The percentage of ASX top-500 companies that use non-standard financial measures such as underlying profit and underlying earnings has almost doubled since 2000 with more than 40 per cent of firms now promoting these metrics to the market.
The troubling conclusion of a study into listed firms' reporting behaviour is that the non-standard metrics are sometimes more useful that the statutory metrics, meaning that investors must make individual judgments to work out if the figures are reasonable or not, defeating the purpose of having accounting standards in the first place.
"Investors and others really need to look carefully on a case-by-case basis about what items the firm is excluding from its underlying measures and ask if it makes sense when measuring the performance of management and the board," Stephen Taylor, a professor of accounting at UTS Business School and co-author of The rise and rise of non-GAAP (generally accepted accounting principles) disclosure, said.
The shift is part of a worldwide trend that is making investors unhappy, because it makes it harder to differentiate between self-serving management behaviour and metrics that genuinely provide more useful information about a firm.
Gap between rules and reality
The research highlights the gap between the financial reporting rules that companies are legally obligated to follow, known as GAAP, and other metrics that management believes allows it to tell the true story of its performance.
The move is also challenging the notion of having a standard set of financial reporting rules that all companies must follow so that investors and regulators can easily compare and monitor the performance of companies within and across industries.
"We observed a growth in firms who primarily emphasise an income result that is presented as an alternative to income measures required by accounting standards," Professor Taylor said of the research, which was funded by the Centre for International Finance and Regulation.
"We see more and more of firms referring to cash earnings or underlying profit, and there's hardly any adequate explanation of what that result is relative to the statutory, or GAAP, results."
He and his fellow authors found that the percentage of ASX 500 firms reporting at least one non-standard earnings measures has grown from just under 25 per cent in 2000 to almost 45 per cent in 2014.
Challenge for authorities
The research, based on an examination of market disclosures by ASX 500-listed firms between 2000 and 2014, is the most detailed analysis of reporting patterns done in Australia.
"The real debate around this whole behaviour is whether this is self-serving behaviour by management or whether it is trying to give investors more useful information than the statutory equivalent,"
"This highlights a real challenge for standard setters as in many respects it is undoing the current requirements for reporting income."
"The other challenge is for investors trying to figure out what is the right number to focus upon."
Companies were most likely to refer to the non-standard metrics in their media releases or preliminary financial statements and the types of non-standard measures used included underlying profit, underlying earnings, underlying profit after tax, underlying earnings before income and tax, cash earnings and cash basis
The study found that the companies often defined these terms differently, and even within a company there could be variation in what was included and excluded from year to year.
The net result is that the non-standard measures of earnings after tax exceeded the standard equivalent most of the time, and the non-standard earnings measures were substantially less volatile year on year.
Written off when it goes bad
Professor Taylor provided an example of asset write-offs and their treatment in non-standard accounts.
"If you record something as an asset and it has an expected useful life, that's a business decision that you made," he said.
"And if it then it turns out that things have changed for whatever reason and the economic benefit from the asset is going to be a lot less, you have to write down the cost of the asset. Isn't that a cost to the business?
"What tends to happen sometimes is firms exclude asset write-offs.
"When we make a good decision the benefit flows through our income and when it doesn't go well we will ignore it."
The researchers noted that non-professional investors tended to be more influenced by non-standard data than professionals such as financial analysts and short sellers.
A separate report from KPMG found that write-downs at the top 50 companies for the past financial year were at the highest level since the global financial crisis but more than $26 billion of the $38 billion in red ink was airbrushed from the results presented to investors.
Related research by governance firm Ownership Matters also found that more than half of the top 300 companies inflated their profits this year.
Standards for non-standard metrics
The corporate regulator does not object to the use of non-standard metrics but issued guidelines in 2011 on how the additional data should be presented.
"It may appear in documents accompanying the financial report, such as the operating and financial review, in analyst and investor briefings, or in other market announcements but should not be presented in a way that is potentially misleading," Douglas Niven, a senior executive at the Australian Securities and Investments Commission, said.
"This means, for example, that non-GAAP information should not be given more prominence than the corresponding [standard] measure, should be clearly described, should not be biased, and should be reconciled to the corresponding [standard] measure."
The KPMG research found that many ASX200 companies were not fully complying with the ASIC guidelines.
The International Accounting Standards Board (IASB) is setting out to create its own set of guidelines on the use of non-standard measures.
The proposal will be that the non-standard information be "fairly presented, not be given undue prominence, that reconciliations be provided to [standard] required totals and there be consistency in the measures provided by entities over time", Sue Lloyd, vice-chair of the IASB, said.
The international body, which sets financial reporting standards used as the basis for the Australian standards, has also begun research into performance reporting including subjects such as whether the IASB "should define any additional subtotals in profit or loss, such as operating profit or EBIT (Earnings Before Interest & Tax), and/or provide guidance around presentation of non-recurring and recurring items".
Meanwhile, accounting professional body Chartered Accountants ANZ (CAANZ) has expressed qualified support for the use of non-standard measures.
"We support clarity and transparency in financial reporting so if non-GAAP measures assist to achieve this then we support with certain parameters around it," Geraldine Magarey, a policy expert from CAANZ, said.
"It also needs to be done for the right reason of providing better information to investors and to the market, not out of self-interest."
Ms Magarey said the advice to members was that the non-standard measures needed to be consistent from year to year.
"[Companies] can't report on something one year because it is good and not the next because it is bad news," she said.
A $108m question for Qantas
Airline Qantas is an example of a firm that uses standard and non-standard performance measures in its communication with the market, with the emphasis varying depending on the document in question.
The results presentation features eight key financial measures on page four, including the underlying profit before tax figure but not the statutory profit figure.
The word "statutory" occurs twice in the entire 38-page presentation, in the notes at the bottom of page 4, and not at all in the CEO's address. A supplementary presentation features statutory results and a reconciliation to the non-standard metrics.
In the media release for its 2016 full-year results, the first two dot points refer to underlying profit before tax of $1.53 billion and statutory profit before tax of $1.42 billion.
The review of operations, which is a shorter version of the preliminary financial report, features a prominent graphic of underlying profit before tax and statutory profit after tax.
Below the graphic is the note: "The Group's Statutory Profit After Tax of $1029 million included $108 million of costs which were not included in Underlying [Profit Before Tax] primarily driven by redundancies, restructuring and other costs associated with the ongoing Qantas Transformation Program."
No further explanation is given in the document as to why an ongoing program that cost $108 million during the year is exempted from the underlying profit measure, and the company did not comment directly on this figure.
This removal of restructuring costs is how Woolworths turned a $1.2 billion loss into an underlying profit of $803 million.
Qantas states that the non-statutory underlying profit before tax is the primary measure used by the company for assessing performance.
The review of operations also features, on page 11, a reconciliation that shows what was removed from the statutory profit before tax to work out the underlying profit before tax figure.
The company also produces an audited set of financial statements that complies with statutory reporting requirements.
"We first introduced an underlying profit measure in 2010, to give our investors a consistent way of looking at our performance year on year, and we've applied the same approach ever since," a Qantas spokesman said.
"Our results provide a reconciliation to statutory profit, we make sure that underlying and statutory profit are equally prominent in our ASX release, and we provide a wide range of other disclosures so that the market has all the information it needs about how we're placed."
