The rules on reporting non-GAAP measures are getting stricter for Canadian public companies, as securities regulators take steps to protect investors.
Under new rules released by the Canadian Securities Administrators (CSA), companies must label non-GAAP measures clearly as non-GAAP, disclose how they calculated them, and explain why they use non-GAAP measures at all. They must also reconcile their non-GAAP metrics with the most comparable measure in their financial statements.
The move by the CSA increases transparency for investors when public companies report results that differ from their financial statements—which use GAAP measures under the International Financial Reporting Standards (IFRS).
For years, company executives have maintained that some non-GAAP measures better reflect company performance. They have included them in their management discussion and analysis (MD&A), press releases, and other public disclosures. Key non-GAAP metrics include earnings before interest, taxes, depreciation, and amortization (EBITDA); adjusted EBITDA; and adjusted earnings.
Non-GAAP rules are new—yet familiar
The new rules will generally be familiar to many in the financial community. The CSA had previously released a staff notice advising companies to follow them as guidelines. What has changed is their scope—and the CSA's ability to enforce them.
“Most companies adopted the staff notice as best practices,” said Armand Capisciolto, National Leader of BDO's Accounting Advisory Services. “But the new rules are more stringent and cover more items. Getting compliant now becomes a race against their financial reporting timelines.”
The May publication of the non-GAAP rules ends a three-year process. The CSA first released them as proposals in September 2018. It then incorporated feedback from accounting firms and other stakeholders before releasing revised proposals in February 2020. This launched another round of stakeholder comments—culminating in the new rules.
Why are non-GAAP measures criticized?
Investor advocates and regulatory bodies have criticized non-GAAP measures as misleading. Because these measures are not defined in one standard way, they say, investors can't rely on them to make investment decisions.
The CSA's crackdown on non-GAAP metrics also reflects the value that investors increasingly place on transparency.
At the most basic level, investors want numbers that they trust to show financial performance. But today's activist investors have taken transparency a step further, demanding corporate transparency on ESG: the environment, social issues, and governance.
Non-GAAP measures (don't) go digital
When the CSA released the proposed rules, one stakeholder suggested they should not apply to websites and social media.
The CSA disagreed, pointing out that executives often share information on all channels in a splintered media marketplace. They don't always consult with their communications or legal departments before doing so.
“That's a big change,” said Armand Capisciolto. “It can be challenging to control what executives say on social media. But it speaks to the growth trajectory of many companies. As they mature, they have to evolve their social media strategies and other governance policies to match the scale of their operations.”
IFRS and non-GAAP reporting
The CSA isn't the only organization reassessing its attitude to non-GAAP reporting.
The International Accounting Standards Board (IASB) is looking to overhaul how companies present financial statements under IFRS. This proposed change will bring some currently non-GAAP financial metrics onto a company's financial statements and make them subject to audit.
The IASB project is still just a proposal. The CSA said it will consider changes to its own rules once the IFRS financial statement presentation standard changes.
How to respond to the CSA's crackdown on non-GAAP metrics
Public companies that report their performance with non-GAAP metrics need to decide: to continue with non-GAAP or abandon the practice. If they continue, they need to stay compliant with the CSA by vetting their MD&A, press releases, and social media posts against the new rules.
Financial leaders may also consider adjusting their financial statements. Non-GAAP measures now need to be reconciled to the GAAP numbers. As a starting point to generate the non-GAAP measures, they can be adjusted to make the reconciliation easier and simpler.
The new rules apply to years ending on or after October 15, 2021, so the first year-ends impacted are October 31, 2021. For most companies, the rules will first impact their December 31, 2021 reporting period.