Additionally, investors were more concerned due to the lack of transparency around how these amounts are calculated, their calculation not being subject to audit, and how they can be reconciled to IFRS figures. And while security regulators around the world have worked to address these concerns, the approaches were still inconsistent where some jurisdictions had less robust regulatory requirements than others, which amplified the issue. However, in Canada and the U.S., these requirements are very similar to what is required by security regulators.
How do the updates alleviate the issue?
In response to the concerns about using non-GAAP and other alternative measures, the new standard addresses the issue and defines management performance measures as well as requires them to be reconciled with the nearest IFRS measures, such as net income or operating income.
This means that users will be able to understand what adjustments have been made to IFRS numbers to arrive at a non-GAAP measure. This provides transparency and clarity to users while also allowing more comparability between similar companies. Explanations about these measures will also be required so that users understand why this non-GAAP measure is important to management and why it is considered useful.
As for businesses, the standards come with a big change to consider and a new level of rigor where providing this additional information needs to be consistent year after year.
Approaching non-GAAP with caution and transparency
The impact of a clear financial representation is undeniable and has the ability to transform businesses by improving access to capital, raising a company's profile in the market, and providing a platform to showcase achievements.
Company executives have argued that certain non-GAAP measures better reflect the company's performance and have included them in the MD&As, press releases, and other public disclosures including earnings before interest, taxes, depreciation, and amortization (EBITDA); adjusted EBITDA; and adjusted earnings as key metrics.
While non-GAAP measures have been sought by companies for various reasons—whether to emphasize certain aspects of its performance or to obscure less desirable ones—the pitfalls of reverting to them entailed a lack of consistency, a lack of definition, and a lack of full transparency. They can create a false sense of security, which comes down to a number that's not audited and not bound by specific standards. However, the upcoming updates do not necessarily imply avoiding or removing these measures but will require an added level of scrutiny and more information to ensure they tie back to IFRS numbers.
The use of non-GAAP measures was recently discussed on BDO's Accounting for the Future podcast with guest Anthony Scilipoti, Founder and President of Veritas Investment Research, exploring the root behind including them in financial reporting.
“It all comes down to the magic number,” says Scilipoti. “The lack of time both analysts and users have, caused them to seek the figures first”. Investors want to know if a company is financially sound, and they want proof in numbers, pure and simple.
A more useful and informative approach to non-GAAP measures in light of the upcoming standard should be less daunting when understanding and clarifying key areas around their use:
- Focus on the why: Why are these metrics being used? Why do they supplement the financial statements? Why do users need them?
- Describe the bumps: Clear communication on how management dealt with challenges and took care of the assets.
- Think long term: Consider this perspective to drive better decisions and communication for the long run.
Transparency is the key to demonstrating readiness and preparedness with the approach of the upcoming standards, and beyond. “There's always uncertainty, yet, knowing that the management team can prepare themselves for that uncertainty, gives a sense of comfort that investors and users seek” explains Scilipoti.
To learn more on this topic, check out our podcast for a full discussion on the acceptance of non-GAAP measures.