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Improving Stakeholder Understanding of Organizational Performance: Making the Most of Supplementary Financial Measures
Many organizational leaders believe that measures developed under generally accepted accounting principles (GAAP) often do not fully capture an organization’s current performance or future prospects. To fill this void, they frequently provide additional financial measures that are not specifically defined by accounting standards: supplementary financial measures.
Many such measures are widely used in both internal and external reporting, for example, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA); Underlying Profit; and Free Cash Flow. However, some commentators believe that organizations use such measures in their external reporting to obscure poor performance.
To help professional accountants address this issue and develop and report useful measures, IFAC’s Professional Accountants in Business (PAIB) Committee has issued proposed guidance, Developing and Reporting Supplementary Financial Measures.
The proposed guidance provides principles regarding the qualities a measure should have and disclosures that should accompany them if reported externally. The guidance is meant for all organizations that want to use supplementary financial measures, regardless of size or structure, private or public. The guidance can also be applied to non-financial measures, such as greenhouse gas emissions or barrels of oil equivalent production.
Considerations for development and reporting
Building on the qualitative characteristics of useful financial information (as identified in the Conceptual Framework for Financial Reporting issued by the International Accounting Standards Board and the US Financial Accounting Standards Board), the guidance recommends professional accountants consider a number of attributes when developing and reporting supplementary financial measures. A supplementary financial measure should be:
- Relevant—used by management to assess performance or employed by knowledgeable users of the external report.
- Complete—provides all the information necessary for a user to understand the phenomenon being depicted.
- Neutral—not slanted, weighted, or manipulated to obtain a desired result.
- Transparent—aligns with its components and accompanied by sufficient explanation to make it as free as is practical from uncertainty and estimation error.
- Understandable and verifiable—allows knowledgeable users to understand its construction and limitations and conclude that it faithfully reports what it purports to depict.
- Comparable—between entities in the same industry and between periods.
- Timely— reported at the same time as the related financial statements.
In addition to these attributes, the guidance provides a number of tips for disclosure of supplementary financial measures.
- To avoid confusion, supplementary financial measures should be clearly defined. Additionally, the purpose of a measure should be disclosed. Further, supplementary financial measures should be labeled as such and be clearly distinguished from GAAP measures.
- When the components of a measure change or their calculation changes, the reason for the change should be explained and the comparative amounts should be restated to the new basis of calculation.
- A supplementary financial measure should include a quantitative reconciliation of the measure to the most directly comparable reported GAAP measure.
- A supplementary financial measure should be presented with sufficient information to enable a user to understand its components and see that the measure is complete, neutral, and free from error.
- An externally-reported supplementary financial measure should be presented so that it complements but does not overshadow an organization’s GAAP measures.
Given the absence of definitions for supplementary financial measures, many jurisdictions regulate their use and disclosure when reported externally. Accordingly, the proposed guidance should be considered in light of the regulations in the particular jurisdiction where it is applied.
The proposed guidance also includes a limited list of relevant resources from IFAC, its member bodies, and other relevant organizations.
The PAIB Committee is interested in feedback from all professional accountants regarding the proposed guidance. Please use the Comment area below or submit a formal comment letter via the IFAC website prior to May 26, 2014.
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