Part 5: Reporting alternative performance measures

Local government: Results of the 2010/11 audits.

Last year, we reported that we were uneasy with State-owned enterprises (SOEs) in the electricity sector disclosing alternative performance measures in their 2009/10 annual reports. In this Part, we report on the disclosures that entities associated with local authorities made. We:

Why we were uneasy

In our 2011 report to Parliament, Local government: Results of the 2009/10 audits, we noted that, in their annual reports, the electricity SOEs were disclosing an amount described as "underlying profit".

Underlying profit is an alternative performance measure to the profit figure determined using approved financial reporting standards and included in the financial statements. Sometimes different terms, such as "normalised profit", are used, but they are essentially the same type of measure. Underlying profit is not defined in financial reporting standards, but it typically excludes changes in the fair value of financial instruments and non-recurring transactions.

By disclosing their underlying profit, entities intend to provide information to users that can be used to assess ongoing financial performance, because it excludes certain items, such as changes in fair value and non-recurring transactions.

Usually, we encourage public entities to include information in their annual reports that is likely to be relevant to users. However, we were uneasy about the practice of disclosing underlying profit because:

  • there is no guidance about what "underlying profit" is, or how it is arrived at, so inconsistent practices are likely;
  • the underlying profit amount is often prominent in the annual report and could overshadow the financial information that was prepared in line with financial reporting standards; and
  • the underlying profit amount is not always clearly labelled as supplementary information that is additional to the information required by financial reporting standards.

Our expectations for reporting underlying profit

In early 2011, we carried out research into underlying profit disclosures and established how we expect local government entities to disclose underlying profit. Our research included looking at how regulators address the reporting of underlying profit. In particular, we looked at work carried out by the:

  • Securities Commission (which was disestablished and replaced by the Financial Markets Authority in May 2011);
  • Committee of European Securities Regulators; and,
  • Australian Securities and Investments Commission.

In March 2011, we gave our auditors guidance on what they should expect when entities disclose alternative performance measures such as underlying profit. We said that if entities in the local government sector disclose alternative performance measures in their annual reports, then we expect the disclosures to:

  • be understandable;
  • relate to information based on generally accepted accounting practice in New Zealand (NZ GAAP24), preferably by reconciling the amounts;
  • be neutral and not used to remove "bad news";
  • be consistently calculated over time;
  • be less prominent than information based on NZ GAAP; and
  • include comparative information.

We said that, for any alternative performance measure to be understandable, we expect the disclosures to contain enough contextual information for a reader to understand what the alternative performance measure is (that is, the principles supporting it) and why it has been included in the annual report.

In general, we expect the alternative performance measure to be disclosed outside the financial statements or in the notes to the financial statements, and for any commentary on the alternative performance measure to be balanced with commentary on information based on NZ GAAP.

Underlying profit disclosures in 2011

We chose to review the underlying profit disclosures made in the 2010/11 annual reports of electricity lines businesses, airport, and port companies. Underlying profit disclosures are usually reported by entities with a commercial focus, and electricity lines businesses and airport and port companies are the main entities in local government that have a commercial focus.

The purpose of our review was to gauge the level of reporting of underlying or normalised profit within the sector and assess how clear those disclosures were.

We did not identify any airport companies that were reporting underlying profit. A few electricity lines businesses and port companies reported underlying profit in their annual reports, using a range of reporting practices. Of the electricity lines businesses and port companies that reported underlying profit, some included it in their financial statements. Others included that information in commentary accompanying the financial statements. In our view, these electricity lines businesses and port companies were trying to provide readers with some insight into how the electricity lines businesses and port companies' performance should be judged.

These electricity lines businesses and port companies did a reasonably good job of disclosing how they calculated underlying profit and how that profit related to the information in the financial statements. However, in our view, their reporting could be clearer.

What next?

We will continue to work with electricity lines businesses, port companies, and our auditors, as appropriate, where we consider that improvements can be made to the disclosures about underlying profit (in keeping with the principles set out in paragraph 5.7).

We will watch the reporting of alternative performance measures (such as underlying profit) in the private sector, where the practice is more widespread. If needed, we will revise our expectations for for-profit entities in the public sector. We want to ensure that practice in the public sector is in line with practice in the private sector, given that public entities that make such disclosures have a commercial focus.

We will watch what is happening internationally, especially in Australia. We note that the Australian Securities and Investment Commission issued a regulatory guide (No. 230) in December 2011, entitled Disclosing non-IFRS financial information.

The Financial Markets Authority has said that it intends to seek input into a draft regulatory guide to disclosing alternative performance measures and other information prepared other than in keeping with approved financial reporting standards. We look forward to seeing the draft regulatory guide.

24: NZ GAAP includes applicable financial reporting standards issued by the New Zealand Accounting Standards Board, which is a sub-board of the External Reporting Board. NZ GAAP establishes requirements for preparing financial statements in New Zealand.

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