The International Accounting Standards Board (IASB) has proposed that listed companies must standardise their definitions of operating profit in financial statements in order to help investors when making comparisons.
The international standard setting body is also proposing a new rule that would regulate how companies explain certain performance measures that go beyond generally accepted accountancy principles (non-GAAP measures).
Having sampled 100 companies, the IASB, which sets standards in more than 140 countries including the UK, found that 63 were using at least nine different definitions of operation profit, which is confusing for investors who rely on operating profit to assess a company’s margins and predict cash flow.
Speaking in a briefing video, Hans Hoogervorst, chair of the IASB, said that he believes the proposals put forward will be a “game changer in financial reporting” and will provide higher quality information for investors while making it possible for companies to better explain their performance.
“Investors have been yearning for this for a long time,” he said. “When investors want to make an estimate of the value of a company, they want to look at profit and loss, and at the operating profit and sustainability of earnings.
“Many companies do that in a different way. So that means one operating profit of one company cannot be compared with an operating profit of another company.
“We find that a very unsatisfactory situation. Investors also find that a very unsatisfactory situation and that’s the reason why we have issued an exposure draft for a new standard that entails a lot of important improvements in the presentation of financial information.”
Current rules require companies to present revenue and profit or loss in an income statement. However, there is no requirement to provide specific subtotals in-between. The International Reporting Standards rule system does not currently define operating profit or subtotals of income and expenses.
“We define revenue at the top and we define profit or loss at the bottom,” said Hoogervorst. “But in between we do not really define any subtotals and both investors and also companies themselves have a need for subtotals to analyse their performance and to analyse different aspects of their performance.”
The new rule would require companies to disclose three new subtotals: operating profit, profit before financing and income tax, and one that includes operating profit, income and expenses from integral associates and joint ventures.
Financial statements would also have to include information about certain management performance measures, and supplementary explanations about why these performance measures provide useful information, how they were calculated, and their relation to the most comparable profit subtotal specified by existing standards.
Management performance measures are helpful for investors to understand how a company views its financial results, but there are concerns about the quality of current disclosures.
Hoogervorst said: “What we do aim to do is to provide a little bit more discipline and transparency around the use of non-GAAP. What we will propose is that, if companies commonly use non GAAP measures or management performance measures, as we call them, for example, in investor packs, that they these measures must be included in one single note in the financial statements so that they’re easy to find for investors.”
By bringing this information into a report’s notes, Hoogervorst explained, it will mean that non-GAAP measures will be subject to audit, and therefore the IASB believe that its proposal will provide more transparency and discipline in the use of non-GAAP measures when reporting.
A third proposal from the IASB would require companies to create a note that lists all elements of income and expenses that are considered unusual, meaning that they have limited predicted value for the foreseeable future.
The aim of this is to improve the level of disaggregation, stemming from a common complaint among investors that too much information is grouped together in one single line item.
Giving an example, Hoogervorst said: “Companies will use a line item called other income or other expenses that encompasses a vast number of expenses. We will provide guidance that will help preparers to present and group together information in line items in a way that is more meaningful to investors.”