Results of FRC’s review of the use of Alternative Performance Measures by UK companies
FRC publishes results of its review of Alternative Performance Measures.
In October 2021, the Financial Reporting Council (FRC) published the results of its review of Alternative Performance Measures (APM) by UK companies. This thematic review assessed the quality of APM reporting in the UK, five years after the implementation of the European Securities and Markets Authority (‘ESMA’) Guidelines on APMs (the ‘ESMA Guidelines’) and the introduction of the IOSCO statement on Non-GAAP Financial Measures. It also follows on from the FRC’s most recent APM thematic review report in 2017.
For the review, the FRC examined the annual reports of twenty companies across a range of sectors with year-ends ranging from 30 September 2019 to 31 March 2021.
The average number of APMs used by companies in the sample was sixteen, with a range from thirteen to twenty three APMs per company. The FRC noted that companies also included APMs in the financial statements or related notes, although their review focused on APMs presented in the front half of annual reports.
The most frequently used APMs were:
- net debt;
- adjusted EBITDA;
- adjusted profit before tax; and
- adjusted operating profit.
Each of the above was used by at least eighteen of the companies in the sample) Perhaps not surprisingly, eleven of the most frequently used APMs related to the income statement. APMs reported by FTSE 100 companies were higher, perhaps due to these entities having larger and more complex operations, and a wider range of messages to convey.
All companies in the sample presented adjusted results. Nineteen of these reported higher adjusted profits, or lower adjusted losses than their International Financial Reporting Standards (IFRS) equivalents. In six cases, APM adjustments changed GAAP losses into an adjusted profit.
Overall, the FRC found that companies provided good quality disclosures around their use of APMs. However, it highlighted that around half of the companies in the sample gave APMs more prominence or authority than GAAP measures in some areas of reporting. The FRC expects companies to ensure that these supplementary measures are not displayed more prominently than GAAP measures and that their narrative reporting does not give them greater focus.
The FRC noted that as high levels of APM usage may obscure relevant GAAP information, companies should consider reducing the number of APMs disclosed, for example, by removing multiple variants of similar APMs and avoiding using APMs with only immaterial adjustments to IFRS measures.
Companies were also reminded to be even handed in their treatment of gains and losses when classifying amounts as adjusting items. The FRC highlighted that companies should avoid practices that systematically present a more favourable view of their adjusted results than GAAP measures; and that it expected companies to highlight limitations of their APMs, e.g. the measures may not be comparable across companies.
Although the FRC was pleased to find that 13 companies (65%) described their Audit Committees’ role in monitoring and challenging APM disclosures it highlighted that it expected all relevant audit committee reports to explain the degree to which they had reviewed and challenged companies’ APMs, where significant.
In line with its 2017 review, the FRC was pleased to find that most companies gave appropriate labels to their APMs and none used labels that were overly optimistic or positive. However, areas for improvement were identified including that companies should not be referring to APMs as ‘statutory’ or ‘reported’ measures in an attempt to distinguish them from similar adjusted measures (e.g., ‘statutory net debt’ and ‘statutory EBITDA').
Whilst nineteen companies provided definitions for all or most of their APMs, the FRC identified cases where companies gave multiple, slightly different definitions for the same APM.
The FRC noted that there was an improvement in the proportion of companies that reconciled their APMs, with more companies providing reconciliations than in 2017. Most companies showed how reconciling items were obtained from amounts presented in the financial statements if the source of the figures was not self-evident. The FRC found that reconciliations were generally easy to locate and was pleased that more companies explained the calculation of ratios in line with the guidance given in 2017.
Some areas for further improvement were, however, identified, where reconciliations of some APMs were omitted, the explanations of reconciling items could be improved, or the APM had not been reconciled to a GAAP number.
The FRC believes that many companies can still improve the quality and value added by their explanations for APMs and adjusting items by providing more granular information and, where relevant, by providing explanations at the level of individual APMs or adjusting items
The FRC expects companies to consider the better disclosures included in its thematic report and reflect on the improvement opportunities and shortcomings highlighted throughout the report.