Disaggregation is key to understanding performance

Limited disaggregation of income and expense items with different characteristics impairs investors’ ability to assess and forecast performance. Recent proposals by the IASB for a new disaggregation principle and related disclosures of ‘unusual’ items will help. However, in our view, they do not go far enough.

The IASB also proposes to include management alternative performance measures (non-GAAP or non-IFRS) within audited financial statements. We welcome this. Additional subtotals can be helpful if they are clearly described and what is omitted is clearly identified. What would also help is to ban the use of labels such as ‘underlying’, ‘core’ and ‘recurring’.


The IASB has recently published proposals to change the presentation and certain disclosures for IFRS financial statements. The main changes impact the income statement and, if carried forward to a new standard, would significantly affect many of the performance measures you use in analysis and valuation.

In our previous article ‘Operating profit – Improved presentation coming soon’ we considered the proposed changes to subtotals in the income statement, particularly as regards operating profit, together with those related to the classification and presentation of associates and joint ventures. Our conclusion is that these proposals would enhance comparability and relevance of financial statements for investors.

In this article we consider proposals for the disaggregation of profit and loss items, including the separate presentation of ‘unusual items’, and the disclosures related to alternative performance measures (non-GAAP or non-IFRS).  

IASB General Presentation and Disclosure Exposure Draft – key proposals

The full text of the ED is available here and the IASB’s ‘snapshot’ summary here.

Disaggregation and unusual items

The disaggregation and separate presentation of different types of income and expense items is vitally important for investors to understand performance1We have previously discussed disaggregation in the context of alternative performance measures. See our article Don’t rely on APMS, disaggregate IFRS – GlaxoSmithKline.. Disaggregation can take the form of less aggregation, for example, the separate presentation of depreciation expense by type of fixed asset instead of for all fixed assets combined. Disaggregation can also take the form of splitting individual gains and losses to reflect the contribution made by different factors. For example, the expense arising from a change in an environmental provision measured on a present value basis may be analysed between the accretion expense, the effect of a change in discount rate and a change in the estimate of cash flows. Both forms of disaggregation are important for investors.

Disaggregation key for investors to understand persistency and to be able to forecast

Disaggregation helps investors in understanding the persistency of income and expense items. Non-recurring, infrequently recurring and recurring but volatile from period to period are characteristics of income and expense items that warrant separate presentation and supporting explanations. Many companies recognise this and provide such analysis, often in conjunction with alternative performance measures which exclude some or all of these items. We support this and have no objection to APMs as such as long as there are clear descriptions and supporting explanations.

However, too many companies label disaggregated items as non-recurring when the expenses are merely infrequently recurring or recurring but volatile. Use of terms such as recurring, core or underlying profit may not provide a fair description of the performance measure presented. It can result in investors ignoring potentially important income and expense items for which a forecast may be non-zero. We think that income and expense items and related subtotals should be described for what they are. A profit before restructuring costs and asset impairments should be described as exactly that and not for example as ‘underlying profit’. Ideally, we would like to see a ban on the use of vague, and generally uninformative, descriptors such as ‘other’, ‘special’, ‘core’, ‘recurring’ and ‘underlying’ in financial statements.

Brewer AB InBev is a good example of the use of ‘non-recurring’…

AB InBev income statement

Source: AB InBev 2019 financial statements

The separate identification of the six ‘non-recurring’ items by AB InBev is very useful. However, we do not think that non-recurring is the correct term to use. Restructuring costs are far from non-recurring for the vast majority of companies. Maybe a specific restructuring project will not recur in the same form but there will undoubtedly be others, particularly for a large multi-national group such as AB InBev. If non-recurring applies to restructuring, we think the same could be said for sales revenue given that income from some individual customers is also likely to be one off.

Not just persistency – other differences in characteristics could necessitate disaggregation

Differences in the degree of persistency of profit and loss income and expense items is not the only factor that should determine how disaggregation is applied; other characteristics can also be relevant. A profit derived from an underlying ‘flow’ is very different from a profit arising from a value change or a remeasurement. Analysing performance is very difficult if these are combined with no analysis given in the footnotes. Furthermore, expense items can have different underlying drivers. For example, employment and energy costs of an airline are affected by different price changes. Forecasting changes in operating margin would be very difficult if these expenses were not separated. This is the reason why expenses need to be analysed by ‘nature’ (see below).

Disaggregation is not only important where it means less aggregation of dissimilar items, but also when it applies to the analysis of a single item into components that have different characteristics, or different linkage to underlying drivers. For some specific financial statement items such disaggregation is already mandated. For example, in many standards, catch up adjustments related to prior periods or the interest accretion related to an item reported at a present value must be separately disclosed. However, there is no general requirement to provide this type of disaggregation. Share-based payments is a good example.

IFRS 2 only requires disclosure of the overall share-based payment expense analysed between equity-settled and cash-settled schemes. However, within these items are catch up adjustments related to prior periods and, for cash-settled schemes, adjustments in respect of share price changes2In our article Forecasting ‘sticky’ stock-based compensation we discuss the disaggregation of this expense and highlight the importance of understanding catch-up adjustments due to changes in estimates of the forfeit rate.. Each of these have very different characteristics, including different persistency, compared with the other components. Only through further disaggregation of the share-based payment expense would investors be in a position to assess performance and forecast the components required for equity valuation. Clearly, IFRS 2 could be amended to achieve this (which we would support), but we think that the same outcome could be achieved through better disaggregation requirements in the proposed general presentation and disclosure standard.

Software company SAP is an example of where this type of disaggregation would be helpful. SAP makes extensive use of stock appreciation rights or cash settled employee stock options. In 2019 the SBP expense was €1,835m and the IFRS reported operating profit €4,473m.

One of the key features of the accounting for cash-settled options is that the obligation to settle these is continuously updated to reflect, amongst other things, changes to the share price, upon which the pay-out depends. This creates a volatile profit and loss expense as illustrated below.

SAP share-based payment expense – 3-year volatility

Source: SAP 2019 financial statements

Due to the volatility of the expense, SAP excludes it from their non-IFRS adjusted operating profit. Their explanation is “The valuation of our cash-settled share-based payments could vary significantly from period to period due to the fluctuation of our share price and other parameters used in the valuation of these plans.” Although, they go on to acknowledge that the expense is recurring, and they are not suggesting that investors ignore it in assessing performance … “In the past, we have issued share-based payment awards to our employees every year and we intend to continue doing so in the future. Thus, our share-based payment expenses are recurring, although the amounts usually change from period to period”.

Analysing SBP just into equity and cash settled components is not enough

SAP disaggregates the overall stock option expense from other employment costs and further analyses it between cash settled and equity settled schemes (as required by IFRS 2), but it does not do any further disaggregation. In our view, what would really help investors is if the expense were disaggregated to also separate the effect of the change in share price, from the more persistent components that represent the amortisation of the option grants excluding the price change effect and the accretion due to the implicit discount unwind of the liability.

This is what we would like to see …

Illustrative additional disaggregation of a share-based payment expense

Note: We have not attempted to produce a disaggregation. It would probably be possible to estimate the accretion amount (although there is no disclosure of the implicit liability discount rate) and the remeasurement effect of the share price change, but we doubt it would be very accurate. It is impossible to even guess at how catch-up adjustments have affected the recognised expense in each period or to directly calculate the amortisation figure.

We think it would be much more informative if SAP were to only exclude the effects of share price and other assumption changes from their non-IFRS measures.

A disaggregation such as the one we illustrate is not without its challenges. It can be done in a number of different ways and there is an arbitrary element to it given the joint effects. However, this has not been a barrier to other disaggregations required by IFRS standards, such as that in respect of the pension expense. Companies are also happy to do their own difficult disaggregations when it suits them. SAP, like many companies, separately identifies the volatile effect of exchange rate changes on its performance measures in its ‘constant currency’ non-IFRS measures.

IASB proposals – disaggregation and unusual items

Many disaggregations related to specific profit and loss items are required by individual accounting standards. However, there also needs to be general requirements to cover other situations. In the draft proposals the IASB identifies that disaggregation should reflect the degree to which characteristics are shared between profit and loss items. A greater number of different characteristics means that disaggregation is more likely to be necessary. We do not object to such a principles-based approach considering the multiple factors that could result in the need to disaggregate. However, we question the likely effectiveness of their specific proposals.

This is part of our response to the IASB.

“We broadly agree with the principles for aggregation and disaggregation; however, we think that this needs to be more narrowly defined (the trigger for disaggregation should be more likely to be met) and should be reinforced by additional explanation and further examples.

Disaggregation of items that have different characteristics is vitally important for investors. Better disaggregation, clearer descriptions of disaggregated items and the end to the use of the term ‘other’ (unless supported by further analysis in the notes) may be the most beneficial changes for investors of a new IFRS based on this ED. However, we do not believe that the wording in paragraph 25(b) or the supporting explanations in B5-B11 will necessarily achieve this. We agree with the explanation in B11 that, if items have more dissimilar characteristics, then aggregation of these items is less likely to result in useful information. However, we think that only one dissimilar characteristic may be sufficient for disaggregation to be essential and that companies should be required to assess whether any one difference warrants disaggregation.

We suggest that the wording be changed so that items must be disaggregated if any one characteristic is dissimilar and, in the judgement of the entity, that dissimilarity is material to understand performance….”

Extract from The Footnotes Analyst comment letter on the Exposure Draft: General presentation and disclosure

IASB proposes the separate presentation of ’unusual’ items

The IASB has separate proposals for the presentation of unusual items, in addition to the general disaggregation principle. They define unusual items as those that are not expected to recur for “several future annual reporting periods”. This approach makes the definition very restrictive as it will not capture income and expenses that are unusual in other ways, such as a recurring item that is merely volatile from one period to the next or an item that arises due to a change in a prior period estimate. While we understand the desire to have restrictive definition of ‘unusual’ or ‘non-recurring’ from a governance perspective, we do not think the exclusion from the unusual category of items that are different in other ways is desirable. If an unusual item disclosure is to be required, we would like to see a broader definition. However, if as we suggest, the general disaggregation requirements were made more effective, we question the need for a separate ‘unusual items’ category in the first place.

“We do not agree with the proposals regarding unusual items.

In our view these proposals are unnecessary (or at least would be unnecessary if the general disaggregation requirements were sufficiently comprehensive). We suggest that the proposals be dropped, and additional work done on disaggregation to ensure that all items with different characteristics, including those that may be regarded as ‘unusual’ or ‘non-recurring’, are reported separately, either on the face of the income statement or in the notes.”

Extract from The Footnotes Analyst comment letter on the Exposure Draft: General presentation and disclosure

A further aspect of income statement expense disaggregation is whether this is done based upon an analysis by ‘function’ or ‘nature’. Analysis by function is where expenses are categorised based on the activity involved, such as cost of sales, distribution costs, or restructuring expenses. Each of these items would include expenses of a different nature such as employments costs, depreciation or energy costs.

Companies can choose how to present expenses on the face of the profit and loss statement. The new proposal is to require an additional by-nature disaggregation in the notes if by-function is used for the primary statement.3The free choice regarding presentation on the face of the statement is currently supplemented by certain by-nature disclosures in the notes. However, investors do not presently receive a full by-nature disaggregation.  We support this and believe this form of disaggregation is essential for investors given the different drivers affecting these components of operating expenses.

The IASB also proposes to restrict the combination of a mixed by-nature and by-function analysis on the face of the income statement. This approach is currently used by AB InBev. In the income statement above, the company mainly uses a by-function disaggregation but some of the specific expense items, which are separately analysed and excluded from their ‘recurring’ profit, are inconsistent with this approach, such as the disposal losses.

We like the approach by AB InBev and do not think it should be banned.

“We do not agree with the proposed prohibition of the combination of a by-function and by-nature analysis in profit and loss. Although removing certain items from a by-function analysis and reporting them separately would make those functional expense items incomplete, we do not think this is a problem for investors. A by-function analysis is not comparable across companies anyway, so any additional lack of comparability because of the removal of certain by nature items for separate analysis would make little difference. What is more important is that, for any one entity, the analysis provide is consistent over time and that items are described correctly for what they are.

We think that a combination of a by-function and by nature analysis can provide greater clarity for investors and link the primary statements more closely with management performance measures. For example, a by-function expenses analysis might exclude the by-nature asset impairment expense. Presenting this separately on the face of the income statement (and the function expenses clearly labelled as ‘excluding asset impairments’), with the addition of a pre-impairment management performance measure sub-total, may give greater clarity than allocating the impairment expense by function and only disclosing it and the MPM in the notes.”

Extract from The Footnotes Analyst comment letter on the Exposure Draft: General presentation and disclosure

Alternative (management) performance measures

Alternative performance (non-GAAP and non-IFRS) measures have become increasingly controversial. This is partly due to their more widespread use (it is now rare to find a company that does not use them) but also due to the seemingly increasing list of items that are excluded and the greater difference between the IFRS (GAAP) profit measure and the APM (almost always the APM is higher). In the case of SAP, over the last 5 years the aggregate adjusted operating profit is 44% higher than when measured under IFRS.

SAP adjusted (non-IFRS) operating profit

Source: SAP financial statements

(1) The adjusted operating (or non-IFRS) profit presented by SAP in their annual report is the measure that management “primarily uses … as a basis for making financial, strategic and other operating decisions”. Expense items are primarily excluded because they are regarded as outside management control or because they are volatile. For a detailed explanation of the reasons for each of the adjustments and the company’s assessment of the usefulness and limitations of their non-IFRS measure, see page 8 of their 2019 annual report.

We do not object to APMs, even where expenses are selectively excluded. If the measure is used by management for running the business, then it is automatically of interest to investors. APMs can also help in forecasting where they exclude items with less (or just different) predictive values and the process of producing APMs, and reconciling them with IFRS or GAAP measures, will often provide disaggregation that would not otherwise be available. 

Remember that APMs themselves will not be comparable across companies, they remain very much a management view. Often (as is the case for SAP above) the measures are designed for use by internal management, which does not necessarily mean that they are also suitable for use by investors as a basis for valuation.

IASB proposals – management performance measures

The IASB proposes to bring APMs (or Management Performance Measures as they call them) into IFRS audited financial statements. MPMs may be presented on the face of the income statement if they form a natural sub-total or will otherwise be presented in the footnotes. Accompanying this are various requirements concerning consistency over time, disclosures of supporting explanations and a reconciliation of the MPM to reported IFRS measures.

Many securities regulators already impose requirements related to alternative performance measures that are similar to those in the IASB’s ED. These are not universal and including them in IFRS and making MPMs subject to audit should produce greater global consistency.

We support all of the proposals.

Differing tax consequences of income and expense items is itself a reason to disaggregate

Where an item of income or expense is excluded from an MPM, the IASB proposes to require disclosure of the related tax and non-controlling interest effect so that investors can identify the net profit impact of the adjustments made to operating profit. While we support this, we think the IASB should go further. The tax effect of profit and loss items can be varied. For example, it is not uncommon to see the tax related to business disposals being significantly below the effective tax rate for profit as a whole.

We think explanations and data about how the effective tax rate differs for specific income statement items is important, irrespective of whether that item happens to be included in the calculation of an MPM or not.

“In our view, disaggregation of taxation (or at least disclosures about different tax effects) is necessary for any item where the tax effect is significantly different from other transactions. For example, the tax payable related to a business disposal gain or loss can be very different from the effective tax rate applicable to the business as whole. We think that this information needs to be provided to investors (ideally as an analysis of the tax charge itself in order to identify the amount of tax related to that disposal) irrespective of whether the business disposal gain or loss is excluded from an MPM subtotal.

Furthermore, we think that differences in effective tax rates applicable to different items in profit and loss is a reason why those items should be disaggregated. If the difference in tax is significant, and relevant for investors to understand performance and to their forecasting of future cash flows, then this, by itself, should be sufficient to result in the disaggregation of these items. For example, if some impairment charges are tax deductible but others are not, then understanding this is important to understanding performance and the effective tax burden. As presently drafted, we do not believe that the requirements would produce sufficient disaggregation in this situation.”

Extract from The Footnotes Analyst comment letter on the Exposure Draft: General presentation and disclosure

Insights for investors

  • The publication of the IASB exposure draft proposing changes to the presentation of financial statements is an opportunity for you to give an analyst or investor perspective on how you believe financial statements should be presented, and to influence financial reporting. We encourage you to submit your views.
  • Expense items that companies describe as non-recurring may well not be. Don’t ignore ‘infrequently recurring’ or ‘recurring but volatile’ expenses, even if they are excluded from management’s alternative performance measures.
  • Try to disaggregate as much as possible. Different items in the income statement can have very different characteristics and different implications for forecasting.
  • An expense may be volatile and have limited predictive value, but a component of that expense, such as interest accretion, may be more persistent and a suitable basis for forecasts.

Your opportunity to influence financial reporting

The IASB is currently seeking feedback on their presentation and disclosure proposals – the deadline for comments is 30th September 2020. We know from first-hand experience that obtaining investor and analyst input in the standard setting process is challenging. However, your views are vital. After all, the primary purpose of financial statements is to provide you, the capital market participants, with the information that you require.

If you wish to endorse our views, feel free to do so. You will find our comment letter here. Alternatively, use the text in this ‘word’ version of our letter and copy, paste and amend as you wish in order to create your own answers to the specific questions asked by the IASB. Your comments do not need to cover all aspects of the proposals; input on just some specific issues would be welcomed.

To send your views go to this IASB web page or email [email protected]


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