Behind the profits facade

International financial reporting standards (IFRS) have copped some sharp criticism but none has been sharper than ANZ chief executive Mike Smith's claim that mark-to-market accounting is "gobbledygook”.

What Smith was complaining about was the requirement for ANZ to report a statutory profit that reflected changes in the value of its credit derivatives portfolio.

Fortunately moves are afoot to help shareholders, analysts and the media to cut through the compulsory accounting adjustments that cloud a clear view of a company's underlying performance.

The release today of new profit reporting principles by the Financial Services Institute of Australia (Finsia) and the Australian Institute of Company Directors (AICD) provide the first template for presenting 'underlying profit' in a consistent manner.

Australian publicly listed companies must report a statutory profit based on IFRS. This can include fair value adjustments for derivatives, one off provisions, impairment losses, revaluation of liabilities and significant transactions.

Since the introduction of IFRS, companies have come up with different ways of expressing the earnings that directors believe are stable and properly reflect the underlying financial performance.

But the Australian Securities and Investment Commission has been concerned that many companies have released financial reports not in accordance with the statutory accounting standards.

ASIC has been concerned about the lack of consistency in the reporting of normalised or underlying profits. Some companies have used the underlying profit as a cover for cherry-picking items that put the best light on their results. Others have disclosed fair value adjustments or impairments without revealing the pre-tax effect.

The International Accounting Standards Board has recognised the need to prepare a new reconciliation schedule to provide greater clarity about underlying financial performance.

The IASB reform process is very long-winded, so industry-based attempts to gain clarity in profit reporting should be welcomed.

Finsia and the AICD have not rushed headlong into setting out new profit reporting principles. The paper released today marks the completion of two years work.

Scott Marshall, chairman of Finsia's financial markets advisory group and head of industrial research at Shaw Stockbroking, says the new principles have benefited from extensive market feedback.

He says analysts and the management of companies routinely adjust their profits for various non-cash and significant items in an effort to make it easier to determine next year's profits.

Marshall says in recent years profit adjustments have not been consistent between companies, some companies have made adjustments but not provided comparable figures for previous years and some companies have amended their adjusted profits without disclosure of the changes.

He says the media plays an important role in communicating profit results and for this reason it would be useful if wire services and other media more rigorously reported underlying profits as well as statutory profits.

The AICD/Finsia principles for underlying profit recommends reconciling the underlying profit figure with the statutory profit and presenting the adjustments in tabular form. An illustrative example of an underlying profit reconciliation table is provided in today's guidance note.

It is recommended that underlying profit be explained in the accompanying management discussion and analysis.

Also, it recommends that both positive and negative adjustments to the statutory profit be disclosed. Underlying profit figures should not be seen as an opportunity for window dressing results.

Smith will still likely complain about the accounting standards being "absurd” but at least the industry is taking action to assist users of financial statements to understand underlying financial performance.