Brydon recommendations: Alternative Performance Measures and Key Performance Indicators
Following the publication of Sir Donald Brydon’s final report on his Independent Review into the Quality and Effectiveness of Audit, this article summarises his proposals on Alternative Performance Measures and Key Performance Indicators.
Sir Donald has acknowledged the increasing reliance and emphasis that boards and management place on Alternative Performance Measures (APMs). Although not based on IFRS or UK GAAP, investors and analysts regard APMs as important indicators included in the front-half of annual reports or within preliminary and other announcements.
APMs represent adjusted IFRS or UK GAAP numbers that are considered by management to be important and provide greater insight into a company’s underlying performance. A familiar example is EBITDA.
Many interested parties have expressed a demand for greater visibility over which of these APMs have been subject to some form of assurance. Sir Donald has recommended that APMs should be subject to audit. He has expressly suggested that it should not only be the calculation that is audited but confirmation should also be provided that no misleading information has been disseminated as a result.
On the subject of Key Performance Indicators (KPIs), of which a number are required in the UK in the Strategic Report, he highlights that these are less clearly defined but are referred to in Section 414C of the Companies Act 2006. That reference describes KPIs as factors by which a company’s performance and position can be measured effectively. A report by the UK Financial Reporting Lab describes them as: “quantitative measures used by directors to assess progress against objectives or strategy, track principal risks, or otherwise monitor the development, performance or position of the business. KPIs could include GAAP numbers, non-GAAP financial metrics or wider metrics.”
The UK Financial Reporting Council (FRC) acknowledges that it will be a matter for the board to judge which KPIs best reflect the way that they manage the business.
Therefore, in his recommendations, Sir Donald proposes that shareholders should be entitled to request assurance over KPIs but that those used in the calculation of executive remuneration should be subject to audit.
A further consideration, relevant to the financial services sector, is the matter of risk-weighted assets. There had been calls from some parties for the auditor to opine, on a true and fair basis, on the calculation of risk-weighted assets in banks. In Sir Donald’s opinion, this process would be an onerous one and disproportionate in relation to the extra assurance provided in addition to that already given by the Prudential Regulation Authority (PRA) and therefore he has not included a recommendation to this effect. He does, however, recognise that bank audit committees would be entitled to include additional audit procedures around the calculation of risk-weighted assets within their Audit and Assurance Policy if they so wish.
ICAS has, for many years, supported the proposal for greater assurance over KPIs, as highlighted in our 2015 paper Towards Transparency: Assurance on KPIs – A practical guide for audit committees and boards. That paper acknowledged that greater emphasis was being placed by boards and stakeholders on the front-half of annual reports, and the narratives information contained therein, and that there was a need for the development and adoption of best practice in the selection and reporting of KPIs. The ICAS paper was designed to support and assist this process. We therefore welcome this recommendation.