Auditors, Investors Debate Formalizing Company Earnings Metrics

Businesses including Bank of America Corp. and Big Four audit firms told the US accounting standards board to hold off on standardizing metrics like free cash flow and adjusted net income that are ubiquitous in corporate earnings reports.

The Financial Accounting Standards Board received mixed feedback on its preliminary inquiry into Wall Street data points that are derived from financial statements or underlying accounting records but don’t fall under generally accepted accounting principles, or GAAP.

Standardized definitions would increase corporate reporting comparability, some groups representing investors and accountants argued in comment letters due last week. However, firms like PricewaterhouseCoopers LLP and Ernst & Young LLP pointed to the measures’ varied use by industry and existing financial reporting guidance as potential sticking points.

“All of that makes it pretty challenging, candidly, for the FASB to sort of focus its efforts in this area,” said Kimber Bascom, KPMG US deputy chief accountant and accounting standards leader.

FASB is looking at “financial key performance indicators,” or financial KPIs. There’s no standard method to calculate these metrics, which can make it difficult to compare across companies.

The board asked the public in November whether it should standardize financial KPIs and whether disclosure related to the metrics should be mandatory for companies, if FASB launches a formal project.

The proportion of S&P 500 companies reporting a financial KPI rose to 85% in 2022 from 65% in 2013, according to the invitation to comment. The metrics include measures such as earnings before interest, taxes, depreciation, and amortization, or EBITDA.

The Securities and Exchange Commission has scrutinized accounting adjustments that paint overly rosy pictures of corporate performance.

Tesla Inc.'s worst quarter in years was recently aided by the adjusted earnings it touted, which was more than double its official net income.

Cost-Benefit Analysis

Investment professionals pushed FASB to take on a project related to financial KPIs, citing concerns about a lack of comparability and opaque financial adjustments.

“Not only do these problems affect investment decision-making, but they also impact governance decisions because most public entities use non-GAAP financial measures in determining executive compensation,” the CFA Institute said in its comment letter.

The group recommended FASB define and require disclosure of the most widely used metrics on an industry-specific basis. Like other groups, they pointed to free cash flow and EBITDA as commonly utilized measures.

Investment analysts also calculate financial KPIs to remove anomalies, such as one-off charges, from companies’ portfolios.

Standardized definitions of common metrics would give them another “check” as they confirm the accuracy of their adjusted numbers, said Ron Graziano, director of accounting research at LSV Asset Management.

“The more inputs we have to test the validity of our numbers, the better,” Graziano said.

An Institute of Management Accountants group broadly supported FASB prioritizing a financial KPIs project, saying it demonstrates the board’s commitment to ensuring financial reporting remains relevant given the metrics’ common use.

Still, others emphasized that there’s already a sufficient reporting framework.

SEC regulations define which metrics are considered non-GAAP financial measures and the agency provides rules related to their disclosure outside of financial statements, EY said in its letter.

Companies must also reconcile their non-GAAP metrics to the most directly comparable GAAP measure, which “creates transparency without the need to standardize KPIs,” according to an International Swaps and Derivatives Association group’s letter.

Additionally, FASB may lack resources to “perform the ongoing surveillance necessary to continually monitor and maintain an up-to-date list of financial KPIs,” the American Bankers Association wrote.

Businesses should be “individually responsible” for compiling and disclosing the metrics relevant to them, Bank of America said in its letter. If a standard set of metrics were required, this could lead company management to create “Financial KPIs to the Financial KPIs,” the letter read.

Industry Variation

Developing uniform definitions for financial KPIs that are industry- or company-specific may be a “cumbersome task,” a Texas Society of Certified Public Accountants group told FASB.

Financial statement users, such as investors, have indicated standardized metrics would need to be industry-specific to be “truly valuable,” PwC’s letter said. While annual recurring revenue is a key metric in the technology and software-as-a-service sectors, for example, the real estate industry prioritizes funds from operations, according to PwC.

The costs of defining certain metrics, therefore, may not justify the benefits, KPMG LLP said in its letter. Instead, the firm recommended the board consider defining GAAP elements that are commonly funneled into financial KPIs.

Disclosures

Some accountants questioned the usefulness and feasibility of instituting additional disclosures.

FASB floated requiring or permitting companies to disclose in financial statements certain newly defined metrics.

Creating prescriptive guidance on metrics and requiring details “would only unnecessarily add to the volume of disclosures,” a Pennsylvania Institute of CPAs group said in its letter.

FASB also discussed the alternative possibility of allowing or requiring companies to disclose a financial KPI in their financial statements if they share that measure elsewhere.

It may be challenging for auditors to design procedures to assess whether a company’s way of defining financial KPIs is appropriate and consistent without having a clear GAAP definition, Deloitte & Touche LLP wrote.

Some organizations, including the Institute of Management Accountants group, favored optional disclosure, as opposed to any requirements.

Wait-and-See

Ultimately, some suggested the standard-setter wait to pursue a project until it’s clear how recent changes to the accounting rulebook are faring.

EY, Citigroup, and Deloitte pointed to FASB’s projects requiring companies to provide more details on the amounts spent on expenses such as staff salaries, as well as expenses impacting performance on a business-line level.

Because investors haven’t had the opportunity to evaluate the benefits of additional disaggregated expense information yet, “it could be premature to undertake a project on KPIs at this time,” Deloitte said.

FASB declined to comment on the letters it received. The board will discuss the feedback at a future meeting.