Most public companies use various performance measures to communicate to investors what management regards as the ‘true’ performance of the business. These measures often aren’t taken directly from the financial statements but include adjustments to amounts reported under IFRS. This has led to concerns about inconsistency and a lack of transparency, attracting scrutiny from investors and regulators, including the UK’s FRC and the EU’s ESMA.
Before IFRS 18, these performance measures were often referred to as alternative performance measures (APMs) or non-GAAP measures. However, IFRS 18 introduced a new term for some of them – management-defined performance measures (MPMs) – and specified disclosures that entities must provide in their IFRS financial statements.
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Definition
An MPM is a subtotal of income and expenses that (IFRS 18.117):
- an entity uses in public communications outside its financial statements;
- an entity uses to communicate management’s view of an aspect of the financial performance of the entity as a whole; and
- is not listed in IFRS 18.118 and is not specifically required to be presented or disclosed by IFRS.
Specific exclusions
IFRS 18.118 specifies that the following subtotals are not MPMs:
- gross profit or loss, meaning revenue less cost of sales, and similar subtotals such as net interest income or the insurance service result (see IFRS 18.B123);
- operating profit or loss before depreciation, amortisation and IAS 36 impairments (aka. EBITDA – see below);
- operating profit or loss and income and expenses from investments accounted for using the equity method;
- for an entity that applies IFRS 18.73, a subtotal comprising operating profit or loss and all income and expenses classified in the investing category;
- profit or loss before income taxes; and
- profit or loss from continuing operations.
These subtotals aren’t specifically required to be presented by IFRS. However, the IASB considered them to be commonly used in financial statements and well understood by users. In the IASB’s view, requiring MPM disclosures for these measures wouldn’t provide useful information because their purpose and relationship to totals or subtotals specified by IFRS are already clear or readily apparent from their presentation in the statement of profit or loss.
The IASB also considered whether to define EBITDA and add it specifically to the list in IFRS 18.118, rather than using the bulkier phrase ‘operating profit or loss before depreciation, amortisation and impairments’. However, the IASB decided not to label this subtotal as ‘EBITDA’ because doing so could imply that operating profit or loss corresponds to earnings before interest and tax, which isn’t always the case. For example, operating profit excludes income and expenses classified in the investing category and may therefore omit amounts that some investors regard as earnings.
Still, if an entity has no income or expenses in the investing category and all earnings before interest and tax are therefore included in operating profit, it may label the subtotal of operating profit before depreciation, amortisation and IAS 36 impairment losses as ‘EBITDA’. In those circumstances, EBITDA falls outside the scope of the MPM disclosure requirements under IFRS 18.118. In other circumstances, particularly when the measure excludes additional items, EBITDA may instead meet the definition of an MPM, assuming the other criteria in IFRS 18.117 are met (IFRS 18.BC362-BC366).
Subtotals of income and expenses
Only performance measures that are subtotals of income and expenses can meet the definition of an MPM under IFRS 18. For example, the following measures aren’t MPMs because they don’t combine income and expenses (IFRS 18.B116):
- Revenue measures: Adjusted revenue, organic revenue, recurring revenue.
- Subtotals of expenses: Adjusted operating expenses, R&D expenditure, general and administrative expenses.
- Measures relating to assets, liabilities, equity or combinations of these elements: Net debt, net working capital, assets under management, invested capital, capital employed, tangible book value.
- Financial ratios: Return on equity, return on capital employed, the debt-to-equity ratio, the EBITDA margin, the asset turnover ratio, the interest cover ratio. However, see Numerators and denominators of financial ratios.
- Liquidity measures: The current ratio, quick ratio, cash ratio, undrawn committed facilities.
- Cash flow measures: Organic cash flow, free cash flow, cash conversion, and adjusted cash flow from operating, investing or financing activities. As part of its Statement of Cash Flows and Related Matters project, the IASB has tentatively decided to propose extending the requirements for MPMs in IFRS 18 to certain cash flow measures not specified in IFRS.
- Non-financial performance measures: The net promoter score, number of active users, sustainability metrics, the rate of employee turnover.
Numerators and denominators of financial ratios
A subtotal used as the numerator or denominator of a financial ratio is an MPM if it would meet the definition of an MPM on a stand-alone basis. Accordingly, an entity applies the disclosure requirements for MPMs to that numerator or denominator.
For example, if an entity uses a “net debt / adjusted EBITDA” ratio in its public communications, the ratio itself isn’t an MPM because it isn’t a subtotal of income and expenses. However, adjusted EBITDA is treated as an MPM even if the entity doesn’t use it on a stand-alone basis (IFRS 18.B117).
Performance of an entity as a whole
If a performance measure doesn’t communicate an aspect of the financial performance of the entity as a whole, it isn’t an MPM under IFRS 18. For example, a measure relating only to a reportable segment doesn’t meet the definition if it doesn’t provide information about the financial performance of the entity as a whole.
However, if a reportable segment represents a single main business activity of the entity, this may indicate that the subtotal provides information about the entity’s overall financial performance (IFRS 18.B114-B115).
Public communications
A subtotal meets the definition of an MPM only if it is used in public communications outside the financial statements, regardless of whether it is also presented in the statement of profit or loss. Public communications include management commentary, press releases and investor presentations. However, for the purpose of identifying MPMs, they specifically exclude social media posts and oral communications, including transcripts of those communications (IFRS 18.118-119).
In developing IFRS 18, the IASB considered introducing specific requirements for private entities, which may be less likely to issue communications that are genuinely public. However, it concluded that the objective of the MPM requirements is to improve the transparency of, and impose discipline on, performance measures communicated outside the financial statements, regardless of whether an entity is public or private. Thus, if a private entity doesn’t communicate performance measures outside its financial statements, no additional disclosures are required. However, the MPM requirements apply to all entities applying IFRS and private entities must comply with them if they communicate subtotals that meet the definition of an MPM (IFRS 18.BC342).
Presumption about communicating management’s view
A rebuttable presumption
IFRS 18 establishes a rebuttable presumption that a subtotal of income and expenses used by an entity in public communications communicates management’s view of an aspect of the financial performance of the entity as a whole (IFRS 18.119-120).
This presumption can be rebutted only if the entity has reasonable and supportable information demonstrating that (IFRS 18.B124):
- the subtotal doesn’t communicate management’s view of an aspect of the financial performance of the entity as a whole; and
- the entity has another reason for using the subtotal in its public communications.
Communicating management’s view of overall performance
An entity may be able to demonstrate that a subtotal doesn’t communicate management’s view of an aspect of the financial performance of the entity as a whole if:
- the entity communicates the subtotal without prominence; and
- management doesn’t use the subtotal internally.
The assessment of prominence depends on the frequency with which the subtotal is referred to and the extent of the commentary or analysis based on it. For example, explanations of changes in the subtotal from period to period, or comparisons of the subtotal with measures used by competitors or with industry benchmarks, indicate that the subtotal is given prominence.
IFRS 18 explains that management’s internal use of a subtotal to assess or monitor an aspect of the entity’s financial performance indicates that the subtotal communicates management’s view of overall financial performance. Accordingly, if the subtotal is also used in public communications, it meets the definition of an MPM unless another part of that definition isn’t satisfied (IFRS 18.B125-B128).
Another reason for using the subtotal
In some circumstances, an entity may use a subtotal in public communications for a reason other than to communicate management’s view of financial performance. These include circumstances in which the subtotal (IFRS 18.B129):
- is required in public communications by law or regulation;
- relates only to non-IFRS GAAP;
- is used to satisfy a request from an external party; or
- communicates information other than information about financial performance.
No MPMs
It’s entirely possible for an entity to have no MPMs within the scope of the disclosure requirements of IFRS 18. This will be the case if an entity (IFRS 18.113):
- doesn’t publicly communicate its financial performance outside the financial statements;
- when it does so, uses only totals and subtotals required by IFRS or listed in IFRS 18.118; or
- uses only financial ratios or other metrics that aren’t subtotals of income and expenses, and those ratios don’t use as a numerator or denominator a subtotal that would meet the definition of an MPM on a stand-alone basis.
Period-specific identification
MPMs relate to the same reporting period as the financial statements. For example, a measure relating to interim financial statements, but not to annual financial statements, is identified as an MPM only in the interim financial statements. Conversely, a measure relating to annual financial statements, but not to interim financial statements, is identified as an MPM only in the annual financial statements.
When identifying MPMs for a reporting period, an entity considers only public communications relating to that period. An exception applies if, as part of its financial reporting process, the entity routinely issues such communications after the financial statements are authorised for issue. In that case, the entity considers public communications relating to the previous reporting period when identifying MPMs for the current reporting period.
However, a measure used in public communications relating to the previous reporting period doesn’t have to be identified as an MPM for the current reporting period if there is evidence that it won’t be included in public communications relating to the current period. If the measure was disclosed as an MPM in the previous reporting period but isn’t identified as an MPM in the current reporting period, this represents a change in, or the cessation of, an MPM. The entity must disclose that change or cessation in accordance with IFRS 18.124 (IFRS 18.B120-B122).
Continuous reassessment
A performance measure may become, or cease to be, an MPM over time. For example, an entity may initially report a subtotal solely because it is required by a regulator and therefore conclude that it isn’t an MPM. However, the entity may subsequently begin to use the measure internally to assess and monitor performance, or it may expand the commentary in its public communications beyond what is required by the regulator. In those circumstances, the measure may become an MPM within the scope of the disclosure requirements of IFRS 18 (IFRS 18.B131).