Global accounting standard setters are turning their attention to the inconsistent and unregulated financial information that investors rely upon but which auditors ignore, a major change in direction for the international authorities after a decade mending problems highlighted by the financial crisis.
“We’ll bring non-GAAP measures into the audited financial statements,” Hans Hoogervorst, chairman of the International Accounting Standards Board, said in a December interview about his 2020 agenda. He was referring to the commonly used management-performance measures that fall outside of the profession’s formal rules, the Generally Accepted Accounting Principles.
As chairman of the London-based IASB since 2011, Hoogervorst presides over a group of global experts who are charged with setting standards for auditing, as well as the preparation and use of financial reports. The new agenda reflects the concerns of the accounting profession’s guardian angels that the proliferation of unofficial metrics may mislead investors about companies’ true health.
As a top priority, for example, Hoogervorst points to the measure known as operating profit, which is supposedly a statement of income from normal operations, but one for which there is no agreed definition. That ambiguity allowed Carillion Plc to declare a healthy profit shortly before its 2018 collapse, with a subsequent parliamentary report slamming its use of aggressive accounting policies to effectively overstate its results.
“Different companies include different things in operating profit,” Hoogervorst said. “There needs to be a consistent methodology for calculating it.”
Other companies have created favorable measures to describe their performance, with big variations from their audited results. WeWork Companies Inc. invented a metric called “community-adjusted EBITDA"—earnings before interest, taxes, depreciation and amortization—to strip one-off costs from its results. It declared a community-adjusted EBITDA of $233 million for 2017, while its audited financial reports that year showed a net loss of $933 million.
There are too many non-GAAP measures in use for the IASB to set formal metrics to calculate them all, as it is doing for operating profit, Hoogervorst said, adding: “This is in response to investors’ demands.”
The IASB, known for its conservative approach, has critics who say it focuses too narrowly on technical details at the expense of more robust principles and that it is making up now for past mistakes.
“Through the 2000s, the IASB was on the rampage, undoing accounting’s roots in verifiability and prudence.” Karthik Ramanna, professor of business and public policy at Oxford University’s Blavatnik School of Government said in a Jan. 16 email. “We’ve seen less such cowboy zeal in recent years.”
Ramanna has been a long-standing critic of the IASB’s continued refusal to make prudence—or emphasizing risks over opportunities—a core principle of international accounting standards. That approach has contributed to problems in areas like debt-accounting in the financial crisis, he said.
Accounting for the Environment
Hoogervorst said the IASB would also address largely unregulated areas such as sustainability reporting—the growing movement to have companies address how they account for environmental concerns like climate change, as well as their social and governance goals.
The IASB has drawn criticism for its go-slowly approach to sustainability reporting, but Hoogervorst it off, saying, “We don’t have the expertise.”
The IASB will publish proposals in the second half of 2020 for revised management commentary guidelines, he said, including stricter guidance over how to deal with sustainability reporting. But companies don’t have to follow these guidelines.
“The IASB has a central role to play over tightening sustainability reporting,” Jimmy Greer, head of sustainability at the Association of Chartered Certified Accountants said in a Jan. 17 phone call. He noted that corporate reporting was inconsistent and used a plethora of different measurements for things like pollution.
Changing management commentary guidelines is not enough, Greer argued, rather, the IASB should take an approach similar to the one it is adopting for non-GAAP reporting: Set a way to calculate some core elements, and provide investors with a detailed note to the accounts to explain the other metrics used.
Hoogervorst and the board also want to address the definition of EBITDA, which is not covered by formal accounting standards.
Moving On from the Financial Crisis
The focus on non-GAAP measures represents a shift in direction for the IASB and Hoogervorst, 63, who has concentrated on fixing the weaknesses in accounting standards revealed by the financial crisis since he took charge in 2011. Hoogervorst, whose second and final term in office ends this year, can now begin to think about his legacy for a period marked with turmoil.
The former Dutch finance minister said changes to bad-debt accounting introduced last year marked a crucial response to the crisis. The old rules allowed banks to avoid recognizing looming debt problems even when they were becoming obvious. But changes to IFRS 9 Financial Instruments he helped to steward mean banks will have to flag all expected loan losses, rather than waiting until a debtor actually defaults, giving regulators and investors more warning of looming problems.
Hoogervorst said that it was not the IASB’s job to catch such warning signs, certainly before banks had concrete reasons to say more debts might default.
The IASB still prefers a neutral approach to accounting, rather than one that emphasized the downside, Hoogervorst said, as he sought to distinguish the job of the rulemakers from that of of the regulators.
“It is not accounting standards’ job to look at economic questions,” Hoogervorst said when asked whether IFRS 9 should be flagging rising global debt levels.