FINANCIAL REPORTING AND IR

Issuers aim to present a clear picture of their financial performance to their stakeholders through quarterly and annual reporting. What a company discloses in its financial statements is governed by generally accepted accounting principles (“GAAP”); for most public companies in Canada, that is under International Financial Reporting Standards (“IFRS”).

Although GAAP provides a consistent basis to record, measure, present and disclose financial transactions, it is based on historic performance and cannot present a complete picture of business prospects on its own. Accordingly, GAAP defined data is increasingly only one component of the information that companies communicate about their financial performance. In addition to GAAP information, companies present non-GAAP measures in accompanying documents to the financial statements. Among these are earnings releases and management’s discussion and analysis (“MD&A”).

With limited authoritative guidance available on the disclosure of non-GAAP measures, concerns over their use have arisen over the years. These concerns include insufficient explanation as to the nature of the non-GAAP measures, including their intended usefulness and calculation, as well as concerns relative to their inconsistent use over time and across entities. In some cases, users of a company’s suite of financial information have struggled to understand, interpret and compare its financial performance.

The Canada Securities Administrators (“CSA”) in 2003 sought to address issues regarding the use of non-GAAP measures with Staff Notice 52-306 Non-GAAP Financial Measures^[1] (“SN 52-306”), which was intended to help companies ensure that their use of non-GAAP measures was not misleading. However, disclosure practices continue to be inconsistent. The CSA has therefore recently proposed National Instrument 52-112 Non-GAAP and Other Financial Measures Disclosure (“NI 52-112”) to replace SN 52-306. While Staff Notices are non-authoritative and provide a ‘suggestion’ of best practices, the new proposed instrument will “provide authoritative Canadian securities legislative requirements for all issuers when they disclose non-GAAP financial measures and other financial measures.”^[2] The proposed instrument will, as a result, also provide CSA Staff with “a stronger tool to take appropriate regulatory action as needed.”^[3]

Proposed Rules

A non-GAAP financial measure is defined as a financial measure that is not included in the financial statements, and is not a disaggregation of a line item presented in the primary financial statements. Non-GAAP financial measures also include ratios and financial outlooks. The proposed instrument sets out a comprehensive list of requirements when an issuer discloses non-GAAP financial measures, including:

• Do not present a non-GAAP financial measure with more prominence than the most comparable financial measure included in the financial statements. For example, do not omit the most directly comparable financial measure in a press release headline or caption that includes the non-GAAP measure or present the non-GAAP measure in bolded or large font, while the most directly comparable measure is not.
• Present the same non-GAAP financial measure for the comparative period.
• Include the following the first time a non-GAAP financial measure appears in the document:
  • Explanation of its purpose and usefulness. What is to be included in the explanation is a matter of judgment; however, the proposed instrument has noted that the explanation should not be boilerplate and should be clear, understandable and specific to the way the measure is assessed and used by management.
  • Quantitative reconciliation of the non-GAAP financial measure to its most comparable financial measure in the financial statements. The reconciliation should be presented in an understandable way, such as in a table. If the reconciling item cannot be found in the face of the financial statements, then the issuer is to provide further explanation on how the reconciling item is calculated and discussion of significant judgments and estimates. Further explanation on the nature is also required if an ‘other’ or ‘adjusting items’ category is used to account for various insignificant reconciling items.
  • If the label or calculation of the non-GAAP measure has changed, then provide an explanation including the reason for the change. The inclusion or exclusion of reconciling items, which were previously included/excluded in prior periods, between the non-GAAP financial measure and the most directly comparable measure is considered a change and would require further explanation.

These requirements are generally consistent with the guidance in SN 52-306.

The proposed instrument introduces new disclosure requirements for segment measures, supplementary financial measures and capital management measures should an issuer choose to provide them in a document. The requirements of the aforementioned are similar to those of non-GAAP financial measures. For instance, segment measures require a quantitative reconciliation between the total segment measures and the most directly comparable financial measure, while capital management and supplementary financial measures require a description of how the measures are calculated.

Under the proposed instrument, management is expected to exercise judgment and consider how the non-GAAP measure is used when determining what the “most directly comparable financial measure” is. For example, if the non-GAAP measure is used in a discussion of the company’s cash generation abilities, then the most directly comparable financial measure will likely be from the statement of cash flows. Other factors for management to consider are the nature and amount, including materiality, of reconciling items between the non-GAAP and GAAP financial measure. 

Proposed Instrument Application

The proposed instrument will be applicable to all issuers, other than SEC foreign issuers (as defined in NI 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers), and is to be applied to non-GAAP disclosures presented outside the financial statements. Generally, when considering applicability we think of written communication, such as press releases and MD&A. However, proposed NI 52-112 extends to other diverse forms of written communication, such as social media. The proposed instrument states that issuers should not disclose non-GAAP financial measures on social media with character limits, as this would prevent the issuer from meeting the requirements of the proposed instrument. This would suggest that issuers are to meet the requirements of the proposed instrument in their social media communication as well. The proposed instrument does not apply to verbal statements; however, if a written transcript of the verbal statement is provided, then the proposed instrument would be applicable to the written transcript.

Specific financial measures that are required under other applicable securities legislation are not applicable to this proposed instrument. For example, Net Asset Value as required under NI 81-106 Investment Fund Continuous Disclosure would not require the additional disclosures as listed in this proposed instrument.

The new rules are not yet applicable, and the comment period for the proposed instrument was open until December 5, 2018. In the meantime, IR professionals should consider the impact of the proposals on their company’s disclosures, as they signify an increasing expectation of transparency and consistency in non-GAAP measures accompanying financial information. With the proposed National Instrument, CSA staff will also have greater enforcing powers, including taking regulatory action if required.

Charmaine Mak, CPA, CA is a Senior Manager, and Rob Brouwer, FCPA, CPA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.