Three quarters of non-financial FTSE 100 companies take a subjective and inconsistent view of reporting exceptional items which can give a misleading view of their performance, according to analysis by Standard & Poor's Ratings Services
The ratings agency says as a result a company's profitability can appear higher than is the case when reporting under International Financial Reporting Standards (IFRS).
Standard & Poor’s (S&P) survey of a sample of 82 non-financial FTSE 100 companies found that over the last four years adjusted operating profit exceeded the unadjusted operating profit in 73% of cases. Some 43 companies presented adjusted operating profit that was greater than the IFRS operating profit in every one of the four years analysed.
S&P's accounting specialist Sam Holland said: ‘Companies reporting under IFRS frequently separate exceptional items they believe are non-operating or nonrecurring to produce adjusted or underlying earnings information that purports to better reflect business performance. However, in our view, taking underlying earnings without taking into account the nature of the exceptional items that a company has excluded can sometimes give a misleading picture of its earnings and future performance.’
The review found that 89% of the companies had presented some form of adjusted profit measure in the most recent period, whether on the face of the income statement, in the notes to the financial statements, or in management's discussion and analysis of the annual report.
The analysis also identified the ‘systematic exclusion’ of certain cost items from many companies' adjusted performance measures, with the most common being impairments and the amortisation of certain intangible assets. The ratings agency said so-called ‘exceptional restructuring costs’ can appear year after year for certain companies, largely because of the need to update operations to remain competitive.
However, 21 companies in the sample had excluded restructuring charges from their measure of underlying earnings (or other adjusted profit measures), despite having restructuring charges in each of the last four years of financial reporting.
S&P says that more prescriptive and specific guidance is required for auditors to assist them as they scrutinise underlying earnings and exceptional items. Where such financial metrics are disclosed, the ratings agency says it would prefer them to be incorporated into the financial statements, to increase the level of audit assurance.
