Non-GAAP reporting: everything has its place

The reporting season for those companies with December year-ends is in full swing − undoubtedly many of you will be putting finishing touches to the layout of this year’s annual report. In the current economic environment, clarity of communication is vital.

Investors want to understand the market context in which a business operates, its strategy and how this links to key business activities, risks and performance indicators. They also want to understand how growth is to be achieved and how this growth will be managed and funded. In terms of financial performance, they want to understand the underlying operational performance, separate from the impact of market changes and one-off events that often mask the real trend. A clear explanation of these components of business activity demands financial, non-financial and narrative information to be presented in a joined up way.

The credit crunch has emphasised the importance of broader aspects of reporting that the financial statements alone can never address. Particularly critical issues are aspects of governance, explanations of the business model and the key risks and relationships to which it is exposed, and the impact of remuneration on culture and behaviours.

All these ‘non-GAAP’ aspects of reporting typically comprise half of the volume of annual reports, but the quality, organisation, consistency and value of what is reported is variable. While the introduction of rigid standards to this element of reporting is not the answer, management should consider what information has most value and how critical elements of information should be aligned.

IFRSs mandate an ever-growing suite of disclosures for the financial statements. It is worth noting that, at its November meeting, the IASB’s Standards Advisory Council discussed the FASB’s disclosure framework project in order to consider whether the IASB should undertake a similar project after 2011 (I may return to this important subject in a future posting). But this is only part of the story. There is a secondary question of what information belongs in the financial statements and what belongs in an accompanying narrative section of the annual report.

The IASB’s discussion paper on management commentary included proposals for a framework to guide the Board in determining whether information should be included in management commentary or in the financial statements. These ‘placement principles’ suggested that information should be disclosed:

• in management commentary if it provides an investor with information that puts the financial statements into the context of the entity and its operating environment; and

• in the notes if it is essential to an understanding of the primary financial statements and its elements (whether recognised in the financial statements or not).

However, the exposure draft issued last June doesn’t pursue this. The IASB believes that Phase E of its conceptual framework project (which is to deal with the boundaries of financial reporting, presentation and disclosure) is the appropriate point at which to resolve questions about the placement of information in annual reports. Until this phase is complete (and work has not yet started), the IASB acknowledges that there will be some overlap between the type of information that is disclosed in the notes to the financial statements and that which is disclosed in management commentary. This of course adds to the challenge for users in searching out the information they require and for preparers in creating clarity in layout and presentation of content.

In the future we may see more clarity around what sort of information should be disclosed and where it should be placed in an annual report. But this presumes that the annual report is and will remain a printed document. Many commentators have observed that annual reports seem to be getting longer and more difficult to interrogate. Perhaps electronic publication and filing, making use of XBRL tagging, search tools and electronic web-based links to drill down into the annual report could be the answer. Again, this is a significant subject to which I may return in the future.

There is a lot that can be done under the current reporting framework in order to maximise the usefulness of annual reports. My colleague David Phillips’ Corporate Reporting blog is the place to go for that subject. But should this be on the IASB’s agenda? Is there merit in a comprehensive presentation and disclosure project, dealing not only with what should be disclosed but also where it should be located, or can we wait until the conceptual framework project finally gets around to Phase E?

As always, I am interested to hear your views, either by commenting here or by email.

Comments

[Paul Wilkinson]

I wonder if the IASB's XBRL team might work with http://www.worldici.com/ to develop a simple application that makes it easy for companies to prepare commentary and notes and makes it easy for investors to find the information they want. The first rule of data management is to report each fact once and only once. The first rule of disclosure is to ensure that actual and potential investors and creditors have easy access to all material information. Since investors and creditors have different views about what facts might be material, tagging both the notes and the commentary would seem to be the most efficient way to make sure investors don't miss particular facts in one or the other location. It seems to me that a combined IASB/WICI business taxonomy, or interoperable taxonomies, could be powerful tools for capital formation in both private and public markets. Perhaps others have thoughts, including whether it makes more sense to start with a free or inexpensive tool for SMEs vs. larger companies.