The Financial Accounting Standards Board (FASB) is taking aim at the confusing array of non-GAAP financial measures that companies use to report their performance, seeking to bring order to a system that has long frustrated investors and analysts.
In a move to improve transparency and comparability across companies, the board on November 14, 2024, issued an Invitation-to-Comment (ITC) No. 2024-ITC100, Financial Key Performance Indicators for Business Entities, as part of research efforts to standardize certain non-GAAP financial metrics commonly reported in earnings releases. The board is seeking input on how to define and report financial key performance indicators, or KPIs, which are based on financial results but aren’t reflected in official Generally Accepted Accounting Principles (GAAP) financial statements.
The lack of consistency in non-GAAP measures has long been a thorn in the side of investors, who struggle to compare performance across different companies. Unlike GAAP measures, which are governed by strict accounting rules, non-GAAP measures can be defined and reported differently by each company, making it difficult for investors to get a clear picture of a company’s financial health.
The FASB’s ITC is a significant step towards addressing this issue and could have far-reaching implications for the way companies report their financial performance. By standardizing non-GAAP financial metrics, companies would be required to provide more consistent and comparable information, making it easier for investors to make informed decisions.
The ITC, which is open for feedback until April 30, 2025, does not express any preliminary views from the Board, but rather seeks input from stakeholders on the project’s priority, the types of KPIs to be defined, and the preferred approach for standard-setting
Research Findings and Rationale
The ITC comes following years of FASB staff research on the prevalence of companies reporting financial KPIs, according to the ITC. The research found a significant increase in the proportion of SEC filers reporting financial KPIs from 36% to 53% between 2013 and 2022. The upward trend in financial KPI reporting was observed across most industry sectors.
The research also examined a sample of public companies that report Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), finding a lack of standardization in the definition of EBITDA’s components, making it challenging to compare EBITDA across companies.
Potential Approaches to Addressing Financial KPIs
The ITC floats two potential approaches toward addressing financial KPIs:
- Approach 1: Standardizing Financial KPIs: This approach would involve defining and disclosing standardized financial KPIs in a company’s GAAP financial statements. The key decision to be made here would be which financial KPIs to define, the ITC says. One option would be to focus on commonly used KPIs, such as EBITDA and Free Cash Flow (FCF), which are widely used by investors. Another option would be to define industry-specific KPIs, such as Funds from Operations (FFO) in the real estate industry or Return on Invested Capital (ROIC) in the retail industry.
- Approach 2: Disclosing Management’s Preferred KPIs: This approach would involve requiring or permitting companies to disclose financial KPIs presented by management outside of the financial statements. This approach is similar to the presentation requirements for management performance measures (MPMs) under International Financial Reporting Standard (IFRS) 18, Presentation and Disclosure in Financial Statements. The key decision here would be to establish criteria for determining which financial KPIs should be disclosed within GAAP financial statements, the ITC says. One option is to require disclosure of all financial KPIs presented by management, regardless of the venue or format. Another suggested option would be to focus on KPIs presented in earnings announcements or other regulatory filings, providing investors and analysts with a clear and consistent view of a company’s performance.
Incremental Disclosures
Under any approach to set standards related to financial KPIs, the accompanying disclosures are also important to consider, according to the ITC. Possible suggested disclosures include breaking down the KPI into its individual components, identifying which line items on the financial statement they relate to, and providing the KPI for previous periods.
For financial KPIs that are not clearly defined, possible disclosures include defining what the KPI means, explaining why management thinks it’s important to report, providing a reconciliation to the most comparable financial reporting requirement, and identifying which line items on the financial statement each reconciling item relates to.
This article originally appeared in the November 18, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
Take your tax and accounting research to the next level with Checkpoint Edge and CoCounsel. Get instant access to AI-assisted research, expert-approved answers, and cutting-edge tools like Advisory Maps and State Charts. Try it today and transform the way you work! Subscribe now and discover a smarter way to find answers.
