Adjusted earnings - a useful measure of performance?

09 March 2015

Guest blogger: Dave Walters, follow him on twitter

The blogger’s views are his own; please share your thoughts, comments and reactions. Comments are moderated before being posted. 

It is human nature to want to present the best possible picture of yourself or those things that you are responsible for. A glance at my annual self-assessment of performance over the years confirms that.  There’s a clear tendency to accentuate the positive and to argue away the bad stuff as ‘one off’ – so that my adjusted performance was, in fact, absolutely without blemish! 

It happens with children too; “Dad, if we ignore the really difficult question, you know, the one that was so unfair, my adjusted mark would have been an A.”

“Your actual mark was a C.”

“Ah yes, but you’re always talking about underlying results, so why can’t I?  Why is there one rule for accountants and another for the rest of us?” 

Good point.

IAS 1 paragraph 85 tells us that “An entity shall present additional line items, headings and subtotals in the statements presenting profit and loss and other comprehensive income when such presentation is relevant to an understanding of the entity’s financial performance.” There are some who are now saying that, in the history of accounting standards, never has one paragraph been used by so many to aid the understanding of so few. This paragraph has been widely used to justify presentation of underlying, adjusted and pre-exceptional measures of performance on the face of the income statement. It is also a particular feature of these measures that:

  • They are company specific;
  • They tend to pull out more debits than credits;
  • At best, they shine a light on underlying performance, at worst, they obscure performance whilst simultaneously shining an unflattering light management; and
  • They take up far too much time on debates about which side of the line (‘underlying’ or not) some pretty immaterial items lie.

There is an accounting standard out there that requires management to talk about the performance of the business through the eyes of management – that is IFRS 8, the segments standard. Analysing performance through the eyes of management by segment is a rich source of information for analysts, investors and regulators. Carving out an adjusted measure in the income statement, to me, is less useful. There’s no standard that drives consistency in what is pulled out or indeed, how it is presented. The information we are often left with is a management accounts on the face of a primary statement. Arguably, investors shouldn’t read into it much more than that. 

Personally, I’m getting rather tired of the endless debates on this topic and regulators are getting increasingly fed up too. In both Europe and the UK, securities regulators now have this as an area of focus and we are seeing more questions to companies; especially where items have been treated inconsistently (exceptional charges should be reversed as exceptional income) and where items appear not to be one off or don’t even appear material. I think the probability of a regulator saying, “enough is enough” and banning adjusted measures of performance on the face of the income statement is rising. And for me, that day can’t come quickly enough. I’d note my view on this has totally changed over the last few years, as the amount of effort that goes into ‘the underlying number’ is inconsistent with the amount of information that it conveys. Fundamentally, I don’t think investors can get what they want from a single ‘profit’ number whether adjusted or not; a better understanding comes from a deeper dive into analysis, preferably by segment, through the eyes of management. In reading this deeper analysis, the reader should continually ask the question: does managements’ analysis (usually based around underlying performance measures) and the consequential differences between the management measure and GAAP measure, appear sensible?  Do the differences, for example, arising from ‘exceptional charges’ or amortisation, or foreign currency volatility or whatever, actually make sense to exclude from the information that management are using to make their decisions? If the adjustments do make sense, then it tells me something about performance. If they do not, it tells me something about management. 

Meanwhile, my mind is turning to year end appraisals. I think I shall claim an underlying 15 blogs (well I’ve had about that quantity of ideas even though only 4 made it to print) and an adjusted average of 1000 views per blog (adjusting for the one that came out just before Christmas when everyone was too busy enjoying themselves to read my whimsical thoughts on how Santa Claus might apply the new revenue standard). That should turn my actual performance from a ‘C’ to ‘A’ (as adjusted)! Just don’t tell my boss – perhaps I should discourage him from reading it and accept 999 views for this one. 

What do you think about adjusted performance? Is this is a good concept for financial reporting or should it be saved for self-assessment?  


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