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Regulators call for improved non-GAAP financial measure disclosures

Published on June 23, 2016

In the first half of 2016, we have seen a renewed focus on non-Generally Accepted Accounting Principle (non-GAAP) financial measure disclosures by securities regulators on both sides of the border, as well as globally. Regulators remain concerned that non-GAAP financial measures may be confusing or misleading, and are presented with more prominence than comparable GAAP measures. Also a concern is the inconsistency of presentation from period to period, often as the result of including “non-recurring” items.

The results of the two most recent Canadian Securities Administrators (CSA) Continuous Disclosure Review Program Activities (Staff Notice) highlighted the concerns over the use of non-GAAP financial measures that were not clearly identified and/or lacking the required disclosures that should accompany such measures. The 2014 Staff Notice also focused on the disclosures around defining specific non-GAAP measures and the need for clear reconciliations to the most directly comparable GAAP measures[i].

In the US, non-GAAP financial measure disclosures have consistently been the topic of US Securities and Exchange Commission (SEC) comment letters, whereby in the twelve months ended July 31, 2015, a total of 235 or 14% of comments letters issued - as a result of 10-K and 10-Q reviews - included comments related to non-GAAP measures (compared to 277 or 13% of letters in the same period ended 2014) [ii]. The nature of the comments included requesting registrants to (1) explain why such measures and metrics are useful to investors, (2) revise incomplete reconciliations of non-GAAP financial measures to the appropriate GAAP measures and address “undue prominence” to the non-GAAP measures, and (3) explain how key metrics are calculated and describe how a key metric is related to current or future results of operations[iii].

All is not lost… well described and transparent non-GAAP measures can and do provide stakeholders with complementary insight into financial performance and cash flows based on what management feels is important– the key is in the disclosures.

Setting the stage

In January 2016, the CSA updated CSA Staff Notice 52-306 (revised) Non-GAAP Financial Measures (“SN 52-306”), with an effective date of January 1, 2016, to reflect amendments to International Accounting Standard 1, Presentation of Financial Statements, effective as at the same date[iv]. The result was the removal of the concept of “additional GAAP measures” except in the context of the statement of cash flows and the reiteration of disclosures that should accompany non-GAAP financial measures.

What does this mean for Canadian reporting issuers?

We believe that the regulators’ ‘call to action’ is for reporting issuers  to undertake a detailed review of their public documents containing non-GAAP financial measures (e.g. Management Discussion & Analysis, press releases, corporate websites and marketing materials) and determine whether such disclosures should be enhanced and/or removed. While we believe there is no immediate expectation of additional regulations related to non-GAAP financial measure disclosure, our expectation is that the increased focus will result in a surge of comment letters (and potential refiling) relating to such disclosures.  

The increased focus may also result in future changes to accounting standards – at the Annual Conference of the European Accounting Association in May 2016, Mr. Hans Hoogervorst, Chairman of the International Accounting Standards Board (IASB) noted “Cutting back the use of non-GAAP measures is primarily the task of securities regulators. But the Board [IASB] should also look at its own role in this matter. We have to acknowledge that non-GAAP measures are also popular because we provide too little guidance in terms of formatting the income statement. The enormous flexibility under existing accounting standards is an open invitation for non-GAAP to step in.”[v]

Where to start?

First steps in reviewing non-GAAP financial measure disclosures should include:

  • Identifying the key or primary GAAP and non-GAAP financial measures that management currently uses to monitor their financial performance and manage their business and that management believe should be presented to stakeholders. Consider speaking to audit committee members and other stakeholders, such as financial statement users, to understand how they evaluate the entity’s performance.  This may identify new measures that should be included.
  • Taking an inventory of all performance measures used in various filing documents and on the entity’s website. In reviewing these measures presented, consider whether these measures are currently used by management and classify them as GAAP, non-GAAP financial measures, performance measures that are not financial in nature or performance measures calculated from information in the financial statements; entities may be surprised to find a number of legacy non-GAAP financial measures that continue to be presented but are no longer a relevant measure. Non-financial performance measures (e.g. square feet available for rent, ounces produced), measures derived from information in the financial statements (e.g. revenue determined under GAAP per square foot) and GAAP measures are not subject to the disclosure requirements set out in SN 52-306.
  • Using the guidance in SN 52-306 as a checklist to ensure non-GAAP financial measure disclosures are complete.  Below are some tips to assess the completeness of non-GAAP financial measure disclosures.

Appropriately define the non-GAAP financial measure

  • Label measures in a manner that clearly distinguishes them from items specified, defined or determined in accordance with an issuer’s GAAP. It should be clear to readers whether measures are GAAP or non-GAAP (e.g. users looking at measures labelled as ‘Cash Flows’ or ‘Net Cash Flows’ but that are not clearly referenced as non-GAAP may assume that the measures are derived directly from the financial statements).
  • Describe measures in a way that is not misleading. SN 52-306 provides the following example, “in presenting EBITDA as a non-GAAP financial measure, it would be misleading to exclude amounts for items other than interest, taxes, depreciation and amortization[vi].” Where other items such as foreign exchange gain or loss, are also excluded, Adjusted EBITDA or another label may be more appropriate to signal to users the nature of the measure. Disclosure of how the measure was adjusted is also be required.
  • Ensure that non-GAAP financial measures are referenced the first time the measure appears. Often measures are presented in tables in the front of the document but not labelled as non-GAAP until later in the document. The referencing should also include a cross reference to where the reconciliation is provided.
  • Explicitly state that the non-GAAP financial measure does not have any standardized meaning under GAAP and therefore may not be comparable to similar measures presented by other issuers. The use of a measure defined by an industry association or regulator (i.e. RealPAC, NAREIT or World Gold Council) does not avoid the need to describe the components of the industry-specific definition and state if any entity-specific adjustments have been made.
  • State why the measure or metric provides useful information to investors and the additional purposes, if any, management uses these measures for. For example, if Adjusted EBITDA, as defined in a debt agreement, is used as a measure of profitability to support compliance with the loan then the discussion regarding the measure should disclose that fact.

Prominence of GAAP and non-GAAP financial measures

  • While management may favour non-GAAP financial measures to monitor and assess the entity’s performance, the regulators’ expectation remains that GAAP measures are of equal or greater importance to stakeholders.
  • Think about whether narratives in the MD&A give more focus to non-GAAP measures. While the discussion and analysis should encompass both the non-GAAP measures and the most directly comparable GAAP measures, the guidance requires that the analysis reflect equal or more prominent discussion of GAAP measures. Ensuring compliance with this portion of the guidance is most likely to require greater effort by management.   

Clear quantitative reconciliation from the non-GAAP financial measure to the most directly comparable GAAP measure as presented in the financial statements

  • Exercise caution when describing reconciling adjustments as non-recurring, infrequent or unusual. Regulators consider transactions/events to be recurring if they are “likely to occur within the next two years or occurred during the prior two years”.
  • Assess whether the measure is balanced (i.e. adjusts for both expenses and gains that are not expected to recur).
  • Think about whether the measure focuses on material adjustments – inconsequential/immaterial adjustments that are not relevant to management should not be included.
  • Present the non-GAAP financial measure on a consistent basis from period to period. Similar to changes to financial statement presentation, if there is a change in how the measure is defined, explain the reason for the change and restate any comparative period presented.

Consistent Themes Around the Globe

In May 2016, the SEC updated its Compliance & Disclosure Interpretations (C&DIs) addressing non-GAAP measures to reflect its concern that such measures may be misleading, more prominent than comparable GAAP measures, or inconsistently presented from period to period. Guidance in the C&DIs includes clarification on what is misleading or prohibited (i.e. what per share non-GAAP measures are appropriate), how to assess prominence on non-GAAP measures and whether to tax-effect non-GAAP measures.

The Financial Reporting Council (FRC) also recently responded to inquiries on the application of the European Securities and Markets Authority’s Guidelines on Alternative Performance Measures, which was issued in October 2015. The guidelines were issued to promote “the usefulness and transparency of APMs [Alternative Performance Measures] included in prospectus or regulated information”[vii].

Finally, in early June 2016, the International Organization of Securities Commissions (IOSCO) released its Statement on Non-GAAP Financial Measures, which sets out 12 elements for issuers to consider in framing their non-GAAP disclosures, thus contributing “to the reliability and comparability over time of non-GAAP financial measures and reduce the potential for misleading disclosure”[viii].

Given the increased scrutiny around non-GAAP financial measure disclosures, we believe that a review of such disclosures should be a priority for management and the audit committee in 2016. As noted by Chief Accountant Mark Kronforst in the SEC’s Division of Corporation Finance at the May 18 meeting of the PCAOB’s Standing Advisory Group, “this next quarter will be a great opportunity for companies to self-correct.”

[iv] IAS 1.55 states “An entity shall present additional line items (including by disaggregating the line items listed in paragraph 54), headings and subtotals in the statement of financial position when such presentation is relevant to an understanding of the entity’s financial position.” IAS 1.85 states “An entity shall present additional line items (including by disaggregating the line items listed in paragraph 82), headings and subtotals in the statement(s) presenting profit or loss and other comprehensive income when such presentation is relevant to an understanding of the entity’s financial performance.” Both items are effective for annual reporting periods beginning on or after 1 January 2016.



Alexia Donoghue, Senior Manager | National Accounting and Securities Services
Alexia is responsible for monitoring quality standards for Deloitte’s public company client filings.  Alexia also provides consultative advice to attest and non-attest clients on general securities filings and financial reporting matters.

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