Senior accountants said the FASB should consider standardizing the definition of EBITDA, the acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization, which shows a measure of a company’s profitability.
The board should weigh developing a standard definition of EBITDA for U.S. GAAP as a starting point to drive consistency around those figures, according to March 7, 2023, Financial Accounting Standards Advisory Council (FASAC) discussions. “And if companies want to make adjustments to it that’s where you kind of get into the non-GAAP reconciliation,” Howard Guild, chief accounting officer at Schlumberger Limited, said. “Does it make sense to have a GAAP definition of these items?” are among questions some want the board to consider, he said. “Obviously, all companies are going to have adjustments to it in all likelihood but at least you have a starting point.”
EBITDA is a business metric that was developed in the 1970s which allows investors to project a company’s long-term profitability and cash flows. The figure is said to be one of the most valuable yardsticks that investors consider when a company is being bought or sold. EBITDA is not a metric recognized under U.S. Generally Accepted Accounting Principles (GAAP) but is one of the most popular non-GAAP earnings measures. Some analysts do not like EBITDA figures, because it can be used to paint a misleading picture of a business and its profitability.
Last year, FASB Chair Richard Jones added a project to the board’s research agenda to consider the interaction with standardizing key performance indicators (KPIs) within the current regulatory framework. A research project is a pre-step to determine whether a topic meets the bar to be added to the board’s rulemaking technical agenda. It would also help the board to gauge the scope of its work, including whether to address the definition of EBITDA. Views about standardizing KPIs typically vary.
In a FASAC session that was not open to the public some practitioners talked about if a standardized definition was developed for EBITDA, whether it should be mandatory or used as a starting point, FASB Vice Chair James Kroeker said. They leaned toward “we could define it, then if used, EBITDA would be done in the following ways – realizing the KPI might not be relevant for each type of industry or business model,” he said. “More of the discussion was around at which level of detail we need to define them. And then obviously the regulatory coordination.”
The topic comes with a plethora of issues the board would need to weigh, including providing companies with options, according to the discussions.
“So, what if you have a debt agreement that has a definition of EBITDA or a definition of free cash flow, but it wasn’t what maybe the FASB comes out with on the definition, so you might have a difference – can you use your contractual debt agreement and that definition?” Lara Long, vice president, chief accounting officer at AGCO Corp., said. “Or, if the FASB were to come up with a definition, can you have an option? – because they could be different,” she said.
The board would also have to consider how granular to be about EBITDA, and free cash flow, Long added. “Do you have to explain the definition of Amortization? the definition of Depreciation? and the definition of Interest?” she said. “We all agree that when some of us are using EBITDA we’re adjusting it, for these types of items, with Interest, with Depreciation and with Amortization and it’s not apples to apples particularly within our industries.”
The FASB wants the accounting profession to write in with suggestions about how to approach KPIs, Jones said. “One of the fundamental questions is, is this a ‘if you have a KPI we’d like you to use a standard definition as a starting point and disclose it’ or ‘everyone should be using the same KPI?’” he said. “Think about that. Is this more of a ‘if used’ or are there some KPIs that have risen to the level that they really should be part of the basic financials for everyone in an industry or elsewhere.”
This article originally appeared in the March 20, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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