Alternative performance measures (APMs) are often the subject of regulator scrutiny within finance and accounting – just last month the Financial Reporting Council (FRC) published a ‘Lab Report’ focusing on their use. But what exactly do they mean?
In this blog, we’ll look at how and why companies use APMs, and consider some of the issues they have faced. For a more detailed review, see our full report from Company Reporting here:
What is an APM?
An APM is a measure of performance or financial position that is not defined in accounting standards or law, although generally most APMs are loosely based on a statutory measure. The European Securities and Markets Authority (ESMA) provided some guidance in 2015 for companies on how best to use APMs.
One example is earnings per share (EPS), a statutory measure of a company’s performance (for IFRS reporters, the requirements are set out in IAS 33 Earnings per Share). Broadly speaking, EPS is defined as the profit for the year, after payments are made to preferential shareholders, divided by the number of shares issued.
However, this measure will only tell part of the story. There may have been a restructure in the year, or a significant currency fluctuation, or a restatement due to accounting rule changes. Any of these changes could make directors think the statutory measure distorts the true picture. To adjust for this, they might add back the costs of the restructure, for example, to the profit figure. That will increase the EPS ratio, with the aim of providing the ‘underlying’ performance of the business. This would be an APM.
What do APMs do to a company’s financial position?
Our recent analysis revealed that 95% of the 20 companies reviewed used APMs that increased profit levels compared to the statutory measure. While there isn’t necessarily anything sinister about that, if companies are presenting their APMs with greater prominence than the statutory measures – something both the ESMA and FRC advise against – they could potentially mislead the accounts’ users.
For example, of the companies analysed that presented EPS in their financial highlights section at the front of their annual report, 31% presented only the adjusted figure; although the statutory figure was presented much later in the report.
APMs may also be used as key performance indicators (KPIs) and by remuneration committees to set the salary package of the directors. Our report found that 95% of companies used at least one APM as a KPI, and 85% of remuneration committees stated they used an APM too.
Why do companies use APMs?
It’s a fair question to ask, if these APMS aren’t defined in statute. As we noted earlier, some may feel that short-term fluctuations will distort the true picture of the business’ progress. By clearly defining an APM, directors can assess how the company is performing and make judgments on its operations.
Similarly, remuneration committees will judge directors on their performance, based on the same metrics, for the same reasons. This is especially important, as currently the pay and perks of senior directors are under a good deal of scrutiny. Annual reports should therefore clearly define and reconcile their APMs, especially the ones that are KPIs and used in remuneration assessments. We found that 90% within our sample included a reconciliation in their annual report.
The challenge for users is that the information they see upfront in an annual report is not always clearly explained, defined or reconciled. This means it can be more difficult to make informed decisions based on it – and it makes it harder to compare different companies too.
The advantage of the statutory information is that it should be much more comparable, although there will of course be industry and situational differences. For example, a manufacturing company may be happy with an operating profit margin of say 15%, whereas a financial services company would be happier with 85%. ESMA foresaw this issue, and advised companies to provide reconciliations for all APMs to their nearest statutory measure.
From the analysis, we identified that there’s a high reliance on the use of APMs within the narrative reporting. Every one of the 20 companies we reviewed used APMs in the first 10 pages of their report, generally in a ‘Financial Highlights’ section.
So what’s the problem?
The biggest area of concern, when considering the ESMA guidance on presenting APMs consistently, is within the Chair and CEO reports. 70% referred to APMs, but only 21% of these referred to a comparative statutory figure.
It is easy to see why APMs are becoming an increasingly important aspect for the standard setters. Whilst there seems to be improvement within the area, there still remains some inconsistency in the reporting of APMs. At the very least, the rise of the use of APMs makes it increasingly challenging for readers of financial accounts to compare companies. Users of financial statements need to remain vigilant when looking at figures quoted in annual reports, and always read the small print.
The analysis discussed in this blog was carried out by our in-house team of experts. The results of the review are discussed in more detail in a Common Practice report available from companyreporting.com. In our analysis, we looked at the annual reports of 20 UK listed companies that have used APMs, identifying what they have reported, where they have reported it, and what they included or left out.