The changes introduced by AASB 18 Presentation and Disclosure in Financial Statements are mainly aimed at improving the consistency and comparability of performance reporting by entities. In practical terms, this means the income statement is about to undergo a facelift.
Current accounting requirements in AASB 101 Presentation of Financial Statements are not overly prescriptive when it comes to the structure of the income statement. New guidance in AASB 18 will promote a more standardised approach to presentation of financial performance which will support more meaningful analysis and improve comparability across entities.
In previous segments of our AASB 18 guidance, we focused on the changes affecting the architecture of the income statement. While the introduction of new categories and mandatory subtotals have attracted most of the attention, a significant change sits outside of the primary statements altogether.
For the first time, AASB 18 introduces specific disclosure requirements related to management-defined performance measures, or MPMs.
These requirements are designed to shine a light on measures that management already use to explain financial performance, but which have historically existed outside the audited financial statements.
Definition of an MPM
An MPM is a subtotal of income and expenses that:
- Is used in public communications outside of the financial statements;
- Communicates management’s view of an aspect of the financial performance of the entity as a whole; and
- Is not a commonly used subtotal listed in AASB 18, or specifically required to be presented or disclosed by another accounting standard.
MPMs are not new measures created by AASB 18; rather, many entities already use such measures in some form because management believe they tell a more meaningful story than statutory profit alone. Common examples include:
- Underlying profit
- Adjusted operating profit
- Normalised earnings
- EBITDA
- Adjusted EBITDA.
Consider a business that incurs a large restructuring cost during the year. Management may believe that excluding the restructuring expense provides a better indication of the entity’s ongoing profitability. That adjusted profit measure may be useful, but AASB 18 now requires management to explain exactly what has been adjusted and why.
Not every performance measure is an MPM
One area that may cause confusion is determining what falls within the definition of an MPM and what does not.
Importantly, MPMs are limited to subtotals of income and expenses. On this basis, the following are not MPMs:
- A subtotal of only income or only expenses such as adjusted revenue.
- Assets, liabilities, equity or combinations of these elements (e.g., net debt).
- Financial ratios such as return on assets. However, a subtotal of income and expenses that is the numerator or denominator in a financial ratio is an MPM if the subtotal would meet the definition of an MPM were it not part of a ratio (e.g., the numerator in an adjusted gross profit margin).
- Measures of liquidity or cash flows such as free cash flows.
- Non-financial performance measures such as occupancy rates, or greenhouse gas emissions.
Furthermore, some commonly used subtotals specifically identified in AASB 18 are excluded from the MPM requirements. These include:
- Gross profit
- Profit before income tax
- Profit from continuing operations
- Operating profit before depreciation, amortisation and impairments (OPDAI).
AASB 18 also excludes subtotals that are similar to gross profit. Broadly, a subtotal is considered similar to gross profit when it presents the difference between a particular type of revenue and the expenses incurred directly in generating that revenue. While many people immediately associate gross profit with retailers and manufacturers, the same concept appears across a range of industries under different labels. Common examples include:
- Net interest income
- Net fee and commission income
- Insurance service result
- Net financial result (investment income less insurance finance income and expenses)
- Net rental income.
Since the above measures are specifically identified within AASB 18 as commonly understood subtotals, they are not treated as MPMs and therefore are not subject to the MPM disclosure requirements.
Public communications outside the financial statements
The trigger for whether a subtotal of income and expenses is an MPM is not whether it appears in the financial statements; the trigger is whether the measure is publicly communicated outside of the financial statements.
While AASB 18 does not define public communications, it does provide a non-exhaustive list of which public communications are considered to be included and excluded.
It is worth noting that AASB 18 does not provide any exemption from the MPM requirements for private entities. However, an MPM only exists when a performance measure is used in a public communication outside the financial statements. In practice, many private entities do not publicly communicate adjusted profit measures, EBITDA measures or other MPMs. Consequently, while the MPM requirements in AASB 18 apply equally to private and public entities, they may have little or no practical impact for many private entities.
Management’s view of financial performance
Not every subtotal of income and expenses used in a public communication will qualify as an MPM. To meet the definition, the measure must also communicate management’s view of an aspect of the entity’s financial performance as a whole.
This is typically the case when management uses a measure to explain, analyse or highlight performance in a way that supplements the subtotals required by Accounting Standards. Measures such as underlying profit, adjusted operating profit or adjusted EBITDA will often meet this criterion because they are commonly used to communicate management’s perspective on the financial performance of the business.
At first glance, determining whether a measure represents management’s view of performance may seem highly subjective. However, AASB 18 simplifies this assessment through a rebuttable presumption. Specifically, if a subtotal of income and expenses is included in a public communication outside the financial statements, the standard presumes that the measure communicates management’s view of an aspect of the entity’s financial performance.
In practical terms, this means entities will rarely be able to debate whether a publicly communicated performance measure is not management’s view of financial performance. The starting assumption is that it is. For example, if an entity regularly presents and discusses a measure such as underlying profit in investor presentations, earnings announcements or other public communications, it would generally be difficult to claim that the measure does not reflect management’s view of performance.
As a result, the more practical challenge for preparers may be identifying which subtotals of income and expenses are being used in public communications, rather than determining whether those measures represent management’s view. Once a subtotal appears in public communications, the rebuttable presumption means it will often fall within the scope of the MPM requirements unless there is clear evidence that the presumption should be rebutted.
Disclosure requirements for MPMs
With the introduction of AASB 18, the days of simply presenting an adjusted profit number with minimal explanation have come to an end.
Where an entity identifies it has one or more MPMs, AASB 18 requires specific disclosures to be presented together in a single note to the financial statements. The single note requirement means required information cannot be disclosed via cross-referencing to other notes in the financial statements. This is to avoid fragmentation of information and to improve transparency.
The information to be disclosed relating to MPMs is shown below.
MPMs must be described in a way that is understandable and does not mislead users. An entity cannot simply choose a label that paints a favourable picture of performance without ensuring the label accurately reflects how the measure has been calculated.
For example, an entity could only use a description such as operating profit before non-recurring expenses if the subtotal excludes all items that the entity considers to be non-recurring. The entity would also need to explain how it defines a ‘non-recurring’ expense. Without a clear definition and consistent application, users may struggle to understand what the measure is intended to represent.
Additionally, AASB 18 requires that an entity provides specific information when it:
- Changes how it calculates any of its MPMs
- Adds a new MPM
- Ceases using a previously disclosed MPM, or
- Changes how it determines the income tax effects in the reconciliation.
Such information includes an explanation and rationale for the change and restated comparative information, if practicable.
Why MPMs matter
Investors, lenders, analysts and boards frequently rely on performance measures that differ from statutory profit. AASB 18 acknowledges this reality rather than attempting to eliminate it by bringing those measures into the financial statements and subjecting them to greater scrutiny.
For preparers, the challenge is not necessarily producing the disclosures. The greater challenge may be identifying which measures are being used across the organisation and ensuring they are applied consistently from year to year.
For users, however, the benefits are clear. Measures that were previously presented with varying levels of transparency will now be accompanied by explanations, reconciliations and audit scrutiny. As a result, users should be better equipped to understand not only what management is reporting, but why management believes the measure is important.
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This article is part of our series exploring the key changes introduced by AASB 18 and what they mean for entities.
Click the links below to explore the rest of the series:
Part 1: An overview of the new disclosure standard
Part 2: Categorising income and expenses
Part 3: New subtotals and operating expense analysis requirements