Description of subtotals (Agenda Paper 21A)

Background

The Board tentatively decided to require three new IFRS-defined subtotals in the statement(s) of financial performance:

• Profit before finance income/expenses and tax
• Profit before income/expenses from investments, finance income/expenses and tax
• Business profit from consolidated entities.

The Board had tentatively decided not to use the term ‘operating profit’ to describe one of the subtotals. This paper sets out the staff analysis and Board discussion for reconsidering the term ‘operating profit’ as well as the terms used to describe the two profit subtotals aforementioned.

Staff analysis

Operating profit

The staff’s research indicated that 42 of 85 entities present both operating profit and the share of profit or loss from joint ventures and associates and that some (but not all) consider the share of profit or loss from joint ventures and associates to be part of operating profit.  Consequently, the staff proposed that the subtotal that excludes the share of profit or loss of associates and joint ventures (i.e. the ‘business profit from consolidated entities’ subtotal) should be described as operating profit.

‘Profit before income/expense from investments, finance income/expenses and income tax’

The staff also proposed to change the description of the subtotal ‘profit before income/expenses from investments, finance income/expense and income tax’ to ‘operating profit and share of profit or loss of integral associates and joint ventures’. This wason the basis that some users may find it confusing to see one subtotal described as operating profit and another one described as profit before income/expenses from investments, finance income/expense and income tax.

EBIT to describe ‘profit before finance income/expenses and income tax’

The staff proposed that the Board prohibit the use of the term ‘EBIT’ to describe ‘profit before finance income/expense and income tax’. This is on the basis that ‘earnings’ is not generally used in IFRS and ‘earnings before interest and tax’ does not faithfully represent the Board’s definition of items excluded form ‘profit before finance income/expense and income tax’. The staff proposed to clarify that EBIT can be used to describe a management performance measure (MPM) when the label faithfully represents the measure.

‘Profit before finance income/expenses and income tax’

The staff proposed that a different description should be used for the ‘profit before finance income/expense and income tax’ as the description does not represent items excluded. The staff discussed two approaches being a direct approach (describing what the subtotal included) and a residual approach (describing what the subtotal excluded).

Staff recommendations

In summary, the staff recommended that:

• a. ‘Business profit from consolidated entities’ should be described as ‘operating profit or loss’
• b. ‘Profit before income/expenses from investments, finance income/expense and income tax’ should be described as ‘operating profit or loss and share of profit or loss of integral associates and joint ventures’
• c. ‘Profit before finance income/expense and income tax’ should be described as ‘profit or loss before financing and income tax’
• d. Entities should be prohibited from using the term ‘EBIT’ to describe the subtotal ‘profit or loss before financing and income tax’

Board discussion

Operating profit and ‘Profit before income/expense from investments, finance income/expenses and income tax’

The majority of Board members supported the staff’s proposal to use the term ‘operating profit’ to describe the subtotal ‘business profit from consolidated entities’ but had ancillary comments. These included the following:

• Numerous Board members supported undertaking further analysis to understand the consequences of making the proposed change and potential consequences if the market has different views of an operating profit metric to that of the Board.
• One Board member thought it was better to have a clear description of items excluded rather than having a positive description.
• It was discussed that there was an argument to have operating profit after the share of profit or loss from integral associates or joint ventures.
• In response to the aforementioned concern, it was discussed that operating profit would be derived from items that are controlled, however associates and joint ventures are not controlled.
• There was some concern around how entities use associates in their business activities, in particular when associates were classified as ‘integral’. The staff’s research indicated that 27% of entities already drew out profit from integral or non-integral associates or joint ventures and therefore the staff’s proposal was to exclude share of profit or loss of associates and joint ventures from operating profit.

One Board member was concerned about the change of the use of operating profit where companies had used this term in the past and would now need to change their financial statements.

EBIT to describe ‘profit before finance income/expenses and income tax’

The staff proposed to prohibit entities from using the term EBIT to describe the subtotal ‘profit or loss before finance income/expenses and income tax’. In response, two Board members agreed with staff analysis but thought the use of the term EBIT was only appropriate for a subtotal that has no interest expense/income. Therefore, the Board members’ suggestion was to steer away from the use of the word ‘prohibit’. Another Board member proposed that labels should be in place. The staff disagreed with the approach of having mandated labels but indicated that any labelling should be a faithful representation of the measures being described. The Board discussed that where there was a management performance measure (MPM), there was still a requirement for the MPM to faithfully represent the measure.

Three Board members disagreed with the staff recommendation of using a residual approach and preferred the direct approach to describe what the subtotal included.  Other Board members preferred the residual approach on the basis this was more intuitive for the market.

Board decisions

Thirteen Board members voted in favour of using the term ‘operating profit’ to describe one of the proposed subtotals in the statement(s) of financial performance.

Ten Board members voted in favour of describing the ‘business profit from consolidated entities’ subtotal as operating profit.

Eleven Board members voted in favour of describing the ‘profit before income/expenses from investments, finance income/expense and income tax’ subtotal as ‘operating profit and share of profit or loss of integral associates and joint ventures’.

Thirteen Board members agreed that entities should be prohibited from using the term ‘EBIT’ to describe the subtotal ‘profit or loss before finance income/expense and income tax’.

There was no board vote on the staff question of whether an EBIT label can only be used to describe a measure that has been calculated a profit or loss plus all interest income/expense and income tax income/expense.

Nine Board members voted in favour of describing the subtotal of ‘profit before finance income/expense and income tax’ as ‘profit or loss before financing and income tax’.