Markets Authority has proposed an update to its guidance for companies who use financial information that doesn't follow generally accepted international rules after a survey found three-quarters of them emphasised numbers that made profits look bigger.

The markets regulator has released an update to its 2012 guidelines on the use of non-GAAP financial information for feedback by April 7. The new guideline repeats that while non-GAAP information can be useful in providing additional insight into a company's financial performance, condition, or cash flow "it has the potential to be misleading if inconsistently presented, inadequately defined, not reconciled to the most comparable GAAP financial information and/or used to obscure financial results determined in accordance with GAAP. "

GAAP stands for generally accepted accounting practice, meaning globally accepted. In New Zealand's case accepted practice is the NZ version of the International Financial Reporting Standards. The guidance is for companies caught by the Financial Markets Conduct Act, meaning they issue securities to the public.

Among the changes from the 2012 guidelines are that non-GAAP measures shouldn't be given greater prominence than comparable GAAP financial information and that one-time or non-recurring items should genuinely be one-offs and if they're used the company should capture every single such item to avoid "cherry-picking" on adjustments.

The FMA reviewed uptake of the 2012 guidelines in 2013, looking at 23 major listed companies which generated a total GAAP profit of $2.3 billion and a non-GAAP profit of $4.1 billion, an additional 76 percent of profit. It found that 17 of the 23 reported a non-GAAP profit greater than their GAAP profit. It also found greater prominence given to non-GAAP measures and instances where "communications were overwhelmed by multiple non-GAAP measures with little or no emphasis on the GAAP measure."

One measure, in particular, raised the most concerns - ebitda or earnings before interest, tax, depreciation and amortisation - a metric so popular it's used by eight of the 10 companies on the NZX 10 Index. The other two use either ebit (earnings before interest and tax) or underlying earnings.

Some of the variations are so protracted they can barely be said in a single breath, such as Z Energy's "replacement cost operating earnings before interest, taxation, depreciation (including gains and (losses) on the sale of fixed assets), amortisation and fair value movements in interest rate derivatives and movements in decommissioning and restoration provision". 

The use of such non-standard terms requires the companies to add a rider to their presentations. Meridian Energy's says that because it uses terms that aren't defined by GAAP or IFRS, the company's calculation of these measures "may differ from similarly titled measures presented by other companies".

Contact Energy says it focuses on ebitdaf, or earnings before net interest expense, tax, depreciation, amortisation, change in fair value of financial instruments and other significant items, because that measure "is commonly used in the electricity industry so provides a comparable measure of Contact’s performance at segment and group levels".

SkyCity Entertainment Group presents "normalised financial information" because it presents company information "that is useful to the investment community in understanding the underlying operations of the group."

Milford Asset Management head of investments Brian Gaynor wrote in an NZ Herald column in December titled 'Old ways must end for good of market' that the increasing use of adjusted or normalised profit figures was among issues having a continued adverse impact on the country's investment markets. He noted an academic paper published by John Crowley, David Lont and Tom Scott last year that illustrated that "adjusted figures are usually higher than IFRS figures and companies have the remarkable ability to turn IFRS losses into adjusted profits."

Gaynor said he took a more cynical view of adjusted profit figures, "mainly because of the ability of rogue companies to make inappropriate and flattering adjustments that are not subject to audit certification."

The FMA's proposed guidance says that the use of GAAP profit measures provide the reader "with financial information that is consistently calculated and comparable over time and across all FMC reporting entities".

When non-GAAP measures are used they should be used consistently from period to period and be unbiased - and not be used "to avoid presenting adverse information to the market or to over-emphasise favourable information."

One concession in the proposed guidance is that companies would no longer have to reconcile non-GAAP financial information with GAAP measures in every document where it is used, provided a reference is included where the information can be easily accessed.


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