So Permanent TSB (“PTSB”) posted a loss after tax loss of (€266m) for 2016.
Of interest to me though is the other “headline” figure that received as much media attention: Profit before tax and exceptional items of €188m.
So what is exceptional or more specifically, what is an exceptional item? According to PTSB’s accounting policies: “Exceptional items are a material component of the group’s profit or loss which would not ordinarily occur while carrying out normal business activities. Consequently due to their materiality, they are presented separately in the income statement to provide ease of analysis for the user of these financial statements.”
PTSB prepares it’s consolidated financial statements under International Financial Reporting Standards (IFRS). One of the main standards, International Accounting Standard (IAS) 1 specifically prevents FS preparers from classifying items as “extraordinary”. However, the use of “exceptional items” does not fall victim to the same prohibition, something that would lead to a very interesting semantics debate I’m sure you will agree.
The exceptional items posted by PTSB can be summarised as:
- Loss on disposal of loan book assets: €399m
- Net restructuring cost for group risk function: €15m
It is quite subjective to determine whether a group can use the exceptional tag or not for a given item and it is certainly very difficult to critique a group’s approach when you don’t have all the background information. However, in PTSB’s case, one item that did not gain “exceptional” status is a gain of €24m from the sale of the group’s share in Visa Europe Ltd. Instead, this gain was included under the heading of “Net Other Operating Income” which feeds directly into the headline profit figure of €188m mentioned above. What makes this a normal business activity and the restructuring cost an exceptional item? Restructuring is not that uncommon for large organisations… Also, the company only holds equity securities relating to one entity – Visa… So is the purchase/sale of these investments an ordinary business activity? Food for thought…
In summary, stakeholders like investment analysts will take annual reports like PTSB’s and prepare their own financial models to represent, for example, their own assumptions of what is exceptional/not exceptional etc. It is doubtful that less technically proficient stakeholders engage in the same exercise but I think a minimum requirement for such stakeholders is to at least have an awareness of the subjective classifications that organisations may use in their financial statements.
We all know accounting profit figures can be “massaged” to some extent but I prefer nowadays to describe accounting profits as malleable.
The term malleable creates a direct analogy between accounting profits and the forging of metal i.e.”able to be hammered or pressed into shape without breaking or cracking.”
An accountant pursuing aggressive earnings management will bend the rules as far as possible without breaking but it appears that accounting regulators have been allowing a degree of flexibility that would make a yoga instructor proud.
As one example, a sample of 380 of the S&P 500 companies reported a 2015 6.6% growth in non-GAAP* profit and yet had an 11% decline in GAAP profit (Ciesielski, J., 2016).
* GAAP: Generally Accepted Accounting Principles (essentially the accounting rules for a given jurisdiction).
Fake-news and post-truth became popular media terms in 2016/2017. It seems that we are now able to apply these terms retrospectively to a lot of financial statements from the last few years. In Europe, ESMA have produced guidelines on the use of Alternative Performance Measures (APMs) in Financial Statements but it is still too early to tell how effective these guidelines will be (see other blog posts for further information).
For those interested, I have attached links to two related short articles from The Economist and The New York Times:
The New York Times
Following ESMA’s (European Security and Markets Authority) introduction of guidelines on the use of Alternative Performance Measures (APMs) in regulated information, the FRC has performed a desktop review on a sample of interim statements published by listed entities since the guidelines were introduced.
In the attached I have highlighted the key points to those with a primary interest in IFRS.
ESMA recently released guidelines covering the use of Alternative Performance Measures (APMs’) in regulated information e.g. IFRS Financial Statements for a listed entity. I have a attached the full guidelines here and have also highlighted what I consider to be the key points in the document (for those particularly interested in the IFRS financial report implications).
ESMA APM Guidelines
The attached report provides an overview of the activities of the European Securities and Markets Authority (ESMA) and the accounting enforcers in the European Economic Area (EEA) when examining compliance of financial information provided by issuers listed on regulated markets:
ESMA Report 2015
The report is long but the three main things to take out of it are:
- There appears to be on-going issues with entities determining whether the control/don’t control other entities i.e. whether they should consolidated these other entities or not.
- There appears to be on-going issues with the recognition of deferred tax assets arising from past company losses.
- APMs’ (Alternative Performance Measures) are continuing to grow in significance and prominence in annual reports and it is likely that we will see continued increase in the regulation around this area.