IASB Chief Warns About Use of Non-GAAP Metrics

May 12 — Entities should exercise caution in using financial-reporting measures that fall outside Generally Accepted Accounting Principles, International Accounting Standards Board Chairman Hans Hoogervorst said May 11.

During a speech at the European Accounting Association annual meeting in the Dutch city of Maastricht, Hoogervorst said that such non-GAAP metrics as other comprehensive income (OCI) might give a distorted picture of a company's financial performance.

Importance of Profit and Loss

In IASB's current work on its conceptual framework—which serves as the foundation for developing and revamping international standards—the board has clearly indicated that it considers profit or loss (P&L) to be the critical indicator of performance, Hoogervorst noted.

“We have also made clear that other comprehensive income should only be resorted to if it enhances the relevance of profit or loss,” he said.

IASB has proposed, for the first time, supplying guidance in the conceptual framework on whether to present income and expenses in P&L or in OCI.

Concerns About Pension Liabilities

Hoogervorst cited some companies' treatment of their pension obligations as an example of how OCI use potentially can mislead financial-information users.

“Current developments in pension schemes, for example, really cast doubts on the wisdom of including changes in the pension liability in OCI, rather than profit or loss,” he said.

‘Semi-Darkness of OCI.’

Hoogervorst cited research indicating that 1,000 U.K. pension plans are struggling with the nation's low interest rates, and that pension obligations could drive about 400 companies into bankruptcy.

“While the pension liability is in full view on the balance sheet, its effect on performance is hidden in the semi-darkness of OCI,” he told meeting participants.

Placing pension obligations in P&L, he said, likely would spur companies to adopt more realistic pension arrangements, more prudent dividend distributions, or both.

Guidance on Non-GAAP Measures?

Hoogervorst's assessment about using OCI echoes similar cautions he voiced in an April 2015 speech on using non-GAAP alternative performance measures, such as earnings before interest and taxes (EBIT) as well as earnings before interest, taxes, depreciation and amortization (11 APPR 08, 4/10/15).

International financial reporting standards offer companies considerable leeway in formatting income statements, he said, and “the enormous flexibility under existing accounting standards is an open invitation for non-GAAP to step in.” (12 APPR 10, 5/20/16) (31 CCW 149, 5/11/16) (48 SRLR 969, 5/9/16) (88 SLD, 5/6/16) (88 CARE, 5/6/16) (See previous story, 05/06/16)

Though responsibility for limiting the use of non-GAAP measures rests largely with securities regulators, Hoogervorst told conference attendees, IASB might consider providing additional guidance on using non-GAAP metrics, such as:

•  defining more subtotals in income statements;
•  providing a principle-based definition of operating income to prevent companies from obscuring impairment or restructuring charges; and
•  tightly defining EBIT.

“We may have to do all of the above—and maybe more,” Hoogervorst said.

Difficult to Define

Concern about using non-GAAP measures reflects broader interest in financial performance reporting, according to Hoogervorst's prepared remarks.

Many investors want IASB to define performance reporting, but he pointed out that the concept has many aspects and in certain respects is subjective—and, as a result, is nearly impossible to define.

Bottom Line

Still, an income statement's bottom line—profit or loss—should remain the most important gauge of performance over time, he said.

Hoogervorst highlighted the doubts financier Warren Buffet has expressed about the sometimes-volatile earnings projections and growth expectations that companies tout in their financial statements.

“This is not only a fair warning to preparers, it is also a reality check for users who make their living by forecasting earnings based on their perception of the persistence of earnings,” Hoogervorst said.

Continuing Work on Performance Reporting

IASB's consideration of P&L and OCI in revising its conceptual framework has proved valuable, Hoogervorst said, but the board's agenda consultation outlining its plans for the next few years shows that further work lies ahead.

“Indeed, our Agenda Consultation makes clear that we will most likely continue working on performance reporting after finalising the Conceptual Framework,” he said.

To contact the reporter on this story: David R. Jones in London at correspondents@bna.com

To contact the editor responsible for this story: Laura Tieger Salisbury at lsalisbury@bna.com